Consumer Portfolio Services, Inc. Q2 FY2020 Earnings Call

Good day everyone, and welcome to the Consumer Portfolio Services 2020 Second 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 are not the statements of historical facts, but may be deemed forward-looking statements. Statements regarding current or historical valuation of receivables are dependent on estimates of future events and are also forward-looking statements. All such forward-looking statements are subject to risks, which could cause actual results to differ materially from those projected. I refer you to the company's annual report filed March 16 and its quarterly report filed May 5 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'll now turn the call over to Mr. Bradley.

Thank you, and welcome everyone to the second quarter earnings call. I must note I wanted to have people on the conference call set up business get their jobs sometimes, but nonetheless - oh my God. So it's been an interesting quarter. Certainly, this is the real COVID quarter because our first quarter ended in March, and March really showed no signs. This quarter has been a roller coaster of not knowing what's going to happen, whether good or bad. The good news is the quarter stood up very well. We went from starting on April, with wondering whether we could do any more securitizations. We had to postpone our securitization. But the market recovered exceedingly quickly and we were able to get off the securitization without any problems, and actually with very good pricing. So that was a very big accomplishment. Everybody is worried about the volumes. Our volumes are off a bit, however, still functioning and everything's going pretty well. I think generally people are being quite conservative right now, both in terms of how long this is all going to last and whether there's going to be a liquidity issue. Everybody is sort of trying to maintain liquidity and being cautious, and so are we. Collections was another big challenge. Our motto always is, you can sleep in your car, you can't drive your house, but it really shows with the government check and the unemployment benefits, our customers are using that money and they're paying us. People wondered how that would all work. But our collection efforts and our results have been really good this quarter, even though we're in the midst of all these problems. So that's another huge highlight of what's going on. The earnings were good, the best earnings since the fourth quarter of 2018. We're hoping that trend will continue. So at the end of the day, we don't really know what's going to happen. So we're going to move cautiously, preserve liquidity. We're buying a little tighter. We're getting good quality paper. So we're doing a bunch of things right. And the results are there to back it up. We went from having an enormous surge in extensions in April to almost back to normal, very flat in June. So for all intents and purposes, our collection efforts are back to where they're supposed to be. The performance is obviously where they're supposed to be. So we've been very pleased with all those results. Again, still lots of unknowns, but we'll sort of talk about that a little more. I'll let Jeff run through the financials.

Thanks, Brad. Welcome everyone. Let's begin with the revenues; revenues for the quarter were $67.3 million. It's a 5% decrease from the first quarter this year and a 22% decrease from the second quarter of 2019. The six-month revenues were $138.1 million. That's a 21% decrease compared to the first six months of 2019. So I think the way to look at the revenues for the quarter is to really think about in terms of three components. Our legacy portfolio ended the quarter at $695 million or 30% of our total managed portfolio, and that portfolio is yielding 18.5%. But then the more recent portfolio, the fair value portfolio is $1.6 billion, 70% of the total. That portfolio is accounted for at fair value. So it's yielding about 10.2%. And remember, that yield is net of credit losses. So you have those two components which are going to be with us for a while, and then the unusual component is a markdown, a negative revenue component of $9.5 million on the fair value portfolio, a markdown that we took as a result of the COVID event and the uncertainty surrounding that. You may recall, we had a $10 million COVID-related markdown on the portfolio in the first quarter of this year. Moving on to expenses, $62.6 million for the quarter, that's down 8% from the first quarter of this year, $67.7 million, and down 25% compared to the second quarter of 2019. The six-month expense numbers are $130.3 million, and that's a 23% reduction compared to the first six months of 2019. So the biggest difference in expenses year-over-year is really the provision for credit losses, which has not completely gone away, but nearly gone away as a result of our adoption of CECL on the older portfolio, the legacy portfolio. But interesting to note, the sequential quarter, we did have some decreases in some of our core operating costs, like our sales expenses, and a number of expense categories that are tied to origination volumes. We had significantly lower origination volumes in Q2 as a result of the COVID event. Provisions for credit losses were $3.1 million for this quarter. That's down 14% from $3.6 million from the first quarter this year, and down 85% compared to $20.5 million in the second quarter last year. Year-to-date provisions for credit loss of $6.7 million is an 85% decrease compared to the first six months of 2019. And so you'll recall we adopted CECL, which is a lifetime allowance standard for the legacy portfolio. We did that back in January 2020 and the intent and expectation at that time was that there would be no further provisions for credit losses on that portfolio. However, the COVID event has caused us to consider that the losses in that portfolio will exceed what our January estimates were. And so we put $3.1 million into that allowance this quarter. And as I said, I think $3.6 million in the first quarter also for the legacy portfolio. Pretax earnings were $4.6 million. That's a 48% increase compared to $3.1 million in the first quarter this year and a 64% increase compared to the second quarter of last year. The year-to-date pretax earnings of $7.8 million is a 44% increase compared to the first six months of 2019. This is a positive pattern for us. For two consecutive quarters we've had year-over-year improvement in our pretax earnings in spite of these COVID-related adjustments and it's the first time really since we have adopted the fair value on the newer portfolio that we've been able to show two consecutive quarters of year-over-year improvement in the pretax number. Net income for the quarter was $3 million. That's a 72% reduction compared to the first quarter of this year, which I'll talk about in just a second, and it's a 67% increase compared to $1.8 million in net income in the second quarter of last year. Our year-to-date net income of $13.8 million is a 294% increase compared to $3.5 million in net income for the first six months of last year. So you'll recall that in the first quarter of this year we were closing the books right at the same time that the government was putting together the CARES Act response to the COVID event. And so we booked an $8.8 million tax benefit in the first quarter of this year as a result of the way the CARES Act got put into place. So that's kind of rippling through those net income numbers. If we look at earnings per share of $0.13 for the quarter, that's up from $0.08 per share for the second quarter of last year. Year-to-date $0.58 for the six months, and that's up significantly from $0.15 for the first six months of 2019. As I said, that tax benefit is rippling through there. Without the tax benefit in the first quarter year-to-date EPS would be around $0.37 per share. Moving on to the balance sheet, there’s not much to talk about, but to mention, you see the continued reduction in amortization run-off of the legacy portfolio. You may notice too that on the warehouse lines, we're only using $56.7 million of our $300 million in warehouse capacity, because the volumes are still somewhat depressed as a result of the economy just beginning to get back on its feet a little bit. Moving on to some of the other metrics, net interest margin for the quarter was $40.8 million. That's down 7% from $43.8 million in the first quarter and down 30% compared to the second quarter of 2019. This is significantly influenced as the fair value receivables become a continuously bigger and significant portion of the portfolio, and remember they're coming out at a lower yield because the losses are baked in. The risk-adjusted NIM, which takes into consideration the provision for credit losses, was $37.7 million for this quarter. That's down 6% compared to the first quarter of this year, and almost flat compared to the second quarter of 2019 a year ago. Core operating expenses were $33.1 million. That's an 11% decrease from our first quarter this year, and a 6% decrease from the second quarter of 2018. For the six months, $70.1 million is pretty close to flat, just a little bit more than the $69.7 million in core operating expenses that we had in the first six months of 2019. As I mentioned, we've got some significant expense categories that are driven directly by origination volumes. So we saw some decreases in the second quarter as a result of that. Our core operating expenses as a percentage of the managed portfolio were 5.6%. That's down from 6.1% in the first quarter of this year and down from 5.9% for the second quarter of last year. We're seeing even on that metric managed portfolio basis, the impact of some of those reductions in the core operating expenses. The return on managed assets is 0.8% for the quarter; that's an increase compared to 0.5% for the first quarter of this year, and also an increase compared to 0.5% for the second quarter of 2019. So again, we're seeing good year-over-year improvement in that important metric. Moving on to credit performance, in spite of all these COVID concerns and everything that's happened and the uncertainty, we were very pleased with the credit performance for the quarter. The delinquency at 9.6% at the end of June is significantly lower than the March number of 12.4%, and significantly lower than the 14.8% in delinquency that we had a year ago. In fact, this is the lowest delinquency number we posted since the first quarter of 2018. It was a pleasant surprise. We know that, due partially to COVID-related support; many of our customers have benefited from the government assistance, and to the extent they've lost their jobs. They're receiving unemployment benefits and bonus unemployment benefits. Frankly, we don't care where the money comes from; we're just pleased to see that customers have taken care of their car loans during the quarter. Brad mentioned extensions. We granted significantly more extensions in the month of April. To give you an idea of some hard numbers, we granted 14,000 extensions on our portfolio in the month of April. In May, it went down to 9,000. In June, we did 4,900 extensions, which compares to 4,500 extensions in June of last year. Even though we had an extension spike right at the beginning of the crisis, it seems to have normalized with what we know today, and the month of June is really just a normal number of extensions. So we're very pleased with that. Net losses for the quarter were also down from the previous year at 7.4% for the quarter, just up a little bit from 7% in the first quarter this year and down compared to 7.8% a year ago. We've talked with many of our business partners and constituents about auction liquidation numbers. We had 34% recoveries in June in the second quarter in terms of our balance at the auctions. That's actually an improvement from the first quarter and about flat from a year ago. In spite of all the turmoil and events that have happened, the auction values have held up pretty well. As Brad mentioned, our ABS transaction; we normally would have done our second quarter ABS transaction in April. In April, those markets were completely shut down. So we bided our time, kept in touch with our partners, our Wall Street partners and investment banks. We saw that window beginning to open up in late May. We let a couple of our peers in subprime auto go out and do their securitizations. Then we took advantage in early June and executed our securitization. Again, we were pleasantly surprised at the resiliency of these markets. We did five classes of bonds. The lowest subscription level was four times oversubscribed, and we had one tranche that was eleven times oversubscribed. This shows there was a lot of demand for those bonds once the markets opened up. Spreads did widen; we did have a blended weighted cost of 4.09%, which is higher than our January deal of 3.08%, but nevertheless, still a very acceptable cost of funds financing for us. With that, I think I'll turn it back over to Brad.

Thanks, Jeff. In running through where we sit today from the marketing originations point of view, I think our watchword is caution. We're going to try and grow back to our normal levels slowly and cautiously. There are less new cars out there because of the COVID problem. A lot of the new car manufacturers haven't produced cars. The mix is beginning to change. We've dropped almost 8% in the percentage of new cars we buy. As a result, we've also been able to raise our APR a little bit. We raised our fees significantly, which has also improved the credit quality. Our loan-to-values are down; our payment-to-income ratios are down. We're really getting a better piece of paper. Even though we're not getting the volumes we were getting, I think we can get back to those volumes. I think volumes across the industry will be slightly depressed mostly because most people are proceeding with caution like we are. But again, it's a little hard to tell; the industry's seems to have plenty of liquidity. It seems like everything is functioning normally, other than car sales being down. People do need cars when their cars break down. So, that's going to drive our industry almost regardless of the economic conditions. The numbers have been very good. The collection averages are doing great; we've been able to get the extensions back down to what we'll call a normalized level, and the delinquency rate is doing really well. Granted, we might be getting a little benefit from the government assistance, but for the most part, we're just performing better than we have before. We've got lots of new technologies that have improved collections. The performance has been something we’ve been waiting for a long time and now it is here. Everybody has asked about the auctions; as you pointed out, they're generally flat year-over-year. We would expect them to remain strong until new car production starts to rebuild. So, we don't have that problem. The ABS markets have rebounded remarkably well. We think liquidity on Wall Street is very good, so in many ways, everything's kind of heading in the right direction, other than we're still in the midst of this COVID crisis, which leaves us wondering when that will end. But considering the circumstances, we're very pleased with how things are going. Overall, we'll just take a wait-and-see approach. I'll make the rest of the comments after the questions. So, let's open it up for questions.

Thank you. Our first question is coming from Kyle Joseph from Jefferies. Your line is open.

In terms of the deferrals or the extensions that you talked about, the volumes were high in April, and they gradually fell down through the quarter. Can you give us a sense for the performance or the extensions that you granted in April? Are they performing consistently with your expectations? And how have more recent deferrals been performing?

Well, we do a fair amount of long-term analysis of extension effectiveness. So, we don't have any data on those most recent extensions, but we monitor that regularly and put some tables in our 10-Q document to show that. In general, we make good extension decisions. One example, Kyle, is that the cash collections have been very consistent. The dollar amounts of cash payments that the customers have made have been steady; they were actually up slightly in May compared to April, and the June numbers were level with May. I think we're satisfied that customers who received that one-month extension recognize they need to be on track after that.

And then in terms of the fair value mark and the incremental provision in the quarter, can you give us a sense of what sort of economic assumptions you are incorporating into those credit forecasts and how those have changed since March 31?

So in the fair value mark, there are two pieces to consider. One is straightforward and the other is a bit more subtle. The main factor contributing to that $9.5 million markdown is essentially we're just looking at the forecast. The whole fair value portfolio, to us, consists of a granular set of monthly portfolios starting from January of 2018. We look at each monthly portfolio, and each has a forecast for future losses. We predict that for the coming six-month window, losses might be around 10% higher. We've incorporated that into our valuation model. The other factor is a bit more nuanced; as Brad mentioned, we're getting a richer yield on the paper that we're purchasing today. To adjust our existing book, we had to adjust the yield on some of the oldest cohorts slightly up to equal the current yield. This adjustment resulted in part of the markdown of the fair value portfolio.

And one last question from me. Can you provide a sense of how volumes trended in April, May, June, and ultimately how they're trending in July?

Generally, they’re obviously going up, probably at a slightly slower rate than expected. We're doing really well with what we're buying, so the offsetting yield adjustments likely compensate for the lower volumes. This summer generally isn't a great time for growth; unless circumstances change dramatically in the next month or so, we would expect slight month-to-month increases. It's not like we're going to jump from 50 to 80 dramatically, but I would hope for at least a 10% increase each month. We'll react according to market conditions. The important thing is we're managing well with our current operations. We would anticipate a modest growth rate of about 10% each month, but we will see.

Next question is coming from Jeff Zhang from JMP Securities. Your line is open.

I just have a quick question. What are your thoughts on recovery values in terms of repossession activities in the near-term and any potential future regulatory actions?

As the market recovers, we believe auction markets will remain strong. There are a few states where repossession is not currently allowed; I think there are five of them. However, this is not having a dramatic impact on our repossession activities. The new car manufacturers have been trying to keep new car sales high for the past few years, creating an unsustainable bubble that COVID has now burst. This situation may ultimately be beneficial for the new car market as production ramps up again and demand catches up. In the meantime, we expect to benefit significantly from used cars going to auction and retaining their values. Thus, regarding repossessions we're managing well in the few states impacted, and auction values should remain strong until new car demand aligns with production again.

I don't have any further questions. Mr. Bradley, you may continue.

Thank you. I probably said we are cautious about 10 times today, but that's the operative word for our strategy moving forward. We're going to proceed carefully. We'll take advantage of markets when we can. It’s important to continue improving our collection processes, enhancing technology, reducing expenses, and managing through this well as best we can. Already, the second quarter has been great, and it’s impressive given the COVID circumstances that we were able to achieve such strong results. We're hopeful this continues and that we can navigate through these challenges ahead. Hope everyone stays healthy and safe. I look forward to speaking to you next quarter. Thank you for attending.

Thank you. This concludes today's teleconference. A replay will be available beginning two hours from now until July 29 by dialing 855-859-2056 or 404-537-3406, with the conference identification number 9486817. A broadcast of the conference call will be available live and for 90 days after the call via the company's website. Please disconnect your lines at this time and have a wonderful day.