Consumer Portfolio Services, Inc. Q4 FY2020 Earnings Call

Good day, everyone, and welcome to the Consumer Portfolio Services Fourth Quarter and Full Year 2020 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 valuations or receivables that are dependent on estimates of future events are also 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 16 and its quarterly report filed November 3 for further clarification. The company assumes no obligation to update publicly any forward-looking statements, which 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. You may begin.

Thank you, and thank you, everyone, for joining us on our call. I think probably the best way to look at the fourth quarter is that it's the end of 2020, and everyone, certainly, us included, is glad to be done with 2020. It's been certainly an up and down year, a difficult year in many ways. But in other ways, it was quite good for us, and certainly, the fourth quarter reflects that. We had, if you take year-over-year, the fourth quarter delinquency was 12% versus 15.5% last year. So that was very strong. Losses were 5% versus 8%, also very strong. The recoveries were not unusual, but what we'll call historically high at 42% versus a normal 33%. So lots of the numbers went the right way. We have many good things that happened in the fourth quarter. We also renewed our Citibank warehouse line. We continue to have a very strong partnership with those folks. We do a lot of deals with them and have a good working relationship, and the line continues to improve each time we renew it. So we look forward to continuing to do our business with them. One thing we didn't do in the fourth quarter was an ABS deal given the pandemic and the cutback in volumes. We didn't have enough volume to really make it feasible to do a deal in the fourth quarter. However, we executed one pretty quickly in the first quarter of 2021, and that deal was probably the best ABS deal in the history of the company, with all-in costs of 1.1%. So that part worked out really well. The negative aspect of the fourth quarter and certainly for the year, which I'll talk about a bit later, was just the struggle for volume. Given the pandemic, given the financial markets sort of closing or slowing down dramatically for a little bit, and even just the foot traffic of dealerships struggled in 2020 and certainly in the fourth quarter. But the flip side of that is we were able to really focus on cutting some expenses. We really focused on core quality. If you look at the ABS performance since literally 2018, it has been substantially better every single year. And I'm not so sure there are too many companies out there that can say that. Certainly, with the lower cost of funds coming along, that's going to help out a few of our overly aggressive competitors. But nonetheless, it's still long run, probably just as good for us. So I'll get more into the year after Jeff runs through the fourth quarter financials.

Thanks, Brad. Welcome, everybody. I'll begin with the revenues. $62.4 million for the fourth quarter. That's a 12% decrease over the third quarter of this year and a 27% decrease over the fourth quarter of 2019. The full year revenues for 2020 were $271.2 million, which is a 22% decrease compared to $345.8 million in the full year 2019. There are three important components when you break this down. First of all, the legacy portfolio now is around $500 million, representing 23% of the total portfolio and currently yielding 18.5%. The fair value portfolio, which includes everything we've originated since January of 2018, is $1.7 billion or 77% of the total portfolio, yielding 10.3%. Remember, too, we've talked about this many times; the fair value portfolio yield is net of losses, which is why you see what looks like such a dramatic decrease in revenues year-over-year. The third component this year is the markdowns we've taken in the fair value portfolio, reflecting the COVID environment: a $6.5 million markdown in the fourth quarter and $29.5 million for the full year. This can be a little confusing. This is kind of a contra revenue item, so it detracts from the revenue rather than being an expense. Moving onto expenses: $56 million for the fourth quarter. That's a 14% reduction compared to $64.8 million for the third quarter of this year and a 34% reduction compared to $84.8 million in the fourth quarter of 2019. Full year expenses were $251 million, which is a 25% decrease compared to $336 million in 2019. We've seen year-over-year reductions in almost every expense category due in part, as Brad alluded to, to lower originations volumes, but also to some of the efficiencies we've built in and technology investments that we've made not only in 2020 but really in the last couple of years that are starting to pay dividends. The biggest decrease in expense comes from the provision for credit losses. Looking in a little more detail, we actually had 0 provision for credit losses in the fourth quarter compared to $7.4 million in the third quarter of 2020 and $21.5 million in the fourth quarter of 2019. We had $14.1 million in provisions for credit losses compared to $86 million in the full year of 2019. Since we adopted CECL for the legacy portfolio in January 2020, we established what we thought was a lifetime allowance for credit losses. Throughout the year, as you know from following this, we've been taking some additional provisions for credit losses related to the pandemic, except for in the fourth quarter, as you see. Pretax earnings were $6.5 million for the fourth quarter. That's a 10% increase over $5.9 million in the third quarter this year, and while a huge increase over $1 million in the fourth quarter of 2019. Full year pretax earnings were $20.1 million, which is over a 100% increase compared to $9.2 million for the full year of 2019. Net income for the fourth quarter was $4.1 million, an 8% increase over the third quarter of 2020 and a substantial increase over the very small fourth quarter net income last year. Net income for the full year was $21.7 million, almost a 300% increase over the net income of $5.4 million in 2019. We've discussed this; the net income for 2020 includes an $8.8 million tax benefit that we booked in Q1 of 2020 as a result of the CARES Act and how it affected our deferred tax asset. Diluted earnings per share were $0.17 for the fourth quarter, just $0.01 over the third quarter of this year and a significant increase over less than $0.01 in the fourth quarter of 2019. For the full year, diluted EPS was $0.90 for 2020 compared to $0.22 for the full year of 2019, and that tax benefit I just mentioned represents $0.37 to the bottom line for 2020. Moving onto the balance sheet, we have a strong liquidity position that has improved throughout 2020 as a result of better-than-expected credit performance in the ABS pools, which resulted in more releases of cash from those trusts. Consequently, we can rely less on warehouse financing, which helps us save on interest expense. The receivables portfolio was discussed earlier, the legacy portfolio down to 23%, and its remaining life CECL allowance now represents 16% of that active portfolio. Looking at the liabilities, I mentioned lower warehouse usage due to lower volumes and the strong liquidity position. The net interest margin for the quarter was $39.5 million, a 14% increase compared to the third quarter this year, a 32% decrease compared to the fourth quarter of 2019. The full year net interest margin was $169.8 million, a 28% decrease compared to the $235 million in the full year of 2019. The blended cost of all of our ABS debt was 4.3% for the fourth quarter and is down just a little bit compared to 4.4% in Q4 of 2019. Core operating expenses for the quarter were $33 million, which reflects a 2% increase compared to $32.5 million in the fourth quarter this year but an 8% decrease compared to $35.8 million from the fourth quarter of 2019. For the full year, core operating expenses totaled $135.6 million, a 3% decrease compared to $140.3 million for the full year of 2019. Return on managed assets was 1.2% in Q4, up a bit from 1% for the third quarter of this year and a large increase compared to 0.1% in the fourth quarter of 2019. The annualized return, pretax return on managed assets, was 0.9% for all of 2020, which is over double the 0.4% from the full year of 2019. The credit performance has been better than expected, given the circumstances. A delinquency rate of 12% at the year-end is a 300 basis point decrease compared to 15.5% at the end of 2019. Annualized net losses for the year were 6.5% compared to almost 8% for the full year of 2019. Brad also mentioned the returns from the auctions. We're still seeing 42% in the fourth quarter, down a little from 45% in the third quarter this year. Brad mentioned the exceptional success of the 2021-A transaction in January, so I can turn it back over to him.

Thank you, Jeff. Looking back at 2020, certainly, the big focus was the pandemic. We started off thinking it would be whatever year we might have thought it would be. By March, we knew where we were going. Normally, we would have done a deal in early April; we couldn't do a deal, and no one else could for that matter. So there was no ABS. For a moment, it looked like 2007 all over again with the markets closing down. But, of course, that did not happen, which is good. We had a problem, and when they finally started loosening up a bit, around April or May, they needed more cash, and the stress levels were increased, requiring more cash. Normally, things like that would have caused us serious problems. Ironically, because of the stimulus and elements of the CARES Act, we picked up $23 million in cash. The stimulus benefitted all of our customers, and suddenly, we had this tremendous cash flow. Now part of that was due to our tighter credit over the years. Consequently, we ended up in a great cash position coming through the pandemic. The next hurdle was what we would do with people not being able to come to the office. We had to come up with a strategy for everyone to work from home, which we timely addressed. All technical and legal tasks were accomplished without any problems. This situation really opens the door for us to make permanent changes in our real estate leases that could save us a lot of money. It's ironic; the pandemic caused numerous problems, and while we'll be glad to see the end of it, it also gave us the opportunity to implement several initiatives. We've started a nearshore collection operation that has proven beneficial. We automated many collection models and spent time on various initiatives that should pay off in 2021, assuming we can finally leave the pandemic behind. The collections during this period have not solely been attributable to the stimulus; I believe the initiatives we have worked on for the last couple of years contributed significantly as well. If you look at our originations and performance, each year has improved progressively. This trend has been developing over time, with the pandemic and the stimulus accelerating positive outcomes in 2020. We've also successfully reduced some expenses; whenever we face such challenges, like in 2007, we tighten our belts, which has positively impacted our performance. Managing the problems was indeed busy, but we maintained focus on improving our processes. As Jeff pointed out, by the end of this year, we should nearly complete our transition to fair value accounting, an essential requirement for us. However, the negative aspect of all this remains the significant challenge of volume growth. Currently, as seen in the fourth quarter and continuing into 2021, due to the low cost of funds, many aggressive competitors are seeking growth for ongoing portfolio performance. We would love to grow but will not do so at unsustainable costs. Hence, we plan to be somewhat more aggressive without jeopardizing our credit quality. As for the future, I believe the low cost of funds will persist. As mentioned, we achieved an unprecedented low cost for our January deal, and, based on current trends in the economy, I foresee interest rates remaining stable for some time. This situation aids numerous competitors, allowing them to hide problems in credit quality. While we will continue our strategic partnerships, we've learned over the last few years that we can achieve greater benefits by collaborating effectively. We have several initiatives lined up for 2021, so we have a lot of positive momentum. However, reflecting on 2020, it was fundamentally about how we responded to the pandemic, and I believe we excelled in that aspect and identified several opportunities amid the challenges. As stated at the very beginning, we look forward to placing the pandemic in the rearview mirror. Hopefully, over the next few months or in the next quarter or so, we will focus on running and growing the business instead of reacting to various marketplace issues. Overall, given how 2020 started, it turned out surprisingly well, revealing numerous silver linings from our efforts. At this point, we are into 2021, and we anticipate a very good year, looking forward to discussing our achievements in the future.

Our first question comes from David Scharf with JMP Securities.

Congrats on getting through a very challenging year. Brad, maybe two things. First off, I know it's difficult to predict what volumes are going to look like this year, particularly with more stimulus coming and the effects of the vaccine on just foot traffic potentially. As we think about the cost structure, I believe last quarter you provided an update that as much as 20% of the workforce may have seen that reduction from a combination of belt-tightening and natural attrition, given the lower volumes. If volumes stay at current levels, will employee costs remain at these levels going forward, or is there even more room to cut?

The easy answer is there's always more room to cut, but the safer answer is I would say they'll stay at these levels. You got it right. Between the belt-tightening and natural attrition throughout this period, we've reduced costs. I don't foresee rehiring to anticipate growth or similar outcomes. Given advancements in automation, we can grow without significantly expanding expenses. The growth situation is complex, as low cost of funds enhances our margin while presenting opportunities for aggressive competition. Our recent deal had a 1% cost of funds, and of course, one could argue that we should be aggressive to capture more market share with such favorable margins. However, quick growth can lead to negative surprises if market conditions shift unexpectedly. Various firms are pushing boundaries aggressively, but we aim to do this carefully, especially considering the ongoing pandemic and limitations in consumer behavior due to recent events. We've noted that Capital One or Santander have been aggressive and can afford to take on more risk, which affects our competitive landscape. To answer your query, I believe maintaining a steady expense line isn’t a bad strategy. After all, generating volumes to increase growth is something we'll have to address.

That's helpful. As a follow-up, regarding the revenue reporting, concerning the 10.3% yield, the risk-adjusted yield on the fair value portfolio. Using that as a basis, as we consider the relatively low delinquency levels now, how does that affect the loss outlook this year, and might we see some pricing pressures based on the lower cost of funding? Should we expect the 10.3% yield to increase or decrease as those factors come into play?

There are many moving pieces involved with the 10.3%. It's understood that estimating losses makes it risk-adjusted; there are also components relating to coupon rates and receivables, along with the fees we either pay or charge to the dealers. As Brad indicated, we're working to leverage various strategies to grow the business. One lever we might pull is to provide better incentives to dealers to encourage contract submissions. Additionally, our risk management team will determine when we can acquire contracts that may seem riskier but do not necessarily translate into higher loss expectations. Our business plan operates well at about a 10.5% risk-adjusted yield with the given pricing, making us comfortable targeting that level with fluctuations based on these other variables.

Our next question comes from the line of John Rowan with Janney.

I want to focus on the implications of the legacy portfolio finally maturing. Jeff, you indicated the size and yield of the portfolio, which would imply revenue generated through the legacy portfolio around $24 million. Correct me if I'm wrong here, but if that's accurate, it suggests that without that, the company may not seem profitable based solely on the fair value portfolio.

There are nuances tied to the legacy portfolio. For example, we either pay or charge dealers fees when acquiring those contracts, which are included in the net yield on the legacy portfolio and recognized as income over its duration. It's a minor component but still relevant in the total revenue picture. I believe that with the 10.5% yield on the fair value portfolio and our decreasing cost structures through efficiency improvements, the company remains profitable.

Could you provide finer details on the actual revenue generated from the fair value portfolio, especially after deducting the dealer fees? It seems that once the legacy portfolio diminishes, unless funding costs drop appreciably, profitability might face challenges.

Also, please consider that we recorded $29.5 million markdowns on the fair value portfolio this year, which impacted the revenue. The majority of that was pandemic-related. For a holistic view of the fair value revenue, we offer a breakdown of the fair value revenue and the legacy portfolio revenue in our 10-K, which should be helpful.

Lastly, regarding the legacy portfolio, I believe losses have been around 11%, with an allowance of about 14% to 16%. If we don't realize that 16% in losses, do we get to credit the difference back through the provision expense, given that those allowances established based on CECL were not charged directly to earnings? Is it accurate that the unused allowances would adjust earnings as the portfolio winds down in 2021?

Yes, that's theoretically correct. I've noticed some institutions that have filed their earnings reports recently have reversed some provisions made earlier due to pandemic-related losses, which come back through the P&L as negative provisions for credit losses.

Our next question comes from the line of Kyle Joseph with Jefferies.

Congratulations on concluding 2020. Regarding the legacy portfolio, a significant portion of the credit strength in the quarter appeared to stem from improvements in that segment. Could you elaborate on what specifically drove that in the quarter and the outlook for that portfolio's credit performance?

We attribute the credit strength, particularly the losses, primarily to the auction recoveries, which have been substantially better. Normally, with a seasoned portfolio like the legacy portfolio, it can fluctuate significantly towards the end. However, this particular segment did remarkably well regarding liquidations at the auctions. Also, overall delinquencies for such a mature portfolio have been better than anticipated.

Can you share your outlook for used car prices in 2021?

I believe our recoveries will drop as manufacturers catch up, leading to decreased demand for auctions. However, at least for the rest of this year, the market appears strong. Regarding the legacy portfolio, these accounts have been in their vehicles for quite some time. Many are fluctuating between current and 30 to 60 days delinquent, and receiving a stimulus check enabled them to catch up unexpectedly. They benefit from the infusion of cash, and as a result, this stimulus has had a clear effect on performance. However, in the fair value realm, while there are benefits from stimulus checks, they're not as pronounced as that in the legacy portfolio. Nonetheless, I think we'll see a robust used car market for the remainder of the year.

For my last question, regarding the fair value markdown, what triggered it in the fourth quarter? Considering the pandemic, the economy has been gradually recovering. Under what circumstances might we expect to see no fair value adjustments going forward?

That's a great question. One thing we’ve learned over time is to remain cautious. So, for most of 2020 and throughout the pandemic, while many positive developments occurred, we were uncertain of the future. Moving into 2021, perspectives vary. Depending on which forecast you believe, we could face significant challenges or already be nearing a resolution. If the reassurances are accurate, we would likely not face more fair value adjustments this year. While we view the future positively, caution remains prudent.

Thank you. I'm showing no further questions. I will now turn the call back over to Mr. Charles Bradley for any additional or closing remarks.

Thank you. I believe we've summed up our current position adequately. The fourth quarter was a positive way to wrap up the year. Overall, 2020 unfolded remarkably well, given the challenges we faced. As emphasized during this call, 2021 should be much more favorable as we won't have to navigate the pandemic, enabling us to focus on our core business of running, growing the company, increasing profitability, and addressing our stock price. Thank you all for joining us, and we look forward to speaking with you again soon after the first quarter.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. A replay will be available beginning 2 hours from now into March 3, 2021, by dialing (855) 859-2056 or (404) 537-3406 with the conference identification number 3998868. 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 any time, and have a wonderful day.