Consumer Portfolio Services, Inc. Q1 FY2021 Earnings Call

Good day everyone and welcome to the Consumer Portfolio Services 2021 First Quarter Operating Results Conference Call. Before we may 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 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 10th for further clarification.

Thank you, and welcome, everyone, to our first quarter conference call. I think the easy way to look at it, we had a nice quarter, worked really well. If you compare it to last year's first quarter, we had an excellent quarter. But again, last year, it was a different kind of year. We're really more interested in getting back on track, sort of our general growth mode and sort of forget about last year's pandemic problems. Certainly, given the circumstances in the beginning of this year, it seems to be the case. Obviously, with the government stimulus checks, it's really put in a huge impetus for us to grow. It's also helped performance tremendously. So we sort of have to calculate a little bit about how much of that is an impact from the government, how much of it is us doing things well, and as we go forward. Obviously, we think a lot of that is because we're doing quite well, but we'll see, and time will tell. A bunch of things we have been working on and we've done a lot like automation and improving the processes. All those are having strong effects on how we go forward this quarter and the rest of the year. In terms of ABS, one of the things we did, we achieved the lowest ABS cost of funds in the history of the company at 1.11%, which is relatively unheard of. But given how the economy was sitting, those are the kinds of deals people were able to get done. Certainly, everyone else has seen that too, but for us, it was sort of remarkable to be able to do a deal at that low cost of funds. That low cost of funds will probably stick around for the foreseeable future. It will probably creep up a little bit as we go forward. But again, it's going to be an enhancement. It's going to be very helpful for the remainder of this year. The government stimulus checks, not everyone we know gets one, but every one of our customers does. And so having that effect has really helped in terms of the delinquency and our charge offs. So as you can see by the performance numbers, as long as those checks keep coming, our performance numbers are going to be very, very strong and should continue that way. So that's also a very good thing. I'll get into more of the specifics of what we expect for the quarter and over the next few quarters after Jeff goes through the financials.

Thanks, Brad. Welcome, everybody. We'll begin with the revenues, $63.1 million for the quarter that's up 1% from our fourth quarter of 2020 and down 11% from $70.8 million in the first quarter of 2020 last year. When you look at the revenue breakdown, we're really in the home stretch of our transition to fair value accounting on the portfolio. The legacy portfolio is only $421 million or 20% of the total portfolio and is yielding about 19% in this quarter. The fair value portfolio is $1.7 billion or 80% of the total portfolio yielding this quarter, 10.4%. And as you know, from our discussions, that yield of course is a net of losses, which are baked into that fair value calculation. The other significant component this quarter in the revenue is the markdown of the fair value portfolio of $4.4 million. This is related to adjusting the yield on some older segments of the value portfolio to match the yield of the paper we bought in the first quarter. So essentially, we raised the yield on some older components of the fair value portfolio, and that results in a markdown of that portfolio. And now all the segments of the fair value portfolio are yielding at about the same percentage. Moving on to expenses. $55.2 million is a 1% decrease compared to the fourth quarter of $56 million and an 18% decrease compared to the first quarter last year of $67.7 million. Especially year-over-year, there are significant reductions in categories such as interest expense and employee costs, and other captions are lower due to somewhat lower volumes, but also due to efficiencies that we've incorporated over the course of the year and the last couple of years. Provisions for credit losses, while there's 0 for this quarter, a year ago, in the first quarter, we took a provision on the legacy portfolio of $3.6 million that was related to the expectations of higher losses due to the pandemic. And I'll talk a little bit more about the CECL allowance as we move down the schedule here. Pretax earnings for the quarter were $7.9 million, a 22% increase over the $6.5 million from the fourth quarter of 2020 and a 155% increase over the $3.1 million pretax earnings in the first quarter of 2020. Net income was $5.2 million, a 27% increase over the fourth quarter of 2020 and a decrease compared to $10.8 million in the first quarter of last year. You'll recall that in the first quarter of last year, we recorded a tax benefit of $8.8 million, which resulted from the CARES Act, the first sort of pandemic-related government action that resulted in this kind of one-time tax benefit flowing through the net income number.

Okay. So to try to get a picture of where we sit today, given all the numbers we've just shared, we're in a very good spot. The pandemic, as much as it ruined last year in many different ways for everyone and certainly us, did give us a chance to sort of set up for the future. And that's what we've done. I think the first quarter numbers reflect that. I think if you're going to pick two words as we go forward this year, one is growth and the other is leverage. We want to get back to growing the portfolio, growing the company. That will be the focus for the rest of this year. And leverage. We've tried to implement lots of automation. A few things we've done include starting to use nearshore collections a while ago. We now use nearshore originations. Along with the automation, we have been able to cut back our workforce by almost 25% in the last year. Because of the pandemic, a lot of effort went into being able to work from home, so working remotely. That really was effective. We were able to do it without any loss.

Our first question comes from John Rowan with Janney.

It's John, obviously. I just want to focus in on what the company looks like, where the profit comes from once we're done with the legacy portfolio, right? I mean, obviously, you're looking at cutting costs, funding costs are down with the last ABS, but I just want a very simple model, right? You're going to have a portfolio that's going to yield 10%. Right now, your funding costs are 4% and your operating expenses are 6%, which leaves no pretax income margin. What changes in that model when the fair value portfolio is the only portfolio? And where do you get pretax profit margin from?

Well, the fair value portfolio is trending up, and the newer step that we put on is at 11% in a couple of monthly cohorts, more than 11%. So they're going on between 11% and 11.2% in individual monthly cohorts. And so that's a function of the structure of the receivables themselves, like what the coupons are and what the fees that we pay or charge the dealers and the expected losses. So we are improving the top line revenue generation of the fair value portfolio. The other component, the big component that you mentioned is really the operating cost as a percentage of the portfolio. The infrastructure that we have in place supports a much bigger portfolio than the $2.1 billion or so that we have on the books. We expect to grow the business this year. We've made some improvements on the credit side of the business in terms of service levels, automation, and pricing. That we think will allow us to grow the business significantly this year. The corresponding servicing and operating costs are not going to increase proportionately. And so we think there's a lot of profit potential in the business model.

But that's just dependent on growth, though, right? Because I mean, you need to generate that leverage on your operating expense base by growing the fair value portfolio from where...

As Brad said, that's one of our priorities, right?

Okay. When will the legacy portfolio finally run off? It seems like it's taking longer than we had initially talked about.

Yes. And that's what happens. When you look at a static portfolio that's just kind of sitting out there running off, a lot of these consumers in these loans, even though they have like a 60-month loan, they get to the end and like, I've got 6 more payments because I've been late often. And so they - more of their payments have gone to finance charges. And so the tail of these loans tends to linger on for a while. But I mean, it's down to $421 million. By the end of the year, it will be nearly insignificant.

Our next question comes from Kyle Joseph with Jefferies.

Just want to understand the fair value marks. I know you talked about it being attributable to kind of the yield enhancement you're seeing on the fair value portfolio. In terms of that yield enhancement, is that a function of higher gross yield and lower expected losses? And then would you expect any incremental yield fair value marks going forward?

Well, so any given period, we look at the receivables that we acquired this month, for example. And it's like, well, based on the APRs on those receivables, the fees that we charge or pay to the dealers, and the expected losses, the IRR is, say, 11.1%. And what we've seen is that when we first started the fair value accounting back in 2018 applying those same variables and assumptions, we got generally lower yields of between 9.5% and 10.5%. But as the business has evolved, a normal evolution over the last few years, we've been able to improve and partially this is due to somewhat lower loss assumptions because of the credit performance, even before the pandemic hit, we've been seeing significantly improved credit performance. And so we've been adjusting the IRRs on these older cohorts to match the IRRs of the new business. It's a combination of better, somewhat lower loss assumptions on the newer business, but also better APRs and pricing compared to what we were getting back in 2018 and early '19. And yes, there are going to be, from time to time in the future, similar types of marks to the portfolio if the economics change. If the competitive marketplace is sort of static, and we keep our guidelines and our pricing kind of the same, then we should have pretty much the same yields which would not create much volatility in terms of marks to the older portfolio. But if we chose to be significantly more aggressive in the pricing, for example, then potentially that would have a domino effect going back to some of the older cohorts or if we drastically change a model. Neither of these things I would expect us to do. But if we drastically change the credit profile, that would impact IRRs in the current business, and again, potentially would roll back to the older stuff. We don't make drastic changes to the pricing and the credit model; it doesn't move the needle very significantly.

Got it. And then, yes, regarding credit performance, obviously, been very strong. But with stimulus in the rear view mirror, weighing in elevated used car prices and which should be an improving economy, how quickly do you expect credit to kind of normalize over the remainder of the year and into next year?

That's an interesting question. Certainly, our hope is that we've done nothing wrong in terms of the paper we're buying currently and the automation we have and our strong collection efforts. We won't really lose too much. But it's kind of like you hope for the best and prepare for the worst. So I think you'll probably see... I would bet over the next second and third quarter, this call, by the end of the third quarter, it should be normalized. And assuming they don't start sending out more checks, there seems to be a lot more uproar about ending this unemployment. The amount of jobs open is crazy and going up. So you would think let's just assume over the remainder of the second quarter, that all stops to get people going back to work. Maybe it takes one more quarter to normalize. So you would probably expect by the end of the third quarter for those numbers to be sort of what we call the real numbers that we're capable of providing.

And there are no further questions at this time. I'd like to turn the floor back over to Mr. Charles Bradley for any additional closing remarks.

So I mean that kind of wraps up our first quarter. Like I said earlier, I think it gives us a great position for the rest of this year. Assuming all things go the way we would hope they would, we would expect things to be good. We will be talking soon enough after the second quarter. Thank you all for attending.

This does conclude today's teleconference. A replay will be available starting two hours from now until May 18, 2021, by dialing 855-859-2056 or 404-537-3406 with conference identification number 7645419. A rebroadcast of the conference call will also be available live 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.