Earnings Call Transcript - CPSS Q3 2023

Operator, Operator

Good day, everyone. And welcome to the Consumer Portfolio Services 2023 Third 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 valuations of receivables depend 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 15th 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 today 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. Welcome everyone to the CPS third quarter conference call. In terms of opening comments, generally speaking, our industry was returning to pre-pandemic levels in terms of loss expectations and performance. However, over the last few quarters, we’ve had many factors making that return more bumpy—like a huge focus on the portfolio performance from the 2021 and 2022 vintages. Interest rates are much higher, thus increasing the cost of funds, and the consumer position in terms of inflation has added to the challenge. Lots of little factors together make this a difficult time. The good news is, even with that, we turned in another strong quarter. We’ve been through these problems before, and CPS is in a very good position to weather any potential storm. It looks like, compared to our competitors, we’re in a much better position than a lot of others and compared to previous scenarios. Our portfolio size, our company size, the experience we have, and the credit controls we have in place put us in a strong position, and I believe we can prove that even better going forward. I’ll elaborate more after we go through the financials and the operations update. Now, I’ll turn it over to Danny.

Danny Bharwani, CFO

Thanks, Brad. Now moving on to the financials, we’ll start with revenues. Revenue for the quarter was $92.1 million, which is 8% higher than the $84.9 million in our second quarter of this year and 2% higher than the $90.3 million in the third quarter of last year. For the nine-month period ending September 30th, revenues were $260 million, which is 5% higher than the $246.7 million in the first three quarters of 2022. Notably, our fair value portfolio is now $2.7 billion and continues to grow. The yield on the fair value portfolio, adjusted for risk and after losses, is yielding 11.3%. Included in revenues for this quarter is a fair value markup of $6 million, compared to a markup of $8.1 million in Q3 of 2022. For the year-to-date period, the markup is $15.2 million in 2022 and $6 million for the first three quarters of 2023. The markup comes from better-than-expected performance in our fair value portfolio, particularly the older vintages that have outperformed our initial expectations, resulting in benefits recognized from our collections and losses from those portfolios. Moving on to expenses, they totaled $77.9 million in the current quarter, compared to $66.3 million in the second quarter of 2023. That’s a 17% increase compared to $56 million in the third quarter of last year, which is a 39% increase. For the year-to-date period, expenses total $208.8 million for the nine months ending 2023, up from $148.8 million last year, a 40% increase. We are comparing four periods, and an adjustment to our legacy portfolio is included in all. This portfolio isn’t accounted for under fair value and is accounted for using CECL. We posted a lifetime loss reserve on these loans, realizing that performance has been better than expected, allowing us to reverse loss provisions over time. The reversal of loss provisions helped reduce expenses by $2 million in the third quarter compared to $6 million in the third quarter of last year. For the nine months, the reversal of loss provision is $20.7 million versus $23.4 million in the same period of 2022. Interest expense is another contributor to the increase. It is $37.9 million in the current quarter and $106 million year-to-date, compared to $23.5 million in the third quarter of last year and $58.7 million last year. The increase in interest expense is mainly due to higher interest costs. The larger portfolio size is also a factor, but the primary reason is the increase in rates we’ve seen. To quantify, interest expense is up 61% quarter-over-quarter and 81% year-over-year. Looking at pre-tax earnings, it is $14.2 million in the current quarter versus $34.3 million in the quarter last year. For the nine-month period, $51.3 million this year versus $97.9 million last year—a 48% decrease. We see similar trends in net income and earnings per share. Net income was $10.4 million in the current quarter compared to $25.4 million last year, a 59% decrease. For the nine months, $38.2 million versus $71.8 million last year. Again, diluted earnings per share manifest those same trends at $0.41 per share this quarter compared to $0.95 last year, and $1.51 for the three quarters ending September 30 this year versus $2.61 last year. Moving to the balance sheet, our fair value portfolio grew by 2% over the June quarter and 14% year-over-year, driven by robust origination levels throughout the year. Our securitization debt is up only 1% sequentially and 9% year-over-year, showcasing strength on our balance sheet as we maintain liquidity despite lower leverage on our loan portfolio. Another strength is our shareholders’ equity; the $265.9 million posted on September 30 this year is an all-time high for the company, driven by 48 consecutive quarters of pre-tax profitability. We’ve demonstrated our durability by posting quarterly profits over the last 12 years. Regarding additional metrics, our net interest margin is $54.2 million this quarter compared to $66.8 million in the same quarter last year, a decrease of 19%. For the year-to-date, it's $153.7 million this year versus $188 million last year, an 18% decrease. Core operating expenses are $42 million this current quarter versus $38.5 million last year, and $123.1 million for the nine-month period this year versus $113.6 million last year, resulting in an 8% increase. Core operating expenses measured against the managed portfolio constitute 5.7% this year versus 5.8% in the third quarter of last year; similarly, 5.7% for the year-to-date versus 6.1% for the nine months in 2022. Our return on managed assets stands at 1.9% this quarter compared to 5.2% last year, with an annualized figure of 2.4% in 2023, down from 5.3% for the nine months in 2022. Now, I’ll turn over the call to Mike for an operational overview.

Mike Lavin, COO

Thanks, Danny. In terms of originations, the third quarter remains solid as we purchased $322 million of new contracts. That compares to $318 million of new contracts in Q2 and $468 million of new contracts during the third quarter of 2022. The slight uptick quarter-over-quarter in originations reflects strong demand in our space. The decrease in volume year-over-year was purposeful, as we scaled back due to macroeconomic headwinds discussed by Brad, while maintaining a tighter credit box and a keen eye on our customers' affordability. Concerning affordability, we hold firm on our payment to income and debt to income ratios. Our monthly payment remains low for our sector at $531, compared to the upper $500s for a used car without factoring in subprime or near-prime customers, and compared to upper $700s for new cars. Demand remains strong in the third quarter, receiving around 8,000 applications a day, similar to 2022 when we had a record origination of $1.85 billion. Our approval rate decreased to 51%, down from 2022 Q3’s 70%; this drop was intentional as we tightened our credit conditions at the end of 2022 and early 2023. Specifically, we limited LTV, capped payments in certain segments, tightened job stability and residency requirements, and made fewer exceptions. Although our approval rate has decreased, it has lowered our LTVs, a leading indicator of losses. The average amount financed for the quarter was $20,100, down about $900 quarter-over-quarter and down $3,000 from Q3 of 2022, likely due to a major pullback in backend products we offer, like warranty and GAP. This has lowered our LTV caps and amounts financed as well as our relatively low monthly payments compared to competitors. Our APR for Q3 was strong, averaging 21%, about a half-point lower quarter-over-quarter, but significantly higher than 18% in Q3 of 2022. This APR was achieved despite tightening our credit box materially in late 2022 and early 2023. Regarding competition, we’re noticing fluctuating participation from credit unions with lower rates, but they often withdraw when losses don’t meet expectations. Demand persists, leaving ample business for the five or six key market players, including ourselves. There remains significant growth opportunity as few new entrants are appearing in the market; regional players continue to withdraw, and credit unions slowly learn that this may not be their target market. We are maintaining at $100 million a month until we see results from our credit tightening and portfolio performance, but we also plan to grow at the appropriate time. On portfolio performance, while macroeconomic factors weigh on our recent vintages, especially 2022 and early 2023, inflation and rising interest rates do present affordability issues for our customers. However, importantly, there has been no recession yet, and most analysts believe any potential recession would be minor and brief. Also, the unemployment rate remains in the mid-3s, well below the target 5s, which is a crucial metric for our business. For the quarter, delinquency rates, including repossession inventory, reached 13.31% of the total portfolio, compared to 10.85% in the same quarter in 2022. Annualized net charge-offs for this quarter were 6.86% of the portfolio, up from 4.93% in the same quarter last year. Extensions increased slightly but remain average over the last five years, while repossessions decreased quarter-over-quarter. Our recovery rates are stabilizing in the low 40s, a rise from the low 30s earlier this year, an encouraging trend as we continue to focus on servicing to collect 2022 and early 2023 loans. In addition, we successfully hired 96 new collectors over the last 10 months to reduce our accounts per collector by over 100, facilitating more personalized and effective collection strategies. We’ve also enhanced our near-shore collection program to tackle DQ accounts and optimize our use of a power dialer. Lastly, we launched our Gen 8 Originations Model, a complete overhaul of our Gen 7 Model from 2021. This new model leverages machine learning AI on recent originations for better applicant scoring, integrating updated alternative data and new fraud scores to combat fraud. We believe this is our best yet and that it will improve performance moving forward. Now, I’ll pass it back to Brad.

Charles Bradley, CEO

Thanks, Mike. That’s a lot of information about what the company’s doing. As both guys noted, it’s been somewhat turbulent times. The industry was quite aggressive during the pandemic with all the influx of capital. Now, we're starting to feel the repercussions as performance from 2022 has not met expectations. However, our performance has been significantly better than many others in the industry. We’re satisfied with our position, as our controls have withstood the test. But we’re not quite ready to pursue aggressive growth yet. We need the 2022 vintage to flow through fully, which it is doing. Initially, we were concerned about the 2021 vintage, but that’s proving to be manageable as well. We expect losses for 2022 to track similarly, thankfully not as severe as for others. Additionally, we require the young 2023 vintage to demonstrate the efficacy of the measures we took late last year and earlier this year. Costs related to inflation hurt our customers’ abilities, and higher interest rates are squeezing our margins. Still, we believe recovery rates are normalizing. We think we are well-positioned to navigate these challenges, as we have faced such situations before. We’re confident about the prospects ahead. Typically, the first half of 2024 is among the strongest periods for us, and we expect to overcome the challenges from 2022 and be positioned to grow again in 2023. We are optimistic that interest rates will remain stable or potentially decrease, and similarly, inflation will begin to ease. So, while we will need to navigate through 2022's difficulties and into 2023, we believe 2024 should be a strong year for our industry and our company. Ultimately, we’re proud of how well we’ve performed compared to many in our space. Thank you for being here today, and we’ll speak next quarter.

Operator, Operator

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