Earnings Call Transcript - CPSS Q1 2023

Operator, Operator

Good day, everyone, and welcome to the Consumer Portfolio Services 2023 First Quarter Operating Results Conference Call. Today's call is being recorded. Before we begin, management had 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 on 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 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, and welcome, everyone, to our first quarter conference call. We definitely spoke not too long ago, so not that much has changed. In terms of the first quarter, it's off to a very strong start. We're very happy with the results. I think the thing to focus on in looking at the first quarter is that we've made a lot of changes in the last two quarters of 2022, mostly as a result of the Fed raising rates, and the 2022 vintage has not really come out of the gates as strongly as we might have hoped. As a result of that, we spent those two quarters and a good part of this quarter tightening our credit, raising our rates and fees, and really sort of realigning everything we needed. One might have thought that would have had a negative effect on both growth and our attraction to dealers in the industry. That's not the case at all. We had a very strong quarter. Even with the tightening and the price increases, we've had strong growth in the first quarter, stronger than we would have expected. So all those things are very positive in terms of our first quarter of the year getting off to a good start. I think we also saw a good thing; our DQ and losses have gone up a little bit, but we still are significantly below pre-pandemic levels; many of our friendly competitors probably couldn't say that. So again, we are beginning to see we made the changes necessary as we start 2023, but we're also still beginning to see the real results of what we've done in terms of having a strong credit model, strong collection model, and having all kinds of work to actually give us a great start to the year, but also help take care of any inefficiencies or things that didn't work well in 2022. So with that, I'm going to turn it over to Danny for the financial details and then Mike, and then I'll get back on a few comments on the industry and the macro.

Danny Bharwani, CFO

Thank you, Brad. We'll go over the numbers. Revenues for the quarter were $83.1 million, which is slightly higher than the $83 million we posted in the December quarter, and up 12% from the $74.4 million in Q1 of last year. The fair value portfolio is now $2.8 billion, yielding about 11.2%, after accounting for losses. Last year's figures included a larger benefit from the legacy portfolio, which was $190 million last year compared to $71 million this year. The legacy portfolio last year had a yield of 17%. Without that comparison, the revenue increase would have been even greater. Also, last year's revenues included a fair value markup of $2.4 million in Q1 of 2022, while we had no markup in Q1 of 2023. Moving on to expenses, they were $64.7 million this quarter, unchanged from $64.7 million in Q4, but up 44% from $45 million in Q1 of last year. These expenses reflect a negative provision from our legacy portfolio using CECL accounting, as we initially estimated lifetime losses that did not occur. We have been gradually reducing excess reserves, with the current quarter seeing a $9 million negative provision, compared to $4.7 million in the December quarter and $9.4 million in the first quarter of last year. Now, regarding pretax earnings, I'll address interest expense, which significantly impacted expense changes; this increased from $16.4 million last year to $32.8 million this year. As we discuss net interest margins later, we will observe some compression in the margins. Despite raising our APRs on loan originations this year, it takes time for the yield to align with interest rate changes on the debt, resulting in some margin compression for the current quarter. Looking at pretax earnings, we reported $18.4 million, which is comparable to $18.3 million in December but down from $29.3 million in the first quarter of last year. In Q1 of last year, we benefited from exceptional credit performance, helped by government stimulus, high used car prices, and low interest rates, making comparisons challenging. Net income aligns with pretax trends at $13.8 million compared to $14.1 million in December and $21.1 million in the first quarter of last year, reflecting a 35% decrease. The same trends are seen in earnings per share: $0.54 this quarter, $0.59 in the fourth quarter, and $0.75 in the first quarter of last year. As for the balance sheet, the finance receivable portfolio grew by 4% from December, now at $2.575 million versus $2.476 million last quarter, and is 35% higher than $1.903 million in the first quarter of last year. This growth is driven by strong origination levels, with $415 million originated in the first quarter compared to $410 million in the same period last year. Regarding securitization debt, it stands at $2,175 million, up from $2,108 million in the fourth quarter and $1,813 million last year, showing a 3% increase from the sequential quarter and a 20% year-over-year rise. This increase correlates with the fair value portfolio, which grew 4% sequentially and 35% year-over-year, demonstrating our maintained liquidity position despite lower leverage on the loan portfolio. The net interest margin for the current quarter is $50.3 million, down from $54.1 million in December and $58 million last year, marking a 13% decrease. The cost of funds on our debt has gone up partly due to rising interest rates, while the yield on our loan portfolio will take time to reflect higher yields under fair value accounting. Core operating expenses were $40.9 million, roughly flat from $40.6 million in December but 8% higher than $38 million in the first quarter of last year. As a percentage of the managed portfolio, core operating expenses are at 5.7% this quarter, down from 6.7%, a 15% decrease from 6.7% in the first quarter of last year. Finally, our return on managed assets was 2.6% this quarter, unchanged from Q4 but down from 5.2% in the first quarter of last year, mainly due to net interest margin compression. I will turn the call over to Mike.

Michael Lavin, COO

Thanks, Danny. From an operations standpoint, as we reported in our last call, 2022 was a record-setting year for us, originating $1.85 billion, which was our best year in our 31-year history, and we were able to grow our originations by 67% year-over-year. So far, 2023 is off to a great start as we originated $415 million in the first quarter, that is down 4% quarter-over-quarter, but up 2% over the first quarter in 2022. We are tracking nicely so far in 2023. The key metric for that is demand for our financial products, which remains strong. We had over 30,000 applications in Q1, a 20% increase quarter-over-quarter and a 41% increase year-over-year. We expect greater demand for our financial products in February and March due to tax refund season; however, we saw a greater influx of applications despite that seasonality. With all that said, we also reported on our last call that we aggressively tightened credit in the second half of 2022. We continued to do that in Q1 in the areas we consider most important. As a result, our approval rate dropped from 72% in the first half of 2022 to 65% in the second half of 2022, and in Q1, it dropped to 59%. That drop is by design and as a result of our credit tightening. Thus, in the first quarter, we continued to narrow the consumers we lend to in order to focus on originating only the upper tranche of the subprime market. Demand was so high that we feel like we're continuing to improve to buy the best subprime paper available. We've been able to maintain a strong APR with the Q1 average at 21.5%, which is up from 20.15% quarter-over-quarter and significantly over 16.14% year-over-year. This aggressive rate rise helps maintain our yield in the face of higher cost of funds that Brad mentioned and perhaps a slight uptick in the losses. One thing we're currently monitoring is maintaining affordability for the car payments for our customers. We look at metrics like debt to income, payment to income, and, based on our latest risk profile, all those numbers are in line with our 2022 trends. For the first quarter of 2023, the average payment was $525, below the average used car payment of $544. That car payment of $544 is an industry average, including near-prime and prime paper. So our subprime payment of $524 looks strong against the industry average. Switching over to portfolio performance: there are certainly some macroeconomic issues weighing on some of our recent vintages. Inflation and rising interest rates are stressing affordability factors, but that's balanced out with good unemployment numbers that historically have been critical in portfolio performance. For the quarter, DQ, including repossession inventory, ended up at 9.92% of the total portfolio, compared to 8.59% in the same quarter in 2022. Annualized net charge-offs for the quarter ended up at 5.2% of the portfolio, compared to 3.29% in the same quarter of 2022. Extensions and repossessions were up slightly over the quarter. On the positive side, recoveries for the quarter ended up at 41.81%, which is below the record level of 61.37% for the same quarter in 2022. Interestingly, we saw recoveries increase month over month in Q1, and they appear to be stabilizing going forward, which is advantageous for managing our losses. Regarding strategic initiatives to improve our performance, we took several actions this quarter, starting from basic strategies like hiring more collectors to lessen the account loads, allowing them to take a deeper dive into the accounts and perform earlier skip work, to more proprietary strategies that have proven effective this quarter. Turning to technology: we continue our five-year quest to invest in new technologies, specifically artificial intelligence-driven solutions aimed at making our business more efficient—for ourselves, our dealers, and our customers. In the quarter, we made significant progress on two such technologies, one on the origination side to streamline underwriting using artificial intelligence and the other on the servicing side to enhance collection efficiency through AI. We continue to promote our dealer portal, providing dealers an easier way to do business with us. On the personnel front, as I mentioned, we hired numerous collectors to improve our portfolio performance, leaving us with 794 total employees across five offices nationwide. We feel we have achieved the scale to handle $150 million a month, $200 million a month, or $125 million a month. It has taken us a few years, but we have reached that scale. So with that, I'll pass it back to Brad.

Charles Bradley, CEO

Thank you, Mike. In the industry, we believe we sit in a very good position. One of the questions is, why? Coming out of 2022, we've seen some issues due to rapid growth across the industry in '22, and I think we owe a lot of credit to our model. Mike mentioned one of the key indicators in the payments. With the inflation problems our customers face, we've managed to keep our payments down. Many others, as reflected in the numbers, have seen customer payments rise substantially. Over time, this is likely to create problems for their performance. So being able to manage that issue, among others, has truly helped keep us aligned with our objectives. We believe 2023 will be an intriguing year for our industry, but CPS is currently in one of the most advantageous positions we could imagine. From the well-known phrase about NFL owners referring to the economy, we focus on the unemployment rate and the securitization market—nothing else matters as much. The unemployment rates remain quite low, and no one is predicting substantial increases in unemployment. We completed another securitization just the other day, and that market remains strong, particularly at the bottom end of the stack. In other words, lower-grade bonds, BB, BBB, are strong and healthy. Therefore, to the extent we care about anything, that's it. Everything else is about ensuring our models work and maintaining our performance. The fact that we are still below industry levels or pre-pandemic levels for both DQ and losses is also highly significant. We saw a slight drop in used car pricing but then observed prices bounce back up. So even that aspect is working very well. Viewed comprehensively, the industry looks good. In terms of the broader economy, as I mentioned, our focus is primarily on unemployment. One would hope everything proceeds well. People worry about mid-bank and small bank issues, but it doesn't seem to be affecting the larger banks, which significantly contribute to securitizations. Before any real problems at the banking level trickle down to affect us, they would have to be substantial. Overall, we feel optimistic about our industry and economy. We take pride in all the right actions we have taken over the last year. We believe this sets a solid foundation for our progress in 2023. Thank you all for joining us today, and we look forward to our next quarter's conversation.

Operator, Operator

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