Consumer Portfolio Services Inc (CPSS) 2018 Q1 法說會逐字稿

Good day, everyone, and welcome to the Consumer Portfolio Services 2018 First Quarter Operating Results Conference Call. Today's call is being recorded. Before we begin, management has asked me to inform you that this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any statements made during this call that are not statements of historical facts may be deemed to be forward-looking statements. Such forward-looking statements are subject to certain risks that could cause actual results to differ materially from those projected. I refer you to the company's' SEC filings for further clarification. The company assumes no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. With us here now is Mr. Charles Bradley, Chief Executive Officer; and Mr. Jeff Fritz, Chief Financial Officer. I will now turn the call over to you, Mr. Bradley.

Thank you, and welcome to our first quarter conference call, our earnings results call. Overall, we are very pleased with the quarter. The numbers worked out the way we would expect them to and so all that's very good. More importantly and important to talk about is effective with the first quarter 2018, we have adopted a fair value accounting for finance receivables acquired in the first quarter thereafter. What this was really all about is that in 2020 -- January 1, 2020, the CECL law will come into effect and that the current expected credit loss standard will be adopted, and we would have to adopt to that on January 1, 2020. And what -- as far as the layman's terms, it is -- I'll let Jeff talk about it a little bit more in a minute. But starting on January 1, 2020, you have to take a provision for the entire expected loss of the loan the day you book it. Today, we take what will be 12 months, and we even take that over 12 months. So in today's accounting, we assume that during the first 12 months alone, we'll build enough reserves against that loan to have 12 months of losses going forward. That's today. Starting in 2020, you're going to have to provide enough for the losses for the loan for the life of the loan day 1. One can imagine that the earnings hit the companies are going to take, and it's public companies in 2020, all companies in 2021. So the earnings hit you would take in 2020 would be rather extreme, so much so that it would wipe out the vast majority of our book value, something we do not want to do. So to prevent that from happening, we've adopted fair value accounting for all loans purchased starting in January 2018.

I'll let Jeff explain the intricacies and the ins and outs of that, but this is entirely to protect our book value in the event that CECL becomes law in 2020. Ironically, in 2020, we could switch back because, at that point, you don't have to take this large charge for the entire portfolio. So what we're really doing is, we're protecting the portfolio we already have and so the portfolio from 2018, 2019 will be fair value. In that way, most of the portfolio we already have will have run off, but the 2018 and '19, it will still be on the books, won't be affected by the CECL hit nearly as much, if at all. So anyway, that's the big thing we had a change in starting with this quarter.

Overall, we think the numbers are what we expected. I think the other thing we're going to talk about -- I'll talk about more in a little bit is how competitive the industry is today. There's a whole lot of folks out there trying to get some things done, whether it's going public or trying to get their PE fellows paid. Whatever it is, the competitiveness has risen to a level that is extreme. We've probably only seen it back in the good old days before everyone collapsed. So it's something we're not playing in, and it's making it very difficult, I think, for everyone in the industry. And again, I'll talk about that more in a minute.

We did -- another point of importance is that our collections is really starting to show some improvement. It's a shame that portfolio isn't growing because if it was, the collection numbers would've been really strong. But even with the shrinking portfolio and an aging portfolio, our collections are really beginning to show some of the results we've been hoping for literally the last few years. We also did notice securitization that went out at 3.46%. It's really settling in to where our securitizations in the last 3 or 4 -- have been in that 3.5% to 4% range. That's really a good level for us. If we could stay there, that'd be nice. Probably that will inch up over time. But again, the securitizations are well received, did real well in the marketplace, so again, another positive. So I'll touch more on sort of what's going on in the industry and what we're going to do about it after Jeff runs through both the intricacies of the fair value accounting and the financials.

Thanks, Brad. Welcome, everybody. Let's talk about the fair value accounting just briefly. So in this method of accounting, we estimate net level yield for each quarterly pool of receivables as they're acquired. This estimated net level yield takes into consideration factors such as the interest rate or the underlying loans, the estimated timing and magnitude of charge-offs over the life of the loans and things like the estimated prepayments.

Then, once this net level yield is estimated in that fashion, interest income on those -- that portfolio, those loans is recognized as revenue as interest income based on this estimated level yield, okay. Now this method varies from the traditional accounting method we've used for the loan portfolio in that there is no provision for credit losses when you use the fair value method. There is no allowance for credit losses on the balance sheet when you use the fair value method because this level yield that I just described is effectively reduced by the impact of the estimated credit losses. So this accounting method that we've adopted is only in place for receivables originated in Q1 2018 and thereafter. The portfolio that was on the balance sheet at 12/31/2017, which we'll refer to as the legacy portfolio, will continue to be accounted for in the traditional fashion, the interest income will be recognized on a gross basis based on the interest rates of those underlying receivables, and we'll continue to maintain an allowance for loan losses and the balance sheet by establishing -- through the establishment of a provision for credit losses on the income statement.

So it's important for folks following the financial reporting to think of us now as having 2 portfolios, the legacy portfolio, traditional accounting and the Q1 2018 and thereafter portfolio, which will use the fair value accounting method. There's going to be a fair amount of disclosure we're drafting in 10-Q now, so there will be a few more details in the 10-Q about how we come up with these estimates and what some of the key inputs are to these estimates for the fair value portfolio.

That's fair value 101. So we'll move on to the results. Revenues for the quarter were $103.6 million. That's down 3% from the December quarter of $107.2 million and down 4% from the first quarter of last year.

The portfolio is level or maybe down slightly on a sequential basis. That certainly impacted the revenues. And what I just described in the fair value methodology is going to have an impact on the revenues, too, because the revenues that we've recognized on the fair value portfolio are net of the expected losses. So that is baked into the revenue numbers as opposed to having a gross revenue interest income number offset by provision for credit losses.

Moving on to expenses. $99 million for the quarter is really flat compared to the December quarter and down just slightly from the first quarter of last year. We had some increases in some core expense categories. But those were largely offset by decreases in provisions for credit losses, again, impacted by the fact that there is no provision for credit losses on the fair value portfolio. In addition, one other fairly subtle nuance of the fair value accounting is that we no longer defer direct originations costs associated with new receivables. So in the old accounting, in the traditional accounting, we would make an estimate of what the cost per loan for acquiring new receivables was. That amount was deferred -- that expense amount was deferred and then recognized over the life of the portfolios. In the fair value world, you don't do that. And so in fact, during this quarter, we had about $1.4 million in expenses that, under the traditional accounting method, would have been deferred most of those flowing through the employee expense line. So we didn't really have a significant increase in these core expense -- employee expense. For example, in the sequential quarter, it was really just that the accounting change or the adoption of the new method doesn't allow us to defer certain employee costs that we did in the past.

Looking at the provisions for credit losses. $40.5 million, down 7% from the December quarter, down 14% from a year ago. I think you can expect to see provisions shrinking somewhat in the future as the legacy portfolio declines. The legacy portfolio is now seasoned at 23.5 months and so that's going to, as I said, continue to decline, the absolute dollars of provisions likely to continue to decline somewhat in the future as well.

Pretax earnings. $4.6 million, that's down 44% from $8.2 million in the fourth quarter last year and down 41% from $7.8 million for the first quarter a year ago. Net income was $3.1 million in this quarter. That compares to $10 million net loss in the fourth quarter of last year. But remember, too, in the fourth quarter of last year, we had a $15.1 million income tax charge as a result of the change in the corporate tax rate, which resulted in a write-down of our deferred tax assets.

Diluted earnings per share was $0.12 for the quarter. That's up from $0.46 loss in the fourth quarter due to the tax charge and then down compared to $0.16 in the first quarter of last year.

Not much changing on the balance sheet. You'll see that we have now broken out on the balance sheet, and we'll continue to break it out, finance receivables in the legacy portfolio, which is offset by an allowance for loan losses and then we have a new line item on the balance sheet, finance receivables at fair value. We originated about $211 million in contracts in the first quarter, and those are all represented in the line for finance receivables at fair value.

Not much changes in the debt section of the balance sheet. We continued to operate with the 3 warehouse lines. Brad alluded to the securitization, which was kind of normal course for us during the first quarter. Looking at some of the other performance metrics, net interest margin was $79.5 million for the quarter. That's down 5% from the fourth quarter and down 7% from the first quarter of last year. The actual blended cost of all of our ABS debt for the quarter was 4%, which is up compared to 3.7% a year ago. And so the general trend of our new ABS costs has been down since 2016, but we still have some of that higher ABS costs from before that time factoring into these figures.

The risk-adjusted NIM was $39 million for the quarter. That's down 2% from the sequential quarter, the December quarter, but it's up 2% from a year ago. And of course, the risk-adjusted NIM is influenced by the provision for credit losses, which, as we said, is down slightly. The core operating expenses $34.4 million, that's up 9% from this fourth quarter and up 13% from a year ago. Again, some of that increase is due to the change in the accounting method for the new receivables, which I alluded to earlier.

That ratio of core operating expenses as a percent of the managed portfolio 5.9% for the quarter compared to 5.4% in December, the fourth quarter of last year, and 5.3% a year ago. It's difficult to get improvement in this metric with the portfolio flat or shrinking. So I think these are kind of the levels that we can expect to see. The return on managed assets, pretax, was 0.8% for the first quarter and that's down from 1.4% in the fourth quarter and 1.3% a year ago.

The credit metrics Brad alluded to, the delinquency was -- all-in delinquency was 8.74% for the end of the first quarter, and that's an improvement over 9.74% a year ago. And so we're really beginning to feel like the servicing platform has had some significant improvements and is humming along nicely and so we're relatively pleased with the servicing and credit performance. The losses, 8.2% for the quarter, up slightly -- were up 1 point from 7.24% in the fourth quarter and 7.9% a year ago.

The auction level numbers just down slightly in the first quarter at 33.8%. As we talked about before, most of the pain of that seems to have been felt in 2015 and '16, and the degradation has been significantly less lately.

First quarter securitization, Brad indicated, we completed in January, blended coupon at 3.46%, was actually the best execution spread over the benchmarks that we've had since the financial crisis. And so the asset-backed market continues to be kind of the one consistent shining bright spot in our business for quite some time now. So we're certainly pleased with that.

And with that, I think I'll turn it back over to Brad.

Thanks, Jeff. So to talk about CECL one more minute. I'm not so sure, when that was put together, it was really meant for companies like ourselves where you have subprime and you have significant losses. And as much as everyone in our industry, and certainly we approve, in that subprime works just fine, having to take the entire loss allowance upfront is certainly a large burden to bear. I think probably CECL is more aimed at the banks where they could make that adjustment rather easily because it's much smaller in terms of a percentage. Anyway, it's what we're stuck with and that's why we've had to switch to fair value for the next couple of years. Remembering that our book value is something close to $9 and someday when our industry settles down and everything comes back to, hopefully, normal and companies trade at book value or multiples of book value, we'll still have ours. So anyway, that's the rationale for all that.

Moving on to the other interesting parts of the industry is the competitive nature of the industry today. As everyone knows, we've talked about cycles, and this is what we loosely call the third cycle, and the third cycle has been dominated by PE players, putting money into companies, trying to grow them a lot, take them public, have somebody buy them, any of those things. Obviously, that hasn't worked out very well for a whole lot of folks. Over the last 2 years, in 2016 and '17, everybody said there will be some consolidation in the industry. There was none. So far this year, 2 companies have gone away. There's probably another one kind of gone away and at least 3 or 4 more on the rope. So 2018 may finally be the year that consolidation happens in the industry, some of the PE guys give up the ghost and things start to move in the right direction.

But of course, before that can happen, you have to have a Hail Mary pass where everybody goes nuts, and so here we are. Everyone is buying as aggressively as we've seen in 25 years. They are doing crazy things in terms of both credit and pricing, and so it's a market we just can't play in. So we'll get to what we're going to about that in a minute. But I think I have mentioned in previous calls that our LTV, we had a goal of around 110%, 111%, we thought 115% was high, and we had that a few years ago. And today, we do sit right around the 111% loan-to-value. I bring that up because the new thing out in the Street is something called guaranteed back-end. And so wildly going around is that all of these lenders are guaranteeing the dealers a guaranteed back-end, which basically allows them to make some money in the loan off the customer. As a result of that, that's just destroying the LTVs. We cannot play nor will we play in that game. It's a great idea if you want to get a lot of paper real quick, the paper is going to be horrible and eventually going to default like crazy. And we're not even 100% sure everyone is doing this, but there's enough folks out there that it's become very interesting, and we'll see how it all plays. But given what I've said earlier, this is the time where people got to get things done, and this is what they're going to do.

So having said that, we'll just sit and watch and try some other things, and here are the other things. We think that things are going to change in the industry over the next year. We currently have -- we used to have back in the day 120 or so marketing reps. People out there roam around looking for loans. And then as things changed, we dropped that number to about 70. We are going to go back to 120. We're going to put, as people like to say, boots on the ground. We're going to try again and do a lot of different markets where we can get our niches filled, remembering that if we get 1 or 2 loans from the dealer monthly, that's just fine. Our average is just under 2 -- 2 deals per month per dealer. To the extent we can put guys in the field in different cities all over the country and they can get 25 dealers, giving them their 2 deals, 50 per guy, we can get back to sort of the levels we would like to have in terms of originations while we wait out the storm.

So as much as -- the other part of that is, the market is tough right now. Car sales just aren't as strong as they were. I think, as I mentioned before, car sales probably should have slowed down in '15 or '16, and instead the manufacturers wanted to maintain the industry and did by all sorts of tricks and leasing and such. And so now there's suffering. And so car sales are down. The used car market is down. A lot of bad weather in the first few months of the year, which also impacts car sales and financing as a result of all that. And so a lot of folks are sort of behind the eight ball in terms of having these big productive years through 2018 that they want. It certainly reflects in our numbers as well. But to the extent we had to grow the company real fast, improve the earnings real, a lot, in this year so we could exit, that would be a huge problem. We don't have that problem. Other folks are going to. But if we can put enough people out there, 1 or 2 things will happen: one, we'll get amount there, they'll get a lot of deals, our business will improve; and two, when some of these big companies fall down, they'll be standing there ready to take a lot of that business. And so somewhat think it's a slightly risky strategy by growing in that way in the face of a struggling industry. But we think it's going to be very opportunistic when things change.

So anyway, that's our plan. That's what's going on in the industry. It's going to be interesting, if not a lot of fun, to see how it all shakes out. In terms of collections, as both Jeff and I pointed out earlier, we think we're really getting somewhere in collections. So like I said, I wish the portfolio was growing because it would really show the portfolio is aging, we're not growing, the delinquency numbers -- delinquency is looking great. We had sort of that opposite effect, delinquency would be the best it's ever been, even so it's the best it's been in 2.5 years. Same thing, the losses. If the portfolio was actually growing, they would look even better. So as much as -- it's a little hard to tell looking just at the numbers, overall, we really think we've finally found what we want in the way we collect loans. And again, down the road, that's going to be important if everybody else -- other folks start having real problems.

We think we've really turned the corner in collections. We're very proud of what we've done, and I think we'll see the results.

Auctions. At least, the auctions seem to have flattened out in that sort of 33% to 36% range. Again, they might get a little softer, but it seems to have stabilized, so that's good, too. In terms of the industry, as people have been reading, the CFPB is changing quite a bit lately. So I think the regulatory environment, one can say that is certainly improving and gone to a place where they shouldn't be worried about it. Certainly, we're probably not. In terms of the economy, we generally do think of our customers being sort of the tip of the economic sphere because they don't have a lot of disposable income. They seem to be doing pretty well. They seem to be not having a lot of trouble keeping up with their loans. We would see it if the economy is starting to turn. So generally speaking, we think the economy is probably good for us, good for our customers and, again, should be good going forward.

So it's probably the short and sweet part of it. We'll open it up for questions.

(Operator Instructions) Our first question comes from Mitchell Sacks of Grand Slam Asset Management.

With respect to the first quarter and the move to the fair value accounting, did that impact the bottom line in terms of net income earnings per share?

Well, yes, it does a little bit, Mitch, because in the traditional accounting, the earnings tend to be a little front-loaded in a portfolio because, think about it, you've got a loan, it's got a 20% coupon, and then we build and so that things start accruing at 20% right from day 1. And then we build, as Brad just mentioned, an allowance over a 12-month period. And so that provision for credit losses is recognized -- begins to be recognized right away, but it's a relatively low amount compared to the 20% coupon that the loan is accruing at. In the fair value world, you're immediately coming up with this level yield that takes into account the losses from day 1. So you're booking a net lower number, but it's again a level number, so there is not sort of front-loading that comes from the traditional accounting, and it's not as lumpy. So I think what's most important, I meant to say this before, is the economics of these receivables is the same, no matter what accounting you use. So at the end of the day, at the end of the years that these loans are on the books, the economic benefit to the company is exactly the same, no matter what amount -- what method of accounting you use, but to your -- to answer your question, yes, it does have somewhat of a negative impact on the earnings at least initially.

The other part of that is that, under the old accounting, as we'll call it, you defer the acquisition costs, and today, you recognize them immediately, and that probably is the most prominent effect at least in the beginning. And over time, we'll catch up to that. But you'll go from deferring it all to taking it all. So that has probably a more negative effect initially than even the fair value, though they're both negative.

That's a good point.

Do you have an estimate of what earnings per share would have been if you had not made the change?

No, we're not going to do that because we don't want to say there's 2 different numbers or 2 different earnings. But it's fair to say that, particularly in this first quarter of adoption, it had a negative effect on the results.

Great. And then in the competition, you mentioned that 2 companies went away and there's 3 to 4, I guess, who are on the ropes. Can you just kind of give us a little bit more detail on kind of what's going on there? And then in terms of the loans you're talking about, these guaranteed back-end loans, what does that effectively make their loan to values?

In the first one, most of the PE money came in, in sort of '12 and '13. So extending on, generally speaking, 5-year windows, '17 and '18 becomes where it's supposed to be out. So the problem is, lot of these guys came and backed these companies, made investments in these companies, and they'd like to see a return. But part of the other problem is to the extent the company grew a little bit more than they should have didn't quite have the controls in place and the results haven't been what they want, even to the extent we didn't make any money, you got a problem. And so a lot of those folks out there today are facing that problem, whether it's small companies, medium-size companies or large companies. It seems, at least from our point of view, across the industry, they all have the same problem in that they try to put together this plan, the plan probably wasn't executed quite as well as it should have and now they're standing there with not great results in terms of losses and not great results in terms of earnings. And they're trying to figure out what to do. And again, in past lives or cycles, we've been -- we've seen how this works, and it's difficult. I have huge amounts of pity for everybody who has faced that problem because it is very difficult to get out of it short of having your back or double down. So that's what's really going on with the companies. In terms of the guaranteed back-end, again, we're not 100% sure everyone is doing it, but it's certainly out there on the Street that whole lot of folks are. Generally speaking, as best we can figure, it pushes the loan-to-value in the 130% to 140% range, which is something that never in the history of our world have we ever seen. Having said that, probably everybody is not doing that, probably every loan is not like that. But when you're doing the fast math of cramming in -- if you think about it, if you're adding $2,000 or $3,000 in our world, our average amount financed is $16,000. So if you want to add $2,000 to that or $3,000 to that, you're talking about 15% or 20% right on top. And so to the extent you're at 110%, 115%, you're in the 130s probably for sure.

And kind of the final question. In terms of expenses, with your portfolio running stable, I understand you're going to spend more on hiring more marketing people. But do you get any efficiencies on the back-end in terms of servicing or as people get -- you don't need to hire new people, you can -- other than for a churn, do you start to get better yields from people servicing the loans that are existing?

You probably don't if you think about it. Let's just say you pick a flat number, we originate whatever the number is every month and the portfolio is growing, then you're going to continue that people to service those exact loans. Since our portfolio is shrinking, you probably get the benefit of not having to particularly add anybody just because you've got bodies standing there that are done servicing the loans running off and they can service the new loans coming on as much as it doesn't work exactly like that. So we would expect that what you really can't do too much of is you can't leverage the guys. The collectors need to service a certain amount of accounts and/or you need a certain amount of collectors to service a certain number of our accounts regardless of the dollar value of those accounts. And so as much as -- the better way to do it is through technology where you're using more and more scoring, more and more credit score card stuff to figure out which accounts you don't have to call at all or call less and things like that, sort of run better jobs for the collection crew. So you get more benefit and efficiencies from sort of the technology than actually sort of the bodies because, again, you need certain amount of bodies to collect a certain amount of loans. It's very hard -- we think our sort of collector ratio to accounts is probably one of the best in the industry anyway, so we probably don't want to toy with that too much. But again, to the extent we can find our ways to sort of eliminate or lower the amount of people we actually have to call, then we get efficiencies that way and/or to the extent we're using texting, which we are and things like that to the extent you can find a way to have the computer generate much of that stuff, then that helps, too.

(Operator Instructions) And this does conclude our question-and-answer session. I would now like to turn the call back over to Mr. Charles Bradley for any additional remarks.

Good. Looks like we must have answered most of the stuff up front. So probably it's a lot to maybe a little bit to comprehend in terms of switching the fair value and maybe the industry comments. But it's going to be an interesting year, I think. The good news is, we're set up in a good way. We have collections going the right way, we have a good marketing strategy that doesn't affect how we're going to buy and credit. As it happens in the industry, there's lots going on out there, lots of folks have to make some decisions and lot of people have tough decisions to make. Hopefully, we'll get some opportunities out of all that. And more importantly, at the end of the day, we continue buying our stock. We think our stock is quite valuable. At the end of all this, we should, hopefully, see that show up and show some results. Thank you, again. We'll talk to you all next quarter.

Thank you. This does conclude today's teleconference. A replay will be available beginning 2 hours from now until April 26, 2018, at 11:00 p.m. Eastern Standard Time by dialing (855) 859-2056 or (404) 537-3406. The conference identification number 6382649. A broadcast of the conference call will also be available live and for 90 days after the call via the company's website at www.consumerportfolio.com. Please disconnect your lines at this time, and have a wonderful day.