Popular Inc (BPOP) 2002 Q3 法說會逐字稿

Good afternoon and welcome to the E-Loan third quarter 2002 earnings conference call. All participants will be able to listen only until the question and answer portion of the call. This conference is being recorded.

I would like to introduce your first speaker for today’s call, Mr. Chris Larsen, Chairman and CEO. Sir, you may begin.

Thank you for joining us for E-Loan’s third quarter 2002 earnings call. With me today are Joe Kennedy, our President and Chief Operating Officer; and Matt Roberts, our Chief Financial Officer.

Let me begin by giving you a quick overview followed by Matt, who will review our financial results in detail followed by Joe, who will provide an operational overview.

Q3 was a great quarter for E-Loan. In the third quarter, we achieved a record gap profit of $3.1 million or 5 cents per share on record revenues of $28.4 million. On a before-tax basis, our profit was $3.6 million or 6 cents per share as compared to a [indiscernible] estimate of 3 cents per share. Our overall revenue exceeded guidance by over $5 million or 23 percent and represented revenue growth of 69 percent from the same period last year. The quarter was E-Loan’s fourth consecutive gap profitable quarter.

And as we talked about in the last call, the interest rate environment has been outstanding for mortgage refinance business. Indeed, we saw a 58 percent increase in our refinance revenue in Q3. Most importantly, we also continue to make good progress in our drive to diversify our revenue base. Diversified product revenue defined as purchased and non-prime mortgages, home equity loans and auto loans, grew to $11.8 million in the quarter or 12 percent sequentially from Q2 to Q3, despite an environment that favors refinancing of first loans over new home equity lines and the continuation of 0 percent manufacturing incentives.

As a result, I’m pleased to report that we are raising our financial guidance for Q4 from a gap profit of $1.5 million to another record profit of $3.2 million on record revenues of $30 million. Further, we are raising our full-year 2002 profit guidance from $6 million to $8.9 million, an increase in 2002 revenue from $88 million to $100 million. I’m also pleased to report that total diversified product revenue will be approximately $44 million for the year.

In addition, we’re also giving 2003 guidance for the first time for record gap profits of $11.2 million on record revenues of $110 million. Matt will give detail guidance and assumptions in a moment.

We’re also pleased to share for the first time our growth target through the year 2005. Our goal is to grow our diversified product revenue 50 percent per year and grow our refinance market share 50 percent per year. Based on these objectives, in 2005, $150 million will be generated from diversified product revenue alone, not including the addition of refinance revenue.

The key accomplishments in hitting this number will be continued technological innovation and strong brand equity. E-Loan is already ranked the number one on-line lending site in America based on Neilson ratings. We will continue to lead by building a differentiated experience that emphasizes trust and unbiased advice as much as low cost and personalized service.

To that end, we are pleased to introduce a new product we call the Loan Wizard, which further helps customers in choosing the right loan for their debt management needs. This product is now available on our newly refined home page, which was launched yesterday, to further emphasize our unique positioning as a trusted lender, themes we have also continued to feature in our expanded T.V. ad campaign. Joe will discuss this new technology in a moment.

In short, we’re not just excited about the results this quarter, but continue to be pleased with our progress that we are making in becoming a diversified and trusted consumer lender. With that, let me now turn the call over to Matt, who will discuss our Q3 financials in detail guidance.

Thanks, Chris. Before I begin the financial review, I’d like to remind you that during this call we may make forward-looking statements based on our current expectations that involve risks and uncertainties even though the actual results may differ from the results described in the forward-looking statements. Factors that could cause actual results to differ include, but are not limited to: general conditions in the lending industry, interest rate fluctuations, and the impact of competitive products. These, and other risk factors, are detailed in E-Loan’s filings with the Securities and Exchange Commission.

Now, I’d like to review a summary of our financial results for Q3 2002. Our earnings press release includes a detailed presentation for your review.

During the third, we closed $1.4 billion and sold $1.2 billion in loans. The mix of our sold loans, among our three primary products, were 76 percent mortgage, 14 percent auto, and ten percent home equity. Refinance mortgages accounted for 62 percent of total close loan volume, up from 54 percent in the prior quarter.

[indiscernible] record 28.4 million, an increase of 69 percent compared to the 16.9 million in the same period last year and up 36 percent compared to the 21 million reported in the prior quarter. Of the total revenue, 75 percent was mortgage including interest income, 11 percent was auto, and 13 percent was home equity including interest income. Prime refinance mortgage revenue accounted for 59 percent of total revenue, up from 51 percent in the prior quarter.

Pre-tax income was 3.6 million or 6 cents per share and after-tax net income was 3.1 million or 5 cents per share on 59.6 million diluted shares. This compares to a net loss of 9 million or 17 cents per share on 53.8 million diluted shares for the same period last year.

As part of the final phase budget process in September, California suspended the use of net operating loss [indiscernible] in 2002 and 2003. This change increased our tax expense by approximately 400,000 in Q3 compared to our anticipated taxes for the quarter.

Direct margin, which is defined as revenue minus variable and fixed operations expense, totaled 13.2 million, an increase of 97 percent compared to the 6.7 million in the same period last year, and an increase of 36 percent compared to the 9.7 million in the prior quarter.

As for our balance sheet, total assets at the end of the quarter were 328.4 million, which included cash and cash equivalents of 32.7 million, of which 2.5 million is restricted and loans held for sale of 269.4 million. Loans held for sale grew substantially in the quarter as we [indiscernible] 182 million more loans than we sold. As we recognize revenue and sold loans, the current billed on our loans held for sale will benefit revenue in future periods.

Total liabilities at the end of the quarter were 277.7 million and included 264.8 million in borrowings related to mortgage, home equity, and auto loans held for sale. And total stockholder’s equity at the end of the quarter grew to $50.7 million.

In June, E-Loan created a qualified special [indiscernible] E-Loan Auto Fund One, which purchases prime auto loans from E-Loan E and holds the loans. The QSPE secured a 540 million credit facility with Merrill Lynch to support prime auto loan production. The new structure mirrors common at-the-back financing structures for auto receivables and enables us to have greater control over the pricing, underwriting, and operational processes associated with our prime auto loan business.

As this was our first quarter of sales to the new prime auto facility, I’d like to briefly review some statistics on those loans. We sold 71.9 million in loans to the QSPE during the quarter with 1.4 million in related gain on sale. In exchange for the loans sold, we received cash and a beneficial interest in the auto loans sold to the QSPE. The primary variables used to calculate the fair value of the beneficial interest that we receive were 12 percent discount rate, 72 basis points life of loan loss rate, and 1.5 ABS pre-payment [indiscernible].

The average loan characteristics were $18,900 loan size, 729 credit score, 28 percent new car and an average APR of 6.16 percent. We continue to sell all our sub-prime auto originations to various sub-prime auto loan purchasers according to their underwriting guidelines. We do not retain any interest in sub-prime auto loans.

Given the recent volatility in the sub-prime auto market, we expect to adjust our mix of sub-prime auto loan purchasers in the near term to provide sufficient liquidity for our sub-prime auto origination.

Now, I’d like to update you on our financial guidance for the remainder of this year and provide our initial guidance for 2003. I will also outline our targeted growth rates over the next three years. Our earnings press release again, includes a detailed presentation for your review.

As Chris mentioned earlier in the call, we are doubling our prior Q4 income guidance. We anticipate continued strong demand for refinanced mortgages in Q4. We also anticipate another solid quarter of growth in our diversified revenue sources: purchase mortgage, home equity, and auto loans. As a result, we are pleased to confirm similar amounts to our prior Q4 guidance for these products, representing an 18 percent sequential improvement over the prior quarter.

Given the above assumptions, we now expect total 2002 revenue to grow to approximately 100 million, representing 47 percent improvement over 2001, and our prior guidance was for 88 million in 2002 total revenue.

We expect 2002 gap net income of approximately 8.9 million or 14 cents earnings per share on approximately 62 million diluted shares in 2002 as compared to a gap net loss of 39.5 million or 73 cents loss per share on 53.8 million diluted shares in 2001. Prior guidance was for approximately 6 million in net income or 10 cents earnings per share.

The following assumptions support our 2003 financial guidance. According to the most recent Mortgage Banker’s Association forecast, refinance volumes are expected decline approximately 50 percent from 2002’s record high level. We expect to grow our refinance market share by approximately 50 percent, resulting in a net 42 percent decline in our prime refinance loan volumes in 2003. Additionally, our revenue per mortgage loan is expected to trend down throughout 2003, returning to our historical levels.

Home equity loan volume is expected to continue to grow as consumers opt for that loan type versus out-cash refinance to meet their needs. Our auto loan assumption [indiscernible] continues manufacture incentive financing with growth primarily driven by improved marketing programs. While we anticipate needing to modify our mix of sub-prime auto loan investors, we are assuming continued strong liquidity in the sub-prime lending market.

Given the above assumptions, we expect total 2003 revenue to grow to approximately 110 million, representing a 10 percent improvement over 2002, but importantly, on a substantially different revenue mix. High mortgage refinance revenue is expected to account for 33 percent of our total revenue in 2003, down from 56 percent in 2002. Our diversified product revenue is expected to total approximately $74 million in 2003. And by comparison, this amount is greater than our total revenue in 2001 of 68 million. We expect 2003 gap net income of approximately 11.2 million or 17 cents earnings per share on approximately 65 million diluted shares in 2003. This represents a 25 percent improvement over 2002 net income.

Over the next three years, our goal is to grow our diversified product revenues by 50 percent per year, while increasing our share at a prime refinance market by 50 percent per year.

While the Mortgage Banker’s Association has not provided any market forecast beyond 2003, we will continue to measure our refinance market share progress against their forecast over time. A compounded 50 percent annual growth rate on a diversified product revenues would produce 150 million in revenue on just these diversified products by 2005.

Now, I’d like to turn the call over to Joe for his operational review.

Thanks, Matt. I’d like to focus my remarks on two major topics. First, the loan wizard technology that Chris talked about. And second, our shift to a more aggressive posture from a marketing standpoint.

We have a two-part mission at E-Loan. The first is to provide consumers with a fast, efficient way to obtain loans at a great rate without the hassle and negotiation traditionally associated with getting a loan. The second is to provide consumers with unbiased education and advice about how to best use that to achieve their objectives.

Over the past several years, we’ve made tremendous progress on the first part of the mission. And now offer consumers highly stream-lined ways to obtain mortgage, home equity, and auto loans.

Our initial steps toward the second objective was focused on helping people understand their credit. Almost three years ago, we were the first company to provide consumers access to their credit scores. Since then, we have provided credit scores to over half a million consumers, helping each one understand their creditworthiness and the specific factors that are affecting it positively or negatively.

Earlier this year, we launched our credit monitoring service, which enables consumers to track their credit score on a monthly basis, enabling them to monitor its improvement as they better manage their credit.

With the Loan Wizard, we are taking a major step forward beyond just helping people understand and track their credit. It is, to the best of our knowledge, the most sophisticated debt advice tool ever developed. So what does it do? Every day, hundreds of consumer asks us the same basic questions. For example, consumers ask, “I need to cash for a major home improvement project. Should I get a home equity loan or refinance my first mortgage and take cash out?” Other consumers ask, “I’m buying a new home. What mortgage product is best for me?” Still others ask, “I’m buying a car and don’t know whether I should get a car loan or use the equity in my home?”

E-Loan’s Loan Wizard is the first tool to ever provide unbiased accurate advice that is specific to each customer’s unique situation. For example, if the customer owns a home and wants to take cash [technical difficulty] how much cash the customer’s seeking. [technical difficulty] the mortgage debt outstanding, the interest rate and number of months left on the existing debt and the customer’s tax rate.

Equally important, the tool asks the customer what they are interested in achieving. Minimizing their payments or saving the most in total interest costs. In return, the Loan Wizard will identify the loan solution that has the lowest after-tax cost over the time period the customer is considering.

Unlike any other debt advice tool, the model works off the actual real-time interest rates and underwriting criteria contained in E-Loan’s underwriting engines. Consumers can even provide their credit scores and input, or alternatively, E-Loan will pull their credit score for free, making the recommendations truly personal and current.

The course of action recommended by the model takes into account all relevant parameters: loan-to-value ratio, credit, currently available interest rate, even actual closing costs. And the recommendations are not generic, rather the output of the model are the specific products in rank order that are best suited to the customer. The actual rates and payments for those loans are shown and the customer can click to apply for the exact loan recommended.

Why does all this detail matter? Because serving one customer at a time fulfills the promise of the Internet, and because making a correct debt recommendation requires this level of sophistication. While a home equity loan might be the right answer for someone with excellent credit, lots of equity in their home who’s looking for a relatively small amount of money; a cash-out refinance may be the right answer for someone with all the same characteristics except [indiscernible] rather than excellent credit.

What makes this tool so unique? The Loan Wizard enables E-Loan to provide advice that cuts across all the major categories of consumer debt. Unlike banks, brokers, or car dealers, that offer only one type of debt product -- or at best, offer all types, but in separate product silos -- E-Loan is product [indiscernible] and is focused solely on helping to direct consumers to the best solution for their need.

Beyond integrating the Loan Wizard into our website, all of our loan consultants are being trained in its use so that they can help customers optimize their loan selection after applying. Why does this matter to the E-Loan brand? Because we are addressing a basic, widespread customer need. And by doing so, enhance our reputation as the company where consumers can save money. Not just because we offer great rates, but also because we help people find the lowest cost solution that addresses their specific need. This is truly a better way to get a loan.

We consider this technology to be a breakthrough for the industry and are exploring patent protection for our solution.

As I indicated in our last call, the most important driver of increased profitability as we move forward is growth in our transaction volume, which is driven primarily by our marketing efforts. To give a bit of perspective, for most of the last couple of years, we’ve really focused on a disciplined approach to building the business. We saw lots of companies a few years back that tried to grow very fast and wasted a lot of money before they really knew what they were doing. We, on the other hand, have been primarily focused on honing our operational capability, while testing a wide variety of marketing approaches.

We are now changing to a more aggressive growth posture. We have a lot of confidence in our operational capability. Our margins are good in all three businesses, and we like the level of customer enthusiasm received for our products and processes. We are, therefore, beginning to raise the level of our marketing spend.

Both the model direct mail and the direct response T.V. that we began using last quarter has performed well for us, increasing our confidence that we can drive our business growth with [indiscernible].

While we continue to press forward on a number of marketing fronts, the most powerful growth lever is probably our return to television. We’ve worked hard to both generate immediate business from T.V., as well as, build brand awareness. This makes us a direct marketer, rather than a traditional advertiser.

Since our return to television in early July, we have seen results that we like and have recently increased our spending level by roughly 150 percent, reflecting our more aggressive growth posture. We are also increasing the spend behind direct mail, which uses a predictive response model that we have developed which is propriety to E-Loan. We are particularly pleased at the amount of diversified product business that both the T.V. and the direct mail are generating.

As our marketing capabilities and efficiency have grown, our partnership with Schwab has become a smaller and smaller piece of our business. In Q3, Schwab accounted for 6 percent of our total revenue heavily weighted towards mortgage refinance. At the same time, Schwab is in the process of obtaining a phone bank charter. It has indicated that upon completion of that process, it would like to originate loans in its own name. Even if they were to choose to use an outside processing shop to perform some of the functions, we would consider such a role to be inconsistent with our strategic focus, which is really all about E-Loan brand and consumer direct lending.

Reflecting all of these considerations, we and Schwab have decided to end our marketing agreement next month. With the dissolution of this marketing agreement, Schwab will no longer be represented on our board of directors. We have deeply appreciated the time and energy Dan [Leaman], Schwab’s EVT and Chief Strategy Officer, have contributed over the past two and a half years. Going forward, we believe that our revenue and bottom line progress will be unaffected by this change.

As we have started the fourth quarter, we have strong demand across the board for all of our products as our heightened marketing aggressiveness is already having an impact. While we are conscious that the loan industry historically sees a bit of a lull in the season from the Thanksgiving to Christmas, we are nonetheless, optimistic about our ability to make continued progress this quarter.

Now, I’d like to turn the call back to Chris to moderate our Q and A.

Great. Thanks, Joe. And now let’s open the call up to any of your questions, please.

Thank you, sir. At this time, we are ready to begin the formal question and answer session. If you would like to ask a question, please press star 1. You’ll be announced prior to asking your question. To withdraw your question, please press star 2. Once again, to ask a question, please press star 1. One moment please.

Our first question comes from Rich Repetto of Putnam, Lovell. Sir, you may ask your question.

Hey, guys, it’s Todd [indiscernible] actually on the phone.

Hey, Todd. How are you?

Good. First question is just on -- wondering if you can give us any insight to the pipeline, currently where it’s at to the fourth quarter and kind of how far in the foreseeable future you guys can predict that right now given the fact that, you know, we’re seeing the marketplace closure rates at an all-time high in the third quarter.

Todd, this is Joe. I would probably echo what most lenders are saying at this point. We entered the quarter with the strongest pipeline ever and continue to feel very good about the outlook going forward -- not just in the mortgage refinance arena, but across the board with our products.

Also, getting on the closure rates, I know that there’s a lag. But I was just wondering if you guys could give us any color to, you know, where you saw your closure rates -- your conversion rates, excuse me -- going in the third quarter. I’m looking here at the second quarter. In the second quarter, it looks like purchase is down a little bit, but still well above what we’re seeing out there in the industry. I was just wondering if you have any color into the third quarter level.

We would expect to continue to have industry-leading close rates. It’s a little early, I guess, we’d be surprised if we didn’t see some progress on the close rates in the auto business, and given some of the demands from a capacity standpoint, a little bit of deterioration on the mortgage side. But still, fundamentally very strong levels and not dramatically different from what we’ve been posting. We’re still ahead of everything else that we’ve seen out there.

And then, going on the auto actually. What are you guys seeing currently in the marketplace? I know the third quarter, there’s a significance presence like you guys reiterated on the zeros from the manufacturers. But what are you seeing currently and as that plays out, how do you kind of see that acting for the remainder of the year and into the next year?

Again, we’re not sitting here kind of forecasting or hoping for any change in the manufacturer incentive levels. We’re presuming that those will continue. At some point they’ll stop, but it’s not presumed in any of our forecasting or planning. Despite that, we continue to make forward progress and are off to a good start this quarter and believe that we can continue the good progress there.

The only situation that we’re watching a bit is what’s going on in the sub-prime world. If you follow that, various sub-prime auto lenders are hitting the wall and as Matt eluded to, we’re using our multi-investor model to kind of work through that and expect that we’ll continue to be able to do so. But, if there’s some substantial change in sub-prime liquidity on the auto side, that could affect us. But at this point, we’re working our way through it.

And then finally, Matt, on the taxes going forward. What are the implications of this? Like, what kind of tax rate do you guys think that we should be using as a model going forward?

Right. Based on the changes in California that I articulated in suspending the [indiscernible] for the next couple years, our effective tax rate will be approximately 9.5 percent, which is really 2 percent for California -- I’m sorry, 2 percent for federal and 7.5 percent for California.

Great. Congratulations on a good quarter.

Thanks, Todd.

Thanks, Todd. Appreciate it.

I have Ted Janus of Palo Alto Investors. You may ask your question.

Certainly. Ted Janus. Hello, gentlemen.

Hey, Ted. How are you?

I’m doing great. First off, you talk about your marketing expenses per quarter and you want to break those down for me. How much is television?

Yeah, in terms of the television, Ted, during the test period last quarter, we spent a little bit less than $1 million on the T.V. And we’ve now moved that to a rate that’s somewhat above $2 million.

Per -- did I hear that right? Per quarter?

Per quarter.

Okay.

One of the great things about television, too, is that it’s a very scalable medium. So even at the slightly above $2 million spend, we still have enormous room to further crank up that lever over time.

Are there any metrics you could cite -- a success a T.V. program beyond the obvious of just how well sales have done in the past quarter?

We track the success of the T.V. extremely closely on a daily basis, we’re able to track the applications that come from the T.V. And we’re not just happy because it’s driving a lot of business, but because it’s driving a lot of business that’s consistent with our target economics and our business model.

Okay. So when this goes up to $2 million on T.V., what will the other breakdown be for marketing?

Well, we’ve outlined a total of $7.5 million in the guidance. And we’ll continue to use direct mail, on-line partnerships and on-line advertising, and then kind of the overhead cost personnel and other kind of non-working marketing [indiscernible] is about $1 million.

Okay. On an unrelated area here, the 50 percent growth rate you had for non-mortgage business. That’s what you projected out for three years; is that right? Non-mortgage, were you going at 50 percent for the next three years?

Non-refinance mortgage, right.

I’m sorry.

Non-refinance mortgage.

Oh, non-refinance mortgage.

Exactly. What we’re trying to do, Ted, is isolate prime mortgage refinance from the other revenue sources that we offer -- or that we generate -- to give everybody a good sense to how those two will move. So, that’s called our diversified revenue sources and it has purchase mortgage and auto and home equity.

Is there anything else in there -- are there others that you would lump in there?

The other -- the other category would be in there as well. As you know, it’s a small amount, like 1 percent or so.

What about the interest on the loans that you carry for that short period of time?

Yes. The interest that’s related to purchase mortgages, for example, will be included in the diversified products revenue. The interest that would be related to prime refinance mortgages would not be.

Got you. Okay. Congratulations on an excellent quarter. That’s it for us.

Thanks, Ted. Appreciate it.

Thanks, Ted.

Tom Berg of JMP Securities. You may ask you question.

Hey, congratulations to you guys.

Thanks, Tom.

Thanks, Tom.

There’s a number of issues that I’d just like to go through. I think, first of all, I’d like to -- I understand a lot of your business does come from Schwab as refi business. But, obviously we’re going to have a -- it’s still 6 percent of revenue and it’s a well established group of customers that Schwab brings to the table as well. Are you guys planning on joining partners or partnering with any other on-line financial company such as Schwab to replace that?

Tom, no we’re not. And based on the business we’re generating from all of our resources, we will not feel the loss of that Schwab business at all here.

Okay.

I wouldn’t over-generalize, but I’d say we have some concern that partnerships with financial services firms such as Schwab, may have a tendency to be refinance centric and may not be rich sources of the kind of business we are focused on building going forward in terms of purchase mortgages, home equity loans, auto loans, etc. And we like the other mechanisms that we have found to generate and grow those businesses.

Okay. I’d also like to ask you a little bit about loans held for sale. Obviously, you guys originated a lot more loans that you sold this quarter. What is your loan held for sale balance going to look like going forward into the fourth quarter and into next year?

Yeah, the fourth quarter will probably be another loans held for sale build not as large from the prior quarter. Into next year, we probably will see loans held for sale turned down slightly over the year as our refinance volumes are forecasted to go down throughout the year.

Just out of curiosity, why did you guys not sell as many loans in this quarter as you have been previously?

During the quarter we closed a record, as you know, $1.4 billion in loans. And that’s basically, 30 percent greater than our prior quarterly record.

Right.

And so, you know, we closed 182 million more than we sold. And so the increase in loans held for sale does provide greater revenue physically going forward in which we consider to be positive and also, as you know, is a record volume quarter for us.

Yeah. Yeah. I was just trying to understand like, going forward just calculating the net interest income off of that balance. It will have certainly some effect on revenues as well.

Yeah. I think that there’s a positive impact for a slightly higher number of days held. Though, I wouldn’t say this signals any kind of change in our approach. Our basic structure is to sell loans roughly in the 30 days after we originate them.

Now, I was also going to ask you about your prime about business. If you could just go into a little bit more detail of why you decided to go with the off balance sheet entity and instead of selling them to the market as you have been historically. I’m just kind of curious as to -- I mean, generally speaking, it’s -- you can almost sell any auto loan in the market. So I was just kind of -- trying -- I know you guys are focusing on pricing and making it easier for yourselves. Is there anything else to the story that I should know?

Tom, this is Joe. That’s really. It’s all about execution and what execution we’re able to get on the auto loans. And in our previous model in which we are [indiscernible] them one loan at a time -- what might be called a correspondent [indiscernible] model -- we just couldn’t see the execution that we’re able to get using this structure. And this structure has enabled us to, both widen our margins and to substantially improve our competitiveness, which is crucial. Because the name of the game in the prime auto business for us is giving consumers rates that are better than the wholesale rates that dealers have. And we made a good step forward this past quarter in achieving that pricing target along with margin expansion. And the result is a very positive development that you’ve seen in our auto revenue and auto volume.

And my final question for you. Is the residual from the prime auto sales -- are you guys going to start segregating that on your balance sheet so we can see that grow in the future?

Absolutely. We’ll provide a tremendous amount of detail around this to make sure that there’s a lot of transparency -- all the assumptions used and the dollar amounts associated with it.

Yeah. Yeah. Okay. All right. Thank you very much.

Thanks, Tom.

Thanks, Tom.

Once again, to ask a question, please press star 1. One moment please.

At this time, sir, we have no further questions.

We just want to thank everybody for joining us today. Thanks very much.