Earnings Call Transcript - CPSS Q4 2022

Operator, Operator

Good day, everyone, and welcome to the Consumer Portfolio Services 2022 Fourth 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 15 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 is Mr. Charles Bradley, Chief Executive Officer; Mr. Danny Bharwani, Chief Financial Officer; and Mr. Mike Lavin, President and Chief Operating Officer of Consumer Portfolio Services. I will now turn the call over to Mr. Bradley.

Charles Bradley, CEO

Thank you for joining us for our fourth quarter and year-end conference call. We might be a bit late this year, but it's better late than never. Reflecting on 2022, there were many positive aspects to consider. Although the fourth quarter may seem slightly down compared to the rest of the year, 2022 can be described as a story of two economies. We began the year in a strong growth phase, with everything running smoothly, until inflation emerged and the Federal Reserve started increasing interest rates. We shifted from a robust growth mode, where we effectively utilized technology and resources, to implementing quick and necessary adjustments to manage our margins by raising rates aggressively. This pivot unfortunately slowed our business down. It's somewhat ironic that after starting the year strong, we had to make a rapid turnaround. The good news is that we believe we executed this transition very effectively within our industry. We managed to tighten credit quickly and raised rates throughout the year. Although the fourth quarter faced challenges, we are pleased with how it concluded and with the overall results. Notably, it was our best earnings year and best year for originations in the company’s history, filled with numerous highlights. Moving into 2023 presents new opportunities, but 2022 demonstrated our capability to grow significantly while also effectively managing a slowdown without compromising our credit performance and margins. It took some time to balance these elements, but we feel proud of how we handled it. Now, I'll hand it over to Danny to discuss the financials, and then we can talk more about industry developments and our future outlook. Danny, please proceed.

Danny Bharwani, CFO

Thank you, Brad. I'll begin by reviewing the quarter-over-quarter financial comparisons and then provide the year-over-year updates. In the fourth quarter, revenues reached $83 million, up from $69.4 million in the same quarter last year, representing a 20% increase. This growth is primarily due to the larger size of our fair value portfolio, which has been influenced by the growth in originations mentioned by Brad earlier. The fair value portfolio is currently yielding approximately 11%, net of losses. There were no fair value marks taken in the fourth quarter of this year, in contrast to an $8.2 million markup in the third quarter and no mark in the fourth quarter of last year. As for expenses, they totaled $64.7 million in the fourth quarter of this year, up from $45 million in the same quarter last year, marking a 44% increase. Key factors behind this rise include the reversal of the CECL reserves we recorded on our legacy portfolio, which is in the process of winding down. Our estimates for losses on this portfolio have been lower than anticipated, allowing us to reverse some of the provisions, contributing to income and reducing expenses for the year. In this quarter, we recorded $4.7 million in loss provision reversals compared to $13 million in the fourth quarter of last year. This all resulted in pretax earnings of $18.3 million for the fourth quarter of this year, down from $24.4 million in the fourth quarter of last year. The net income for the quarter was $14.1 million, reflecting a 26% decline from $19 million last year. The key factor in the year-over-year changes in net income and pretax earnings is the lower reversal of loss provisions for the CECL portfolio. Our diluted earnings per share for the quarter stood at $0.59, down from $0.71 in the same period last year, a decrease of 17%. I will revisit these metrics for the year-over-year comparison. For 2022, total revenues were $329.7 million, representing a 23% increase from $267.8 million in 2021. The main contributors to this growth were the portfolio increase and fair value marks we realized over the year. We recognized a total of $15.3 million in fair value markups for 2022, compared to a $4.4 million markdown in 2021. Expenses amounted to $213.5 million, up 6% from $202 million in 2021, indicating we increased revenues without a significant rise in expenses. In terms of loss provision reversals, we reported $28.1 million in 2022, compared to $14.6 million in 2021, leading to a significant rise in pretax earnings, jumping 77% from $65.7 million in 2021 to $116.2 million in 2022. Net income also followed this trend, increasing by 81% from $47.5 million to $86 million in 2022. Diluted earnings per share increased by 76% from $1.84 to $3.23 in 2022. Turning to the balance sheet, our unrestricted cash balance was $13.5 million at the end of 2022, compared to $29.9 million at the end of 2021. Our fair value receivables grew by 42%, rising from $1.7 billion in 2021 to $2.5 billion in 2022. As for our liabilities, our outstanding debt increased with our warehouse lines raised to a total capacity of $400 million during the second and third quarters of 2022, giving us ample warehouse capacity, while our securitization debt rose alongside our servicing portfolio. Regarding key metrics, our net interest margin increased by 26% year-over-year, from $192.6 million to $242 million in 2022. Core operating expenses rose by 9%, from $141 million in 2021 to $154 million in 2022, and as a percentage of the managed portfolio, core operating expenses decreased from 6.6% in 2021 to 6.1% in 2022, largely due to our efforts to control expenses while expanding our managed portfolio. Our return on managed assets improved from 3.1% in 2021 to 4.6% in 2022. These trends reflect our ongoing focus on managing our portfolio growth while keeping expenses in check. That concludes the financial overview. I'll now hand it over to Mike.

Michael Lavin, President and COO

Thank you, Danny. As mentioned, 2022 was a record year for us. We originated $1.85 billion in 2022, compared to $1.1 billion in 2021, representing a 69% growth in originations year-over-year, which is our highest rate ever. Notably, we achieved these origination records while operating more efficiently than in the past. For instance, we had 755 employees in 2021 when we originated $1.1 billion, and we managed to originate $1.8 billion in 2022 with just 777 employees. This equates to a 69% growth in our originations with only a 2.9% increase in our workforce to support that growth. Looking at the fourth quarter, we originated $428 million, which was slightly lower than the $468 million in our record-setting third quarter but still up from the $328 million we did in Q4 2021. We achieved these results even as we tightened our credit in the second half of the year. Our growth has allowed us to significantly reduce our operating expenses moving forward, and our investment in new technologies, particularly in artificial intelligence and machine learning, has improved our efficiency among other advantages. For example, our Generation 7 AI model was fully developed in 2022, helping us originate high-quality subprime loans more effectively. It's crucial to highlight that our record growth coincided with raising rates, increasing fees, and tightening credit. For instance, our average APR was 15.99% in February 2022, but ended the year near 21%. We also raised dealer fees throughout the year and became more selective with our credit decisions midway through the year by implementing low loan-to-value caps, reducing our back-end allowance, and eliminating various exceptions for declines. Consequently, our overall origination percentage dropped as we exercised increased selectivity, but the strong demand for our products compensated for our tighter credit approach. By the end of 2022, we believe we acquired the best available subprime auto paper on the market. Regarding competition and market demand, new car prices reached record highs in 2022 as manufacturers limited inventory, despite the easing of COVID-related chip shortages and inventory issues. Meanwhile, used car prices dropped towards the end of the year, leading more buyers to consider used vehicles, which represent most of our origination business. In the past, we lost many deals to credit unions, but in 2022, it seemed they were stepping back from this segment. Additionally, some larger competitors left or scaled back their operations as they shifted towards being full-spectrum lenders. In terms of competition, our niche is less competitive, with only a few players consistently active in this space, as opposed to industries with hundreds of competitors. We have a strong market presence in the upper subprime spectrum, while our closest competitors primarily target the lower end. This competitive landscape remained stable in 2022, benefiting from high barriers to entry. Our business is relationship-focused, requiring a loyal dealer network and proprietary origination and servicing models backed by extensive data to ensure strong portfolio performance. It is a capital-intensive, highly regulated industry that demands specialized experience. On the performance of our portfolio, our year-end 2022 delinquency rate, including repossession inventory, was 12.62%, up from 10.53% at the end of 2021. Our annual net charge-offs for the fourth quarter stood at 5.83%, compared to 2.57% in Q4 2021. It's worth noting that extensions experienced a slight increase in 2022, representing 2.98% of the outstanding portfolio, which is the second-best year for extension usage. We utilize an AI-driven scoring model for extensions, which has enhanced our efficiency in managing them. Overall, we are pleased with our performance in 2022, especially given the economic headwinds and the end of government support that bolstered our 2021 results. Although the 2022 industry vintages have been somewhat uneven, early indications suggest our vintages are performing better than the industry average, and our portfolio curves remain below pre-pandemic levels. We were among the first to tighten credit in 2022, consistent with our long-standing approach as a cautious lender. Our investments in AI and machine learning continue to drive our portfolio performance and servicing efficiency. For example, our Generation 7 AI model guides our collectors on how and when to communicate with borrowers. Towards the end of 2020, we adjusted our algorithms to better handle early issues, and with further proprietary strategy adjustments in the latter half of 2022, we have enhanced our performance compared to the industry averages.

Charles Bradley, CEO

Thank you, Mike. And so that's kind of where we are today. 2022 seems almost a long time ago, given the ups and downs having that great first half of the year and then sort of a challenge in somewhat second half of the year. But I think the most important thing to see is that, and as Mike and Danny both pointed out, through 2022, we're able to adjust and move both our credit criteria, our pricing model almost seamlessly to kind of react to what was going on in the industry. We're not quite sure everyone else did quite that. But nonetheless, we're very happy with how we did it. I think in the future, that bodes very well for adjusting to the different sort of market levels. Certainly today, once again, things are moving around. But the fact that we're able to go through 2022, and on the one hand, grow so significantly and so successfully shows that they have to pull back some, shows that we can move with the rising and lowering tides just as easily. And I think that's very important going forward because we've been doing this a long time. And the one thing that you can always count on is things will change. And sometimes they change in a time. So I think, again, we're very pleased with how it worked. I think the industry overall. I think we sit very well off of our 2022 performance. Certainly, all the performance behind that has been very excellent. And so we kind of look forward to how we think 2023 could go. Most importantly, on sort of the technology side, we've been able to use lots of technology, more and more coming every day that actually, we almost can shrink our people and what we need to continue to grow. And so the combination of those things really puts us in a spot where we can sort of look forward to what we're doing, see what the industry does, the ups and downs of the free money in 2021 and '22 or mostly '20 and '21, that's over with. Now we're getting back to what we might look at as sort of the normal course in our industry. And so again, we'll have to kind of ride with what the inflation numbers do and the banking issues and such. But overall, I think based on what we've done in 2022 and 2023, it looks like a new year, new things we can handle, and we're looking forward to the challenge. With that, thank you all for joining us, and we will speak to you rather soon in April.

Operator, Operator

Thank you. This concludes today's teleconference. A replay will be available beginning 2 hours from now for 12 months by the company's website at www.consumerportfolio.com. Please disconnect your lines at this time, and have a wonderful day.