Consumer Portfolio Services, Inc. Q2 FY2021 Earnings Call

Good day, everyone, and welcome to the Consumer Portfolio Services 2021 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 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 10 for further clarification. The company assumes no obligation to update publicly any forward-looking statements, whether as a result of new information, future 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 to our second quarter earnings call. The easy way to do this is that we had a really good quarter. It's probably one of the best quarters we've had in the history of the company, not just because of the earnings, but just the way the company is now functioning. We literally are firing on all cylinders across the board, from marketing originations to collections, just about everything we can think of, it's all going about as well as we possibly can get it to go. So that certainly makes it look good for this quarter and hopefully quarters going forward. Sort of highlights of it. One of our things coming out of the pandemic was to focus on growth. And you can see by the numbers that we've done that. We originated, let's see, 286 million new contracts, that's 39% growth quarter-to-quarter and 112% year-over-year. So pretty good numbers there. Part of the reason for that was a focus on data analytics. We have a brand new scorecard that's working wonderfully well. It's probably the best one we've had. It's our Gen 7 scorecard. We actually have a Gen 8 in the works. Again, we think that trend will continue, but it's been very helpful in terms of the marketing push. And again, we have a continued focus on collections. We're using multiple new scorecards that have been very, very effective. All the branches are performing wonderfully. So again, everything is going well. Also, we focused on efficiency coming out or through the pandemic. We cut the workforce but we've still been able to get all these good results. So we cut the workforce by 25%. And literally, we've lost nothing there. So we've been able to become more efficient through technology. We're doing a few things offshore or nearshore. So all these things are kind of coming together to really come up with performance. We also, as we pointed out in the press release, raised $50 million of new capital basically under the premise that the best time to raise capital is when you don't need it. And so we did. We got a nice rate on that, and that will be helpful in the future as we continue to grow. One last note and probably one of the most important, whether it's because of the stimulus or just improved collection processes, over the last 12 months, our cash flow over forecast has been $65 million. So we've achieved $65 million over and above the forecasted cash flows over the last year. So we're certainly in the strongest cash position we've ever been in as a company. So all those things, like I said, just straight really across the board, stock price is finally moving up a little bit. I'm going to focus on that some more. And I'll go into a little more detail on all these things after Jeff walks through the financials.

Thanks, Brad. Welcome, everyone. We'll start with the revenues for our second quarter, which totaled $66.8 million. This represents a 6% increase over the first quarter of this year and is slightly down compared to $67.3 million for the second quarter of 2020. Year-to-date earnings stand at $129.9 million, a decrease of 6% compared to the first six months of 2020. One positive aspect this quarter is that we have no marks in our fair value portfolio, which caused some fluctuations in our results during 2020 due to adjustments made for COVID. The legacy portfolio is decreasing, currently at about $346 million, making up 16% of the total portfolio. Although it yields 18%, its contribution to our revenue is becoming smaller each quarter. Meanwhile, our fair value portfolio has grown to $1.8 billion, accounting for 84% of the total and yielding 10.9%, net of reported losses since we adopted fair value accounting in 2018. Regarding expenses, we incurred $52.9 million this quarter, down 4% from the first quarter of this year and down 15% compared to $62.6 million in the second quarter of 2020. Year-to-date expenses total $108.1 million, reflecting a 17% decrease from $130.3 million in the first half of 2020. As Brad mentioned, we had a substantial staff reduction in 2020, resulting in year-over-year reductions in nearly all operational expense categories, especially in interest expenses and provisions for credit losses. Currently, provisions for credit losses stand at zero, marking the third consecutive quarter with no provisions on the legacy portfolio. After adopting CECL in January 2020, we had accounted for some additional pandemic-related losses in the first three quarters of that year. Our allowance for that portfolio remains robust at over 20%, showing significant improvement in credit performance. For the quarter, pretax earnings reached $13.9 million, representing a 76% increase from the first quarter and a 200% increase compared to the $4.6 million seen in the second quarter of 2020. Year-to-date pretax earnings are at $21.8 million, which is a 179% increase from the first half of 2020. We are pleased with our performance this year, as highlighted by Brad, and we will discuss some of these components further along. Our net income for the quarter is $9.7 million, up 87% from the first quarter and 223% from the second quarter of 2020. Year-to-date net income stands at $14.9 million, an 8% increase from $13.8 million in the first half of last year. It's important to note that last year included an $8.8 million tax benefit recorded in the first quarter due to the CARES Act. The diluted earnings per share for the quarter is $0.39, reflecting an 86% increase from $0.21 in the first quarter and a 200% increase from $0.13 in the second quarter of 2020. Year-to-date diluted earnings per share is $0.59, just slightly above the $0.58 posted in the first half of 2020. Turning to the balance sheet, we currently have $43 million in unrestricted cash, a situation not often seen on our balance sheet. As Brad mentioned, we conducted a residual financing in the second quarter, closing with $50 million in new financing. This adds to our liquidity, built up over the last year due to better-than-expected credit performance. Our current liquidity is the strongest in our history, allowing us to rely less on warehouse financing, which is evident in our financials. The legacy finance receivables portfolio is now 16% of the total, with a substantial allowance for losses of about 21%. Our warehouse lines stand at $77 million, with a $200 million capacity, indicating we are utilizing less warehouse financing and incurring lower financing costs. The residual financing line has two components: an amortizing facility from 2018, which is now down to about $16 or $17 million, and the new $50 million facility with a lower APR. In terms of operating metrics, the net interest margin for the quarter was $47.8 million, a 13% increase from the first quarter and a 17% increase from $40.8 million in the second quarter of last year. Year-to-date, the net interest margin is $90 million, up 6% from $84.6 million in the first half of last year. This improvement is largely linked to developments in the ABS markets. The blended cost of our ABS debt for the quarter was 3.7%, compared to 4.5% during the second quarter of 2020, with lower costs for recent ABS deals compared to older amortizing transactions. Core operating expenses for the quarter totaled $33.9 million, slightly down by 1% from the first quarter and nearly flat relative to the second quarter of 2020. Year-to-date, core operating expenses are at $68.1 million, down 3% from the first half of 2020. We are seeing significant efficiencies from technology and improving operating leverage, and we expect further improvements as our portfolio begins to grow again. The return on managed assets for the quarter was 2.6%, a 73% increase from the first quarter and a 225% increase from the second quarter of 2020. For the first half, the return is 2.1% compared to just 0.6% for the same period in 2020, driven by gains in net interest margin, lower costs of funds, and improved credit performance across the portfolio. Looking at credit performance, the delinquency rate at the end of the quarter was 8.3%, rising slightly from 7.8% at the end of the third quarter but down significantly from 9.6% at the end of June 2020. The net annualized losses for the quarter were 2.8%, considerably down from 6.3% in the first quarter and 7.4% in the second quarter of last year. For the first half, annualized losses are at 4.4%, a notable decline from 7.2% in the first half of 2020. This improvement is largely due to vehicle auction performance, where we recovered 57.8% of our balances in the second quarter, surpassing the previous high of 43.3% from the first quarter of this year. Overall, our delinquency rates are the second lowest since the second quarter of 2015, with the lowest being last quarter. Our net losses are the lowest in many years, and these year-over-year improvements are especially noteworthy given a smaller average portfolio size compared to last year. In terms of the ABS markets, our second-quarter ABS transaction was completed in April 2021 with strong demand across the capital structure, resulting in a blended yield of 1.65%. Notably, we recently closed our third quarter securitization at an even lower blended cost of funds of 1.55%. As Brad mentioned, these trends are all positive, and we are quite pleased with the results. I'll now turn it back over to him.

Okay. Looking more closely at these numbers, it's clear we're experiencing significant growth. The important question is how we're achieving this growth. The new scorecard is certainly beneficial. We've increased our sales force, and we've likely grown by 30% over the last two quarters, with expectations for an additional 40% to 50% growth in the coming quarters. This is all part of the strategy of having a strong presence in new territories. We've utilized new modeling and data collection techniques to identify better markets. Although we've had to lower some interest rates to compete with others in this low interest environment, our credit performance remains strong. The new Gen 7 scorecard has positively impacted our credit metrics, improving both capture and approval rates, allowing for increased volume while still adhering to credit standards. We currently have 6,000 active dealers, with a goal of reaching 10,000. Although we are performing well, we believe this is just the start of even better results as we continue expanding our sales force and enhancing our metrics and modeling. In servicing, as Jeff highlighted, our delinquency rates are excellent and losses are at an all-time low. This can be partially attributed to the stimulus packages. While our company didn't receive much direct government funding, our customers benefited significantly, and we've seen a return from that stimulus. Currently, the stimulus impact is lessening, but we aim to attribute a growing portion of our performance to our robust collection and origination models. In collections, we've introduced a new scorecard and upgraded our communication system, which includes a more effective power dialer and improved text and chat options for customer engagement. This is essential for keeping pace with advancements in technology. As Jeff noted, our auction results are outstanding. While it's not a huge number in the grand scheme, it does contribute positively; we are performing significantly better than we have in the past, now almost 12 points above previous highs. Regarding our sales force, we've increased efficiency and reduced costs by about 25%, resulting in an estimated annual savings of $5 million. We're also focusing on real estate, having recently implemented a hybrid work schedule that allows employees to work part-time from home and part-time in the office. If implemented effectively, this could significantly reduce our commercial real estate footprint. Several of our leases will be up next summer, and we have already reduced costs by around $1 million per year with one branch adjustment. We believe there is still more potential for further efficiency gains in space, personnel, and technology. Continuing with cash flow, the stimulus and childcare credits will help maintain momentum. Overall, our systems are functioning well, and we have a highly experienced workforce working in our favor, combined with government assistance. Regarding the industry, the landscape is intriguing; there have been very few new entrants lately compared to five years ago when many failed. Some fintech companies are entering, but straight originators are rare, which is advantageous for the industry. The lower cost of funds has introduced competition similar to what we saw in 2014 when larger banks targeted lower credit tiers. This increase in competition affects our interest rates and the APRs we can offer customers, currently around 19%, which may drop slightly as we continue to adapt to the market. Despite the low-cost funds, our business model is still viable. As the market stabilizes, we anticipate an increase in the cost of funds, but we believe we will progress well. The economic outlook appears stable for now, although inflation is a concern; however, we expect at least the next 18 months to two years to be manageable before encountering major challenges. This is an opportune time for our company to thrive, with all operations running smoothly and effective models in place. With the low-cost funding available and the ability to generate significant capital, we are in a strong position to achieve substantial progress in the upcoming quarters. I will now welcome any questions.

Our first question comes from Kyle Joseph with Jefferies.

Congrats on a good quarter. First question. Obviously, we're on the heels of the stimulus at this point, but I started to see child tax credit payments going out. Do you see any impact in July from those checks? And how would you expect the change in that payment to affect the seasonality of your business this year?

We constantly consider this. Typically, summer can be challenging for our industry, yet this summer is going well. July is performing as well as June, possibly even slightly better. We're experiencing growth beyond what the second quarter indicates. While many believe that stimulus is the driving force, a significant portion of it, including direct payments, ended months ago. The child tax credit may offer some assistance, and people returning to work is certainly beneficial. However, it's difficult to envision maintaining these outstanding results indefinitely. I believe there’s a balance to be struck between our past performance and our current situation, and I see no issue there. We are well-positioned to sustain our performance. Auction prices will likely fluctuate eventually, but we have implemented measures to mitigate their impact. We are prepared to adjust to these changes. Additionally, the cost of funds will likely rise in the future. Historically, our average cost of funds has been in the 4-5% range, while currently, it is at 1.5%. Our business model is not built to sustain such low costs; it is designed for higher expenses. We will capitalize on the advantages of the current environment but are ready for changes.

Got it. Just a quick follow-up for modeling, making sure I got this right. As credit normalizes, if it ever eventually does, how do we think about potential fair value marks? Would it be that losses have to exceed what you’ve anticipated in your model to trigger a fair value mark, and not necessarily just that they have to go up? Is that right, Jeff?

Yes, that's correct. The fair value mark could arise from a few different factors. One reason could be a significant change in credit performance compared to our initial estimates, and we feel confident about that. Even for the receivables we added today, we're using roughly the same estimated credit losses as we did for cohorts back in 2019, before the pandemic benefits were realized. We are very comfortable with that aspect of the estimates. The other possible reason for a mark could be market conditions. For instance, if there were a major change in prices or the costs that companies like us incur to acquire new business, that could lead to a mark on our books. The market is relatively stable despite some fluctuations, so we're not expecting much movement in that area at the moment.

We have a question from Jeff Zhang with JMP Securities.

It looks like volume is really strong for the quarter, the strongest in 5 years. Is that a good quarterly level that we should be looking at for the remainder of the year and into next year?

I would think so. Certainly, we're almost halfway through the third quarter, and the volumes look about the same. I think it's going to be a combination. Normally, things slow down in the summer. This year, it's not so much the case. The lack of cars may dampen results down the road, but we would guess that Detroit will start ramping up quickly, so they have a great year next year. There might be a little dip, but based on what we've seen so far, we feel pretty safe saying we expect origination volumes to continue along this trend through the rest of the year.

That's great color. Just a quick follow-up. I thought I heard you say the yield on the fair value portfolio was 10.9% for the quarter. That seems to be quite a big pickup from last quarter. Should we expect that number to tick up for the balance of the year?

I think what we've seen is that our economic model targets an 11% yield on the fair value portfolio. When we first started the fair value cohorts back in 2018, many of the first 1.5 years of cohorts were less than 11% because of pricing and what we paid for them at the time. Some of the marks we've taken have actually moved up those coupons, while negative marks over the last year were offset by increasing yields on some of the older cohorts that were below the current market prices. For modeling purposes, you probably want to be in that neighborhood of 10.9% or 11%.

There are no further questions at this time. I will turn the floor back over to speaker, Mr. Charles Bradley, for any closing remarks.

Thank you. Probably last but not least and certainly most important, we certainly care about the stock price, something I didn't mention too much. It has moved up somewhat substantially in the last couple of quarters. Our goal is still to continue to find ways to create more shareholder value. I think our book value today sits at $6.50 per share. Certainly, that's a place to start, but we need to keep doing that. Now that we have a lot of cash, we're certainly buying shares. We buy the maximum amount of shares we can buy in the market every day. We'll continue to do that. I think we bought around 160,000 shares this past quarter. We're doing everything we can that way in terms of repurchasing shares. We will continue to focus on shareholder value and increasing it as we move forward, riding very significant progress in terms of the overall operation of the company. With that, we'll look forward to talking to you at the end of next quarter, and thank you all for attending the call.

Thank you. This concludes today's teleconference. A replay will be available beginning 2 hours from now until August 19, 2021, by dialing (855) 859-2056 or (404) 537-3406 with conference identification number 1592925. A broadcast of the conference call will also 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.