Consumer Portfolio Services Inc (CPSS) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2017 Consumer Portfolio Services Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference Mr. Bradley, President and Chief Executive Officer. Sir, you may begin.

Thank you. Bradley, if anyone cares. Welcome to our call. I think the way to, sort of, sum up the fourth quarter and then 2017 as a whole is we're sort of glad to have it done and over with. As I've mentioned in prior calls, we spent a lot of 2017 sort of retrenching, working on collections, working on performance, working on improving our credit line, and we've done that. And so, on the one hand, it was very good that we were able to do all that. On the other hand, it slowed down our normal production. We only did around 860 million as opposed to the past few years, we did about 1 billion. So going forward, we would like to change that.

But focusing on the fourth quarter sort of its normal annual slow kind of a market. The market's still very competitive. As I mentioned, our focus is still on credit and collections. And I think some overall points are the portfolio is aging a bit. So as much as sort of the performance numbers in collections may not look particularly better. If you reevaluated them based on the aging or if we were growing, they would look significantly better. And as I mentioned before, that's one of our goals, was to get collections going the right way, and so we have achieved that.

Couple other highlights. We renewed our Credit Suisse warehouse line, and we also did a securitization in October that priced out at 4.49% which was one of the best deals we've done in the long time. We'll get into it a little bit later, but the securitization market's been very good. Spreads have tightened. Even with the rate hikes over the last year or so, we've been able to actually lower our cost of funds. And so it bodes very well for the future in our industry and for CPS.

But I'll get in a little more detail about that in a minute. Will let Jeff run through the financial results.

Thanks, Brad. Welcome, everybody. We'll begin with the revenues. For the fourth quarter $107.2 million, that's a 2% decrease compared to the previous quarter, the third quarter of this year, and a 1% decrease compared to $108.2 million in the fourth quarter of 2016. For the year-to-date revenues $434.4 million, a 3% increase over $422 million in December -- for the 2016 year. So for the quarterly revenues, I mean, I think, we're seeing a continuation of pattern that's developed throughout 2017. The sequential revenues are down slightly as was the portfolio down slightly from the third quarter to the fourth quarter, despite originations for the fourth quarter of $191 million.

Moving on to the expenses. $99 million for the fourth quarter, that's a 2% decrease compared to $101.4 million in September of '17 and a 4% increase over $95.5 million a year ago. So the year-over-year increase in expenses is largely due to increases in interest expense and to a lesser degree employee costs. In the sequential quarter, the total expense was down slightly, highlighted by a significant decrease in the provisions for credit losses.

Let's look at the loss provision for the quarter. $43.7 million, that's an 8% decrease over the third quarter of this year of $47.3 million, and it's roughly flat with the fourth quarter of 2016. For the year-to-date numbers, full-year numbers $186.7 million in credit losses, and that's up slightly 5% compared to the full year of 2016. So again, you see that's sequentially down for the fourth quarter, flat year-over-year. Brad alluded to the aging of the portfolio. The portfolio is at about 21 months of weighted average seasoning at this time, and that's directly related to what's been sort of a down year of originations compared to previous couple of years.

Pretax earnings for the quarter $8.2 million, that's a 1% increase over $8.1 million in the third quarter of this year and a 35% decrease compared to the fourth quarter of last year. Full-year pretax earnings $32.1 million and that's a -- also a 35% decrease over the full year of $49.7 million in pretax earnings in 2016.

Moving to net income or technically loss for the quarter. $10 million net loss for the quarter. And as we said in the press release, that reflects the $15.1 million charge to income taxes to accommodate a write-down in our deferred tax assets, which is pretty common, as many of you have probably seen, other banks and finance companies have had similar breakdowns to adjust for the new corporate income tax rate. Without the write-down, net income for the quarter would have been $5.1 million, which would have been a 9% increase over Q3 of '17 and a 32% drop compared to the fourth quarter of last year. Full year net income, including the tax loss, was $3.8 million. Without the tax loss, the full year would have been $18.9 million, also up 35% from the full year of 2016.

Diluted earnings loss per share for the quarter, $0.46 loss per share for the quarter. With -- again, without the charge, the earnings for the quarter, net earnings per diluted share, would have been $0.20. And that would also have been -- well, can that -- also without the tax charge, the full-year diluted earnings would have been $0.69 per share, rather than the $0.14 that we reported.

Moving on to the balance sheet. Not much really changed in terms of the balance sheet and how we operate the company and the liquidity for the quarter. Brad mentioned that we did renew the Crédit Suisse, Ares warehouse line in the quarter for another 2-year period. I mentioned that we purchased $191 million in contracts and that's $859 million for the full-year period. The net and gross allowance for the period or as of the end of the year here, were 4.7% and 5.7%, which is flat sequentially more or less to the third quarter, but up year-over-year compared to 4.2% and 5.4%. And so we had a relatively strong fourth quarter in credit performance, in spite of what are typically some seasonally challenges in the fourth quarter. We were actually very pleased with the fourth quarter credit performance results.

Moving on to some of the other performance metrics. The net interest margin for the quarter was $83.5 million, that's down 3% compared to $86.2 million in the third quarter of this year, down 4% compared to the fourth quarter of last year. Full-year net interest margin, $342 million, which is roughly flat to the full-year net interest margin for 2016.

So we've got a few things going on here. Brad alluded to the really good performance in the asset-backed market, which has generally led to the lower ABS balances over the course of 2017. The actual blended cost of all of our ABS debt for the quarter was 3.82%, which is up slightly from 3.78% in the third quarter of this year, went up a little bit more compared to 3.6% in the fourth quarter of last year. But as I said, the trend has -- have been very positive over the course of 2017.

The risk-adjusted NIM, $39.9 million, a 3% increase compared to $38.8 million in the third quarter this year, and that's down 7% compared to the $43.1 million in the fourth quarter last year. The NIM, of course, is further influenced by increase in the provision for credit losses year-over-year.

Core operating expenses for the quarter $31.6 million, up 3% compared to the third quarter and up 4% compared to the December quarter of 2016. Full year core operating expenses $123.3 million, an 8% increase over the full year core operating expenses for 2016. So you have these, kind of, slight increases primarily in employee -- for the full year, primarily in employee costs and somewhat in occupancy as we have actually added some space in a couple of our locations over the course of the last year or 18 months. Core operating expenses as a percentage of the managed portfolio, 5.4% for the quarter, that's up only slightly from 5.2% in the third quarter and 5.3% in the fourth quarter of last year. Full year operating expense margins 5.3% in -- for the full year '17 compared to 5.1% last year. The increases I just mentioned in the previous caption there.

Return on managed assets, 1.4% for the quarter, that's flat for the third quarter and down slightly from 2.2% last year. Full year return on managed assets 1.4% for 2017, down from 2.2% for the full year of 2016.

Looking at the credit performance metrics. The delinquency at the end of the year was 11.25%, that's up from 10.27% in the third quarter, and also slightly from 10.96% last year. Again, significantly influenced by the somewhat shrinking portfolio and the aging of the portfolio. Net losses -- net credit losses for the quarter 7.24%, down from 7.96% sequentially from the third quarter and up from 6.97% a year ago. Annualized net losses for '17 -- 2017, 7.68%, up from 7.03% compared to last year.

One thing that, I think, it's somewhat of a positive is, there's been a lot of kind of concern and gloom over the return on the auctions for the vehicles we sell at the auctions. Those numbers are 34.7% for the quarter were relatively flat and really about the same levels they were a year ago. So we've managed to maintain our productivity, our efficiency, our returns at the auctions in spite of what's been sort of a dark cloud hanging over that aspect of the business for some time.

In the fourth quarter, we completed our 2017 desecuritization, that was -- goes back to October. The blended coupon on that deal was 3.38%. We sold $196.3 million with bonds. The -- that coupon represented 160 basis point in blended spread over the benchmarks. And that's the best execution that we have gotten on the securitization since the 2014-A deal, which was very noteworthy. The asset-backed market has been very good to us. And of course, this is not a fourth quarter event, but we did just recently in January, complete the 2018-A securitization for $190 million with actually improved execution from a blended spread standpoint. So again, it continues to be very strong and positive aspect of our business. Our bonds are -- continued to be well received in that marketplace.

So with that, I will turn it back over to Brad.

Thanks, Jeff. Running through the categories. In marketing, over the last couple of years, we sort of thought you could do more sort of an electronic presence in marketing, you had DealerTrack and the like. And we probably might want to revisit that or have revisited that. And we now think that your presence in the dealership is much more important. And with that, we're -- we've been focusing on expanding our marketing department, beginning to grow it again. We were very sort of flat in 2017. One of our goals for 2018 is to aggressively grow the marketing department, so we can expand in our footprint, again, which will lead to more loan growth. The topic or the trend for 2018 is going to be loan growth in the marketing department.

In originations, we probably have achieved what we've set out to do there in 2017. We ended up 2017 fourth quarter with a weighted LTV of 111%, which is the lowest in probably 5 years. That was a real focus. LTV is probably the leading indicator of credit performance. And so we set out to lower that down. It was -- it really averaged around 115% last year in 2016. And so that's a substantial difference going from 115% down to 111%. Since those loans are only a year old, it should begin to show some real benefit as we go forward in terms of the product we've originated.

We did give up a little bit of APR to get the better product. And that just shows you that the market out there is still very competitive. However, we think times will change, and we'll be probably even be able to pick up some of that APR, hopefully, going forward. The most important part is the product we're originating is going to perform better than what we've already got. So moving on to what we already got, we've focused a lot on collections, as both Jeff and I have mentioned. We really think we've turned a corner. If the company was growing the way it normally would, the delinquency numbers would look substantially better. They don't look particularly great, but they don't look particularly bad either. But if we were growing, they would look real good. And that's probably most important when it comes to delinquency.

If you look at the trending annualized net losses, it was a higher year at the -- in the first quarter of 7.9%. We have got it down to 7.6%. We think over time that number should improve as well. When the paper we've originated in 2017 starts to flow through, we should see improvement there. So as much as the collection numbers don't look spectacular, there is lots of little parts that should make them look a whole lot better as we go forward. So again, we seem to have accomplished what we wanted to in the collection world in 2017. But having said that, it probably took us 3 or 4 years to get collections back on track. I'm not so sure that many of our friendly competitors in the industry could say that today. I think it's been a real struggle for everyone. We're pretty close to saying, we've got it licked. And wonder how many other people can say that. So that's a very good thing for us and hopefully, will benefit us going forward.

Moving on to the capital markets. As Jeff mentioned, they're very strong. We probably had the best execution on securitizations that we've had maybe in the history of the company. Even with the rate hikes, our October 2016 deal, which we called '16-D, have priced out with an average cost of funds of 4.49%. The deal we just did this Jan -- this past January averaged out at 3.46% and that's with all the rate hikes. And the reason is you're having spread compression, because all that money out there looking for a place to go and everybody likes subprime auto, the rate of securitization deals performed very well and that is causing the spreads to tighten and really helping us. Now sort of the downside of that is probably helping everybody else too. So some of our friendly competitors who are having trouble in the market, if you can keep that lower cost with funds that probably gives them a little more runway to get things turn around and fixed. But nonetheless, overall, it's a very positive thing for both CPS and the industry. The fact that Wall Street and the capital markets really like the paper and are willing to pay up for it. And we're having oversubscription on all tiers of our bonds. It's getting to be a really good thing, and we would expect and hope it to continue.

Some other highlights or points. We've now purchased 6.2 million shares, repurchased that many shares over -- since 2015. And we're continuing that program. We're probably, obviously, the most active buyer in the market on a daily basis. And given the price, we think that's the right thing to do, and we'll continue to do that. As I said, the industry, I don't think -- we keep hearing rumors about this and that and this company or that company, nothing has come to fruition today. But again, looking forward a little bit in 2018, everyone probably expects some things to change in terms of M&A in 2018. Like I said, the low cost of funds probably gives people a little more time, a little more room, but again, one might hope that those things could change.

In terms of what we want to do, we've now sort of accomplished what we wanted to do and -- even for the last 3 years in terms of collections and the last year or so in terms of originations in credit quality. So 2018 for us should be, let's get back in the market, let's find a way to grow, let's get the portfolio expanding again, and make all these numbers we worked hard to achieve show up even better.

Overall, the economy with the tax cut, that should have a nice effect. We really haven't seen the tax refund season yet. That should probably start very shortly. That will give us a boost. And then as we can sort of start growing and expanding, we should hopefully be able to ride the tax expansion or the tax refunds as a kick-start and then grow from there. So hopefully, all that will come to pass and go the right way, but that's sort of the goal for what we're going to do in 2018.

2017, as I said, most importantly, is behind us. We've done a lot there. We've accomplished a lot, but I think, it sets us up very well for 2018.

And with that, we'll open it up for questions.

(Operator Instructions) And our first question comes from the line of David Scharf from JMP Securities.

Brad, just wanted to make sure I heard correctly. It sounds like you're pretty confident notwithstanding the competitive environment, but based on what sounds like a lot of progress on the internal collections and recovery front that you seem to be more focused on reaccelerating origination growth production. Is that a fair assumption, as we think about getting back above $1 billion of production this year? Is that a fair assumption on our part?

It's a fair assumption. Making it reality, of course, takes a little bit of time. But like I said, we've done about everything we think we need to do or needed to do in terms of the credit quality we buy today and in terms how our collections perform. So you've got those 2 pieces where we want them, then what's next is to grow. Having said that, the market continues to be difficult and everybody is really competitive, that could slow the progress. But nonetheless, I think, we have some ways where we can get out there and grow, and we're certainly going to try. Again, we'll have to see how that goes, and we've got 4 quarters to prove it. But certainly, we're going to try and do it, and unless something odd happens. I don't think there is people that are out there growing because they have to grow, and then there is people who are trying to make things work. And so in that environment, there should be room for us to sort of carve a piece and that's what we're going to try and do. But yes, our goal will be to get back to the $1 billion level. We'll see, if we can achieve it.

Got it. And in that context, I mean, given the improvements in collections and so forth, do you view the 111% LTV, which you noted, as sort of a 5-year low? I mean, is that something that you have room to play with now? Did you feel like you erred on the side of excess caution as you were pulling back and focusing on internal servicing last year?

That's an excellent question. It's very nice to say 111% is our number. I mean, we probably could have lived with 112%, 113%. We didn't like 115% very much. So we might have a little room to play with that. I would like not to have to do that. But we'll sort of see. We might -- we probably would like to see the performance come in a little bit with that kind of number on it. And if it's low enough, then maybe we would move it, but we'll see. A lot is going to depend on what the market's doing. The fact that we went to 111% is probably one of the reasons we didn't grow much in 2017. And my guess is other folks are kind of going the other way. But we'd be curious to see what other people do. They start falling back, then 111% could stand to the extent they don't. And we like sort of how the collections come in and the performance comes in. We might nudge it a little bit. But we're probably relatively comfortable with 112%, 113% not too much higher than that. So 111% has given us a little room.

Got it. And another sort of growth-related question, as we think about the investments, just trying to get my arms around, whether the increase in marketing embodies visiting the dealer and so forth. I mean, should we still see the efficiency ratio likely improve this year? Or is there more marketing expenditure we should front-end load?

I think, I would hope that even with sort of loading up on marketing, the benefit of what you buy will weigh -- should significantly outweigh the cost. You may, if it goes slowly, catch a little cost first. But in the end, the reps will more than pull in enough to cover the expense of the reps themselves. So I would -- try to hedge my bet a little by saying, no, you won't see any expense increase, because if it goes slowly, it just might. But in the long-run, the growth will well overshadow the cost.

Got it. And one final question for Jeff. The implementation of fair value accounting, I guess, a couple of years in advance of the new CESL rules. Can you talk a little bit about maybe the disclosure we can expect starting with Q1 for purposes of treating the portfolio?

Well, first, for all those who saw that, because of the CESL coming in, in 2 years, we want to protect our book value and -- under CESL, so you'd have a large hit to the book value when you make that adjustment in January 1, 2020. So by adopting fair value in 2018, we're going to avoid the vast majority of that hit. That's why we're doing it. And we would probably rather talk more about that in the first quarter when we have something more definitive to talk about. But Jeff can explain how that process is going to work.

And from disclosure standpoint, yes, I mean, I think, we want to be transparent, obviously, and make sure that people can understand what revenues are coming from which aspect of the portfolio. So the balance sheet most certainly will break out the 2 portfolios, the traditional portfolio and the more recent fair value portfolio. And then, for instance, in the earnings release, in the MD&A, we can bifurcate the portfolio interest to each segment of the portfolio.

And our next question comes from the line of Mitchell Sacks from Grand Slam Asset Management.

With the tax bill changing take-home pay for the average worker, have you guys thought about how that impacts both existing portfolio and sort of how you look at credit going forward?

Sure. I think whatever number you pick, the way we sort of look at it is, everyone's going to have a little more money in their pocket and then our particular customer, that money should be pretty much earmarked towards paying us. So on just the face of it, any kind of tax cuts benefits our folks probably more than anyone else, because they probably are very tight on disposable income. One of the things we sort of go along with is the theory that even though the actual money isn't going to be that much per family, with the sort of improving economy, much better consumer optimism that money is going to feel like more money to a lot of folks. And so that just spur the economy. Hopefully, our guys will be able to get more jobs if they need to or different jobs, so we won't worry about people losing their jobs quite as much in this market. So it's hard to think it won't be beneficial straight across the board. It'll help us both in terms of the performance. It'll mean our customers going forward as we buy them should perform better. Having said that, that's kind of a big bet to say let's loosen our standard, because all going to have more money. But these -- the answer is, if we continue what we're doing, the performance should improve somewhat naturally in terms of the new customers, and again, even more so from our old customers.

And then in terms of the net charge-offs, the sort of the move in the right direction, is that a trend? Or is that just more of a seasonality thing? Can you just talk a little bit about that?

Sure. Well, the fourth quarter is almost always the worst quarter of the year. So to the extent we've done pretty well there, my kind of hope, it gets better from there. I think probably the way we would look at it somewhat objectively is we think we've got it towards flattened out. So any improvement going forward would be great. And I think, again, if you compared us to some of our friends, a lot of folks are still trying to figure that out. And we might say, we've got it done. So we would like to either stay flat or improve, and we would tend to think it'll improve.

Okay. And then sort of a final question. In terms of -- on the employee cost side, are there any economies that you think you guys can realize there as you've sort of hit this plateau? Or are you still more geared up for growth?

I mean, you could, but the problem is that we started growing. We've cut some jobs. If things are going, we're just going to hire more back, and we'd rather have them there and train. We originated $1 billion in 2018. You are not going to see the employee cost, I mean, it just disappear. I mean, they'll go back to where it's supposed to be. So it's not something we're going to -- it's really -- most of the people sort of we could argue we spend that money on, are people where we're sort of hiring and growing ourselves, in other words, training. And so you just don't want to throw away that training, just to say you cut cost. So we always -- we probably run more efficiently than anybody in the industry anyway. So we're not overly concerned with that kind of aspect of it. But just to do it for the sake of cutting cost, probably isn't the wise move for a bright future.

(Operator Instructions) And our next question comes from the line of John Hecht from Jefferies.

I apologize, I missed some of the prepared remarks, and I actually had to drop out for some of the questions, so I apologize if this is redundant. But -- and I know you did talk about some of the competitive aspects of the business. But I'm wondering, within those layers of subprime and near-prime lending, where you seeing more and/or are less competition? And are you able to kind of pass on rate increases at this point in time? And do you see opportunity there?

We probably don't see any opportunity to pass on rate increases per se. We are beginning to hearing noises about some of the friendly competitors. It's funny, because we've been hearing all along that people were struggling and that we were struggling. And so now you're probably hearing a little bit more. But again, until something actually happens, I'm not going to get too excited about it. But once something happens, you might see more things happen. I think the competitive environment is such that we may be able to eke out a little bit of rate increase, but by and large, I think, as I've said in past calls, in this market, you have us and around a couple others that are doing kind of okay. And then you got a lot of people that have the PE guys behind them, and they're trying to make a mark. So they need to grow and they need to be aggressive, and they've been very aggressive over the last few years. I don't know that, that's going to change unless all -- some of the IPO market jumps up, which it won't. So there'll be sort of -- we'll have to wait and see. But -- so I guess, the answer is, no. We don't think the competitive environment's going to improve until few people fall over. And as a result of that, probably it'll be hard for us to move much of APR along to the customer. Remembering though that since we've gotten these much better spreads in our deals, we're getting a little room that way anyway.

Okay, that's helpful. And then the question -- the second question would be, what's your -- what have you guys seen in terms of residual value transfer? And what's the outlook in '18 versus the trends we saw in '17?

You mean of sales or financing of residuals or -- you mean, are you talking about...

No. more of the used car values, what are you guys seeing there?

Actually, we think, auction values look like they're leveling out. They're right around 34%, 35%. As we've said before, the real low is around 30%. And they don't seem to be pushing past 34%. Having said that, I wouldn't want to be held to that. But they've been rather consistent in that 34% to 35% range for a few quarters. The extent it stays there, that would be great. Again, if our best was 42% or something like that and the worst is 30%, you're sitting kind of in the middle. I don't know that I would think that number is going to improve a whole lot, but it may not go down much.

Okay. And last question. Just to get the balance sheet management. You guys have been somewhat range bound in terms of debt to equity levels over the past several quarters. How should we think about your plans for that over the next year or 2? And then that in the context of how you might prepare for CESL implementation as well?

Well, we're probably -- one of our big concerns is hanging on to our book value, since it takes so long to create in the first place. And that's really what drives our CESL preparation. I think as -- if you get the book value -- it's an impossible task to keep your book value growing enough to make your leverage given that debt really look good. But it certainly looks better and most people that know what's going on, can look at the book value and keep it, set it aside from the actual leverage based on your finance portfolio. So I think we like to see it improve. We're going to continue. But if we start growing again, the numbers are going to go the other way. So -- but that should be a positive. To the extent our portfolio grows and it increases the leverage against our book value, we're probably comfortable with that, particularly since we have a pretty good book value. So -- but obviously, that's a focus. As I said in 2018, we want to grow. We think, we've got collections and originations going the right direction. Part of the accounting end of this is we need to focus on what's going to happen in terms of the balance sheet over the next couple of years, when CESL does get implemented in 2020.

Okay. And just final question, do you guys -- did you mention your tax rate -- given tax reform that we should be thinking about for the year?

Yes, that's not completely come into focus yet. But you should be thinking in terms of 29.5% to 30% blended effective tax rate for 2018.

Thank you. And at this time, I'm showing no further questions.

All right. Well, like I said, 2017, we're hoping will be the accumulation of our regrouping and rebuilding and getting everything going in the right direction and leading to a hopefully, prosperous and growing 2018. It's early in the year, we'll have to see how it goes. So far, it's doing pretty well. So we're optimistic that both the industry should show some signs of doing a few things. If the M&A activity ever gets going that would be a positive for the industry and for CPS, because obviously, if people get bought, then you have better people running the place -- those places. If people go away, that creates more opportunity for everybody else. So once an M&A activity begins, that'll be a very good sign. It'll make it easier for us to grow. Even with that, we're going to try real hard to grow anyway. So we kind of think 2018 is going to be interesting sort of all way around. As I said, with CESL coming in 2020, there's some preparation to be done, but again, in the long-run that benefits us more than sort of just waiting around to 2020 and taking a big hit.

So thank you, everyone, for attending the call, and we look forward to talking to you rather soon towards the end of April or in middle of April.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.