Consumer Portfolio Services, Inc. (CPSS) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q4 2017 Consumer Portfolio Services Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instruction will follow at that time. [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. Welcome to our call. I think the way to, sort of some up the fourth quarter and then 2017 as a whole, we are sort of glad to have it done and over with. As I 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 and then again, it slowed down our normal production. We only did around $860 million as opposed to capacity, as we did about 1 billion, 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 is 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 and collections may not look particularly better. If you re-evaluated 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, as to get the collections going in the right way. And so we have achieved that. Couple of other highlights; we renewed our Credit Suisse warehouse line, and we also did a securitization in October that priced out at 4.49, which is 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 and our industry and for CPS. But I'll give you a little more detail about that in a minute. We'll 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 $191.1 million. Moving on to expenses, $99 million for the fourth quarter, that's a 2% decrease compared to $101.4 million in September of 2017 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 is down slightly, highlighted by a significant decrease in 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 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, see that sequentially down for the fourth quarter, flat year-over-year. Brad alluded to the aging of the portfolio. The portfolio is 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 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 write-downs 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 2017, 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. 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 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 Credit Suisse Ares warehouse line in the quarter for another two-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 typically some seasonal challenges in the fourth quarter. We were actually quite 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 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 got a few things going on here. Brad alluded to the really good performance in the asset-backed market, which is 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, and up a little bit more compared to 3.6% in the fourth quarter of last year. But as I said, the trend has 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 of 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 expense is $123.3 million, an 8% increase over the full-year core operating expenses for 2016. We have kind of, slight increases primarily in employee – for the full-year, primarily in employee cost and somewhat in occupancy as we have actually added some space in the 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%, for the full-year 2017 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 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 2017, 7.68%, up from 7.03% compared to last year. One thing that – I think is somewhat of positive is it’s been a lot of concern and gloom over the return on the auctions. We saw healthy options. 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, or efficiency, or 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 de-securitization that goes back to October. The blended coupon on that deal was 3.3%. We sold $196.3 million coupons. The coupon represented 160 basis points in blended spread over the benchmarks. That's the best execution that we have gotten on a securitization since the 2014 a deal, which was very noteworthy. The asset back 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'll turn it back over to Brad.

Thanks, Jeff. Running through the categories, in marketing, over the last couple of years, we certify you could do more sort of electronic presence in marketing had dealer track 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've been focusing on expanding our marketing department, beginning to growth 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, trend for 2018 is going to be loan growth in the marketing department. In originations, we probably have achieved what we set out to do there in 2017. We ended up 2017 fourth quarter with a weighted LTV of 11%, which is the lowest in probably five years. That was real focus. LTV is probably the leading indicator of credit performance. And so we set out it was to lower that down. 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 able to pick up some of that APR, hopefully going forward and probably able to pick up some of that APR, hopefully going forward. And 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 Jeff and I 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 all look particularly great, but they aren't 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 in the first quarter 7.9. We have got it down to 7.6. We think over time that number should improve as well, when the paper we have 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 small part that makes them look whole lot better as we go forward. So again, we accomplished what we wanted to in the collection world in 2017. But having said that, it probably took us three or four years to get collections back on track. I'm not so sure, that many of our friendly competitors, in the industry, can say that today. I think, it's been a real struggle for everyone. We're pretty close to saying, we've got it leg. I 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 onto the capital markets, as Jeff mentioned, a 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 that priced out with an average cost of funds with 4.49, the deal that we just did this past January average 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 sub-prime auto, the rate securitization deals performed very well and that is causing the spread to tighten and really helping us. Now sort of the down side 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 of funds that probably gives them little more run way and get things turnaround fixed. But nonetheless, overall, it's very positive thing for both CPS and the industry, but 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 going 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 of repurchased that many shares since 2015 and we continuing that program. We're probably, obviously, most active buyer in the market on a daily basis. And given the price, we think that's 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 and 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 funds probably gives people a little more time, a little more room. But again, one might hope those things would change. In terms of what we want to do, we've now, sort of, accomplished what we wanted to do 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 work 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, growing and expanding, we should hopefully get a ride the tax expansion of the tax refunds that kick start and then grow from there. So hopefully, all that will come to pass and go the right way, so that's the sort of goal of what we are 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 for questions.

[Operator Instructions] And our first question comes from the line of David Scharf from JMP Securities. Your line is now open.

Hi, good morning. Thanks for taking my questions today. Hey, Brad, just wanted to make sure, I heard correctly. It sounds like you're pretty confident that notwithstanding the competitive environment, but based on what sounds like a lot of progress on 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 a 1 billion of production this year? Is that a fair assumption on our part?

It's a fair assumption, making a reality, of course, takes a little bit of time. But like I said, we've done about everything, we think, we needed to do, and in terms of the credit quality we buy today and in terms of our collections perform. So we have got those two pieces, where we want them and what's makes us to grow. Having said that, the market continues to be difficult and everybody is very competitive, that could slow the progress. But nonetheless, I think we have some ways so that we can get out and grow and we certainly are going to try. Again, we will have to see how that goes and we have about four 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 there is people that are trying to make things work. 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 it. 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 a sort of a five-year low? I mean, is that something that you have room to play with now? Do 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 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'd move it. But we will see. A lot is going to depend on what the market's doing. The fact that we went to 111% is probably one of more reasons, we didn't grow much in 2017. And my guess is other folks are kind of going the other way. But I’d be curious to see what other people do. They start falling back and 111% could stand to the extent they don't. And we like, sort of, how the collections coming and the performance have been. We might nudge a little bit, but we are probably relatively comfortable with 112%, 113% not too much higher than that. So 111% will give us a little room.

Got it. And then another sort of growth-related question, as we think about the investments. Just trying to get my arms around, whether the increase in marketing and bodies 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 should significantly outweigh the cost. You may, if it goes slowly, catch a little cost first. But in the end, the revs will more than recover the expense of the revs themselves. So I tried to hedge my belly a little by saying, no you won’t see any expense increase. Because if it goes slowly, 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 two years, we want to protect our book value and so you would have 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 are doing it. And we would probably rather talk more about that in first quarter when we have something more definitive to talk about. But Jeff can explain how that process is going to work?

And from a disclosure standpoint, yes, I think, we want to be transparent, obviously 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 two portfolios, the traditional portfolio and the more recent fair value portfolio. And then, for instance, in their earnings release and the MD&A, we can bifurcate the portfolio to each segments of the portfolio.

Got it. Thanks very much.

You are welcome.

Thank you.

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

Hey guys. 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 is going to have a little more money in their pocket and our particular customer, that money pretty much earmarked towards paying us. So I'm just on just the face of it, any kind of tax cut benefits our folks probably more than anyone else, because they probably are very tight on the disposable income. One of the things that we sort of go along with is the theory that even though the actual money isn't going to be that much for 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 where the economy hopefully our guys will be able to get more jobs if they need to our 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, help us both in terms of the in terms of the performance. It will meet our customers going forward as we buy them should perform better. Having said that that's kind of a big, bad to say, let’s losing our standard all in more money. But these are the answer is that we continue what we are 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 the trend or is that more of a seasonality thing. Can you talk a little bit about that?

Sure. The fourth quarter number is always the worst quarter of the year. So we've done pretty well there. My kind of hope is better than there. I think probably the way we would look at it somewhat objectively is we think we have got it towards flattened out. So any improvement going forward would be great. And then again if you compare 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 will improve.

Okay. And then some of the final question in terms of the employee cost side, are there any economies that you think you guys can realize there as you sort of hit this plateau or do you still more geared up for growth?

I mean you could, but the problem is, we started growing. We cut some jobs. If things are going, we will hire them back and we further have them there in train. We originated $1 billion in 2018 and I’m going to see the employee costs. I mean it disappear – I mean I’ll go back towards post of it. So it’s not something we’re going to – it’s really most of the people sort of we – we could spend that money on people were hiring and growing ourselves in other words training. It's just you don't want to throw away training so that you cut the cost. So we thought about more efficiently than anybody in the industry anyway. So we're not overly concerned with that kind of aspect of it. But just for the sake of cutting cost probably isn't the wise move for bright future.

Thanks.

Thanks, Mitch.

And our next question comes from the line of John Hecht from Jefferies. Your line is open.

Hey, guys. I apologize, I missed some of the prepared remarks and I actually had to drop out for some of the questions, so I apologize it is redundant. And I know you did talk about some of the competitors aspects business, but I’m wondering, within those areas, sub-prime in your prime lending, were you seeing more and/or less competition and are you able to kind of pass on rate increases at this point in time, do you see opportunity there?

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

Okay. That’s helpful. And then the question – the second would be, what did you guys seeing in terms of residual value trends we’re seeing. What’s the outlook in 2018 versus the trends we saw in flat 18?

You mean of sales or financing of residuals or talking about…?

These kind of value when you replenish – are what you guys are seeing there?

Actually we're thinking of, auction values look like they’re leveling off. They're right around 34%, 35%. As we 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 have been rather consistent in that 34% to 36% range for few quarters. The extended stay there, that would be great. Again if our best was 42% or something like that, and the worst is 30%, so we're kind 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. You guys have been in a similar ranged now 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 two, and then that is the context of how you might prepare for the implementation as well?

Well, we’re probably – one of our big concerns is hanging on our book value, since it's taking a lot of create in the first place. And that's what's drive our seesaw preparation. I think it's an impossible task to keep your book value growing and up to make your leverage given the debt really look good. But it certainly looks better and most people know what's going on can look at the book value and keep it, and 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 it will start to growing again, the number starts. But that will be a positive. To the extent, our portfolio grows and it increases leverage against our book value, we're probably comfortable with that, particularly since we have a pretty good book value. Obviously, that’s a focus. As I said in 2018, we want to grow. We think we’ve got collections and originations going in 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 year, when CESL does get implemented in 2020.

Okay. And final question, did you mention your 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.

Okay. Great. Thanks very much guys.

Thank you. End of Q&A

Thank you. At this time, I’m showing no further questions.

All right. Well, like I said, 2017, we're hoping will be the cumulation of our regrouping and rebuilding in getting them and go in the right direction and leading to a hopefully, prosperous and growing 2018. Early in the year, we want to see how it goes. So far, it's doing well. So we're optimistic that both the industry should so some signs of doing a few things. If the M&A activity ever gets going, that will be a positive for the industry and for CPS. Because obviously, if people get bought and you have better people running the place, those places. The people go away, that creates more opportunity for everybody else. So once that M&A activity begins, that will be a very good sign. It will make it easier for us to grow. Even with that, we are going to try really 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 is some preparation to done. But again, in the long run that benefits us more than, sort of, just waiting around in 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 middle of April.

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