Consumer Portfolio Services, Inc. Q1 FY2020 Earnings Call

Good day, everyone, and welcome to the Consumer Portfolio Services 2020 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. Any statements made during this call that are not statements of historical facts may be deemed forward-looking statements. Statements regarding current or historical valuation of receivables, because dependent on estimates of future events, also are forward-looking statements. All such forward-looking statements are subject to risks that could cause actual results to differ materially from those projected. I refer you to the company's annual report filed March 16th and its current report filed April 16th for further clarification. The company assumes no obligation to update publicly any forward-looking statements, whether as a result of new information, further events or otherwise. With us here now is Mr. Charles Bradley, Chief Executive Officer; and Mr. Jeff Fritz, Chief Financial Officer of Consumer Portfolio Services. I will now turn the call over to Mr. Bradley.

Thank you, and welcome, everyone, to our first quarter conference call. Certainly, these are challenging times for the company. We have a lot to talk about. We've made several changes. It’s all landing in the first quarter, but we'll get through it while trying to address all those issues and then move to questions. So first off, the quarter was great. We actually had a very good quarter, certainly the end of the quarter got interesting. But we'll cover the specifics of the quarter, and we were very pleased with how everything worked. Originations functioned well, and collections were great. Overall, it was a strong quarter, particularly as tax season typically shows good results. The COVID problem began sort of halfway through March, but it really didn’t have an effect on the first quarter, which is why the numbers were good and we had solid operational results. Other than that, next we want to discuss the accounting changes. We made the change to implement CECL as of January 1st. That's composed of a few parts. Now we're operating with a global legacy portfolio and a fair value portfolio. So again, the accounting is getting a little more intricate, and we'll walk through that as well. Also, we'll talk about the coronavirus and the COVID situation. It is still early to tell the total effect it might have on the portfolio, but we’ll walk through some effects regarding originations, collections, and performance, at least with our best estimates in those areas. There are a few positives coming out of some of these challenges, which we'll address. So let’s get to it. At the beginning of the first quarter, we were very happy with the results, across the board. Originations were very good. Our sales and marketing department is doing a tremendous job in terms of penetration. We’re purchasing what we want without overextending. Collections had a very strong quarter with excellent delinquency numbers and loss ratios. It’s unfortunate that we started the year so well and then encountered this COVID situation. While that is beyond our control, if we just analyze the first quarter, it was an exceptional quarter for the company. Regarding the accounting changes we adopted, we decided to adopt CECL when we switched to fair value at the beginning of 2018, anticipating CECL from January of this year. Ultimately, it will benefit the company to proceed this way. Jeff will now walk through some of those changes.

Thank you, Brad. Welcome, everybody. We'll start with the revenues. In the first quarter, revenues reached $70.8 million. This reflects a 17% decrease compared to the fourth quarter's $85.7 million and a 20% decrease from the first quarter of 2019. The significant and unusual component affecting revenues this quarter was the markdown of the fair value portfolio amounting to $10.4 million. As you likely know, the fair value portfolio consists of receivables we've originated since January 2018. The manner in which we account for these does not account for credit losses—instead, they are factored into the yield we recognize in the revenues. Each quarter, we evaluate the carrying value of the fair value portfolio to ensure it is stated at fair value. Due to recent events at the end of the quarter, we undertook a review of the components of the fair value portfolio, estimating the potential impact of the pandemic on cash flows, defaults, and severities. With assistance from our risk department, we identified credit demographics and characteristics of the fair value portfolio, resulting in the markdown of $10.4 million reflected in the revenue line. Aside from that, revenues mainly comprised interest income. The legacy portfolio, now representing 33% of the total, yielded approximately 17.8% in the first quarter, while the fair value portfolio, making up the remaining 67%, yielded about 10.5% this quarter. Moving on to expenses, total expenses reached $67.7 million for the quarter—a 20% decline from the fourth quarter of last year and a 21% decrease year-over-year. The most significant change in expenses was the provision for credit losses, which I'll discuss shortly. Most other core operating expenses remained stable sequentially but increased roughly 10% year-over-year. Interest expenses also decreased sequentially, which we will elaborate on later. Regarding the provision for credit losses, it stood at $3.6 million for the quarter—down 83% from the December quarter and down 85% from the first quarter of 2019. We discussed earlier that we opted for early adoption of the CECL accounting method for the legacy portfolio. This annualized the allowance for credit losses, effective January 1st of this year. This means we established $127 million in lifetime remaining losses for the legacy portfolio, offset by a tax affected entry to retained earnings. The $3.6 million seen this quarter is our estimate of the pandemic's impact on the legacy portfolio. Without the pandemic, we believe there would have been no provisions for credit losses this quarter because of our established lifetime CECL allowance. We worked with our risk department to estimate the pandemic's impact on the legacy portfolio. The actual outcome remains uncertain, but something we will continue to monitor. Pretax earnings for the quarter were $3.1 million, significantly up from what was essentially a flat fourth quarter of last year, and up about 15% from the first quarter of 2019. Net income for the quarter reached $10.8 million, once more substantially increasing from the flat performance in the fourth quarter of 2019. Notably, this quarter's results also included an $8.8 million tax benefit due to the CARES Act passed recently, which aims to assist companies and individuals amidst the pandemic.

Thanks, Jeff. Alright, let’s discuss the coronavirus and its impacts. One of the first things we did, as many others did, was tighten credit. We wanted higher income, ensuring a higher payment ability. We effectively stopped making exceptions to any of our programs and raised our credit scores across the board. We anticipate a negative impact due to these changes, so tightening credit was a necessary step. In March, we initiated about $100 million in originations, but that has significantly dropped since then. We would expect this figure to settle at about half over the next month or two, depending on the duration of social distancing measures. In the long term, we are positioned for very good growth, but for now, we are evaluating our options. In terms of workforce, we qualify as an essential industry, which enabled most of our staff to work from home beginning in mid-March. We've also ensured that collections personnel are capable of working from home; however, most are currently working from the offices. We did have one office where someone contracted the virus, which has since shifted to a work-from-home model. Although we might see a slight decrease in effectiveness from remote work, overall efficiency remains stable. Our staff is dedicated, and no one is remaining idle at home. Many of our employees can perform their functions just as effectively as before. Regarding expected losses, as Jeff highlighted, we anticipate a fair value loss of $10.4 million alongside a legacy loss of $3.6 million. After thorough analysis by our risk department, it is clear that no one truly knows the duration and extent of the portfolio's effects given the current circumstances. Those estimates are based on a 6 to 10-month outlook. As time advances, we will gain a clearer picture; however, being cautious at this stage remains prudent. Notably, many of our customers are receiving $1,200 checks in aid, and all our customers qualify. Our collections team is focused on ensuring these payments contribute towards their obligations to us. We may also consider offering extensions to customers who have been reliable, potentially stabilizing overall performance depending on this situation's duration. It’s worth mentioning that our exposure to industries severely impacted by this pandemic is limited, particularly in sectors like restaurants, where most employees don't fit our customer profiles. Our portfolio should be insulated from drastic impacts, unlike 2008, and we remain optimistic given these circumstances. Regarding repossession, activity has substantially declined. We're committed to operating as effectively and normally as possible; this includes collections and originations but anticipates slower back-end functions like auctions and legal processes. We've undertaken initiatives to prepare for a potential influx of repossessed vehicles once the auction markets reopen. It’s essential to be ready for adjustments to liquidation values and recoveries from such sales. Our liquidity situation is strong, leveraging $300 million warehouse credit facilities at just 47% utilization. This provides more than enough flexibility across various durations to navigate this challenging time. While we usually conduct securitizations at quarter-end, the successful January securitization allows us greater stability during this period. The potential influx of $23 million from the tax benefit will also provide added robust liquidity, meaning we can operate securely. Overall, we're well-prepared and adaptive, with reduced volumes not critically jeopardizing our strategy. These may very well be beneficial aspects amidst this overall disruption and uncertainty that arrives for our industry. Furthermore, to understand the competitive landscape currently, we are observing that others are pulling back, tightening up, or even halting some operations, indicating how our nimbleness may provide opportunity. We’re ready to strategize as market conditions shift moving forward. Thank you for your attention.

Thanks for all the color, Brad, Jeff, and I hope everybody stays safe. Hey, Brad, I'm wondering as we look forward and you highlighted there are more unknowns than knowns at this point. For the next couple months, it sounds like your expectations are that dislocations will lead to reduced origination volume. But since we don’t know when social distancing measures will end or how this will ultimately phase out, can you share how many months you expect demand for origination to be below 50%? At what point do you evaluate the company's fixed cost base and the size of the business? This may require more than just a couple of months of reduced capacity.

Certainly we're considering all those factors. We have identified a few priorities. First is liquidity—without liquidity, various challenges arise. Our liquidity is sound. Before the tax refund, we were well positioned for the next three to five months. With the tax refund, our liquidity extends even longer. While we are not deeply concerned about liquidity, managing liquidity hinges on originating loans. We expect origination volumes to remain depressed for at least three months, potentially longer. Our initial strategy involves originating enough loans monthly to maintain our loan portfolio size. If this proves impossible due to prolonged challenges, we would look into reducing fixed overhead. We have effectively reduced costs in numerous instances and have prior experience from 2008 to guide us. The good news is that we believe we are in a stronger position this time. We lack clarity on the duration of these challenges. While dealerships remain open and continue selling cars online, we are taken aback by the current origination volumes which have not decreased drastically yet. The primary challenges remain the uncertainty of return to typical market behavior and when Wall Street markets regain stability. Ultimately, we seek clear indicators on when employment rates return to normal and Wall Street’s functionality resumes.

When you say we're going to originate enough to keep our portfolio stable, does that encompass both the fair value and legacy portfolios, or is this strictly in reference to the fair value portfolio remaining stable while the legacy continues to amortize?

The legacy portfolio will amortize as expected. Therefore, when considering our portfolio stability, we refer to maintaining our managed portfolio size, ideally around $2.4 billion to $2.5 billion, by offsetting the depreciation from the legacy portfolio’s amortization. Our target for origination would be somewhere in the range of $70 million and possibly a little higher. Currently, we might experience a slight decrease if we only achieve around $50 million. Nonetheless, it’s difficult to gauge accurately since this remains a fluid situation.

Could you provide the charge-off dollar value from the legacy portfolio for the quarter? I know typically you can derive it from other figures, but since the day one adjustment to CECL was made, I'm uncertain if I can back into it accurately.

Yes, John, I can provide that. We had approximately $20 million in net charge-offs from the legacy portfolio during the quarter.

If we exclude the CECL adjustments alongside the tax benefits, fair value adjustment, and changes in provisions for the fair value portfolio, it appears that your charge-off number indicates a loss situation without CECL. Could it be accurate to say that CECL is the primary reason you're reporting profitability at this time?

Indeed, the CECL adoption presents a unique transition as the net losses are recognized over several years. While we won’t conduct a pro forma reflecting CECL’s absence, we aim to clarify results and their implications. CECL is simply the guideline, and we’ve adapted well, proactively adopting measures over the past two years to mitigate the impact during this quarter.

It's important to emphasize that our core business remains profitable. Although CECL provides a short-term gain, the underlying basis of operational profitability hasn't changed. The impact of COVID is certainly noticeable, but we hope this is a one-time situation. The fundamentals driving our business continue to remain intact.

Despite potential cost reductions due to the pandemic, G&A and salaries show a 12% increase year-over-year, which is considerable given a stagnant portfolio. Can you comment on any plans to ensure costs remain stable rather than seeing growth at that rate?

Indeed, we've made several hires in anticipation of a strong growth year. However, with automation technologies coming in, we expect to reduce overheads significantly, independent of any pandemic impacts. We find ourselves in a challenging position having anticipated a robust 2020, with the resulting adjustments to operations necessary. Our historical experience prepares us for such adjustments. We recognize the necessity to monitor and amend costs if the situation demands. Currently, we cannot repurchase shares; however, considering the current stock price, we might evaluate that strategy.

We've discussed demand side challenges with volumes down about 50%. I’d like to shift to the supply side and any competitive disruptions resulting from the ABS market. Reports indicate used car prices have risen despite lower volumes. Have you observed any offset from reduced competition?

That’s a critical question. We've begun hearing various industry rumors about competitive actions. Several originators have ceased operations, while many have experienced layoffs and tightened controls. We may obtain additional volume as a result. However, we remain cautious about estimating the scope just yet. Importantly, we are distinguished by not relying on private equity backing or complex funding structures; our primary focus is maintaining stability within the Wall Street market for ABS deals. The current situation leads us to cautious optimism. As we gauge the shifting landscape, we intend to remain adaptable.

With regards to pricing, have you begun adjusting your pricing strategies or is it still premature at this stage?

We're slightly adjusting prices to evaluate customer response. Our goal is to identify whether we can maintain volumes with a price increase. It's vital to remember that while March began favorably, the first two weeks of April have shown significant reductions, which align with our expectations. We're still assessing the ongoing situation—it's too early to understand long-term trends.

Lastly, regarding residual values, are you modeling these based on the experience of 2008? Acknowledging that the cash for clunkers program influenced that cycle, how do you view current residual assumptions?

We maintain that our residual values should hold if this situation resolves quickly. However, volatility remains, with potential for variation based on unemployment impacts. It is crucial to understand that while we’re starting this process, we must evaluate the conditions closely. The key determiner will be seeing individuals return to work and understanding how that affects our customer portfolio. Clarity on these issues will shape our strategic outlook.

Thank you. I will now turn the floor back over to Mr. Charles Bradley for any additional or closing remarks.

Thank you. I appreciate everyone attending the call. These are indeed challenging times. The positive aspect is our preparations have set us up to manage this. We have dedicated significant time to ensure we can continue functioning. Unlike some industries, we haven't closed operations. The jobs within our company are actively functioning. This year was originally set to demonstrate strong growth, and while we expect dips, I remain optimistic about a rebound. The disruption facing our industry may prompt positive changes. Regardless, we can navigate this effectively. It is reasonable to believe that this situation won’t surpass the hardships of 2008. Since we’re still early on, we are taking careful steps. Thank you again for your interest, and we will speak next quarter.

Thank you. This concludes today's teleconference. A replay will be available beginning two hours from now until April 23, 2020 by dialing (855) 859-2056 or (404) 537-3406, with the conference identification number 3094613. A broadcast of this 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.