Earnings Call Transcript - CPSS Q3 2022

Operator, Operator

Good day, everyone, and welcome to the Consumer Portfolio Services 2022 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 valuation of receivables are dependent on estimates of future events and 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. Mike Lavin, Chief Operating Officer; and Mr. Danny Bharwani, Chief Financial Officer of Consumer Portfolio Services. I will now turn the call over to Mr. Bradley.

Charles Bradley, CEO

Thank you, and welcome to our third quarter conference call. It's nice to be able to say we had another extremely strong quarter. It's what we expected, and certainly what we want to continue to do. I'll give you a few highlights, and then I'll turn it over to the guys. One of the things we did—timing is everything—we renewed our Ares facility in June. We renewed that line and increased it from $100 million to $200 million. We did the same thing in July with Citibank. We renewed and increased that line from $100 million to $200 million. So now we have $400 million in warehousing, and it's very nice to not be in the market right now looking for warehousing or trying to increase warehousing. So we're quite happy we accomplished that and got it done before the market started to change. Another interesting thing is that our portfolio has been growing enough this year so that our core operating expenses had dropped below 6%. That's always been a target for us. We think we can do even better than that. I think our target now is to get them below 5%, but given the increasing size of the portfolio and the size of the company, a strong focus on those core operating expenses is very important. And it's nice to be able to say we're doing quite well at achieving those goals. Also, another highlight would be that we did the July securitization. As everyone should know, the cost of funds in the market has been going up. So we're pretty happy with that deal at about a 6% all-in cost. It was up a bit from the deal before, but nonetheless, the most important thing for us is to be able to sell our bonds in the marketplace, and there was strong demand, and we got that deal done easily. Thinking of the marketplace today, as everyone knows, everyone's worried about the economy; we're in some sort of potential recession. We had the Fed raising rates hand over fist. So we're trying to combat that as well, and we think we're doing the appropriate thing. By raising rates, we've raised our rates over 200 basis points in the third quarter. We've also cut the fees we paid to dealers across all deals. The interesting part about that—we've also tightened credit—and the interesting part is that the business isn't particularly slowing down. So the demand for financing for these cars—remember that our number one customer is a person who has to have a car, not a person who's just lightly shopping for one. So we would expect business to continue. But if it does, and the Fed keeps raising rates, we're going to walk along and raise our rates just as quickly so that we can continue to try and maintain our margins. There's always a problem; maybe the credit isn't as good, but our credit is performing quite well. Many of our competitors are citing that they've gone back to pre-pandemic levels in terms of delinquencies and losses, and we're still well ahead of those levels. So we're very happy with where we sit in that circumstance as well. There are sort of more things to talk about, but I'm going to turn it over to Danny to go over the financials, and then Mike will go over the operations.

Danny Bharwani, CFO

Thank you, Brad. Going over the financial results for the third quarter, our revenues for the third quarter were $90.3 million. That's up 10% over the $82 million we posted in our second quarter, and it's up 32% from the $68.6 million in our third quarter of last year. The main driver for the increase in revenue is the increase in our servicing portfolio, which is driven by the fair value portfolio. If you've been listening to these calls in the past, you'll remember that we switched over to fair value accounting five years ago beginning in 2018, and that fair value component is now 96% of our total portfolio. That has grown—I'll talk about that more when we cover the balance sheet, but that has grown 8% quarter-over-quarter and 41% year-over-year. So that is yielding 11.4%. You might recall if you've been on these calls in the past that the yield on our fair value portfolio is net of losses. So the 11.4% is after our expected loss assumptions. The legacy portfolio is now down to only 4% of our total and is yielding 24%. Included in these numbers for the third quarter is a fair value mark of $8.2 million. That represents some losses and COVID reserves we posted back in the last year or two, where we are now realizing that these losses are not materializing. So we have $8.2 million of these reversals in our fair value portfolio that we didn't have last year in the third quarter. Going over expenses, it's $56 million in the third quarter compared to $47.8 million in the June quarter and $49 million in the third quarter last year. That is up 17% over the sequential quarter and 14% year-over-year. Those results include a similar reversal for losses on our legacy portfolio that did not materialize. In this case, it's $6 million of reversals of loss provisions in the current quarter compared to $1.6 million in the third quarter of last year. Looking at pretax earnings for the quarter, it was $34.3 million. That's up slightly from $34.2 million in our June quarter and significantly up from $19.5 million in the third quarter of 2021. For the nine-month period ending September, our pretax earnings were $97.9 million compared to $41.4 million. That's up 136% year-over-year. Similarly, our net income is $25.4 million for the current quarter compared to $25.3 million in the June quarter. That's up 85% from the $13.7 million we posted last year. For the nine-month period, we're seeing a 151% increase in net income to $71.8 million compared to $28.6 million a year ago. Our earnings per share is up to $0.95 for the current quarter, from $0.52 in the third quarter of last year. That's up 83% for the year-to-date period, $2.61 compared to $1.12 last year, which is a 133% increase. Looking at the balance sheet, a couple of things of note: our fair value portfolio, like I mentioned, driven by our originations rate for this year, which is at record-breaking territories. We're originating a large number of loans; we'll cover that later, but the fair value portfolio is up 8% over the June quarter and 41% year-over-year. Brad discussed the increase in our warehouse capacity to $200 million, which we announced earlier this year. Our debt levels are up if you look at the balance sheet, but that's commensurate with the rise in our loan portfolio originations this year compared to last year. Looking at other metrics, our net interest margin is $66.8 million compared to $63.3 million in June and $50.2 million a year ago. That's a 6% increase over the sequential quarter and a 33% increase year-over-year. On a year-to-date basis, our net interest margin is $188 million compared to $140.2 million last year. That's a 34% increase. Our core operating expenses of $38.5 million in the current quarter compared to $37 million in June and $32 million last year. That's a 4% increase quarter-over-quarter and a 19% increase year-over-year. On a year-to-date basis, our core operating expenses are $113.6 million compared to $100.4 million. That's a 13% increase. Taking those core operating expenses as a percentage of the average managed portfolio, for the quarter, it's 5.8%. In June, it was 6%, so it's come down a little bit. It was also 6% in the third quarter of last year. On an annualized basis, it's 6.1% this year compared to 6.3% for the first nine months of last year. And finally, our return on managed assets for the quarter was 5.2%. That's down from 5.5% in June, but it's up significantly from 3.6% in September of last year. For the nine-month period, our return on managed assets was 5.3% this year compared to 2.6% last year. I'll turn the call over to Mike.

Mike Lavin, COO

Thanks, Danny. In personnel and facilities, we're currently at 794 employees. We've fluctuated between 750 and 800 employees since we reduced our workforce during COVID in 2019 by 22%. 407 of those employees are in servicing, 247 are in sales and origination, and the rest are in support departments. I think it's important to note, and very interesting to cite that we originated $1.1 billion in 2021 with roughly 750 employees, and we've surpassed that volume in 2022 so far with the same number of employees. We think that's a testament to our investment in new technologies, leading to more personnel efficiencies. I think it's safe to say that right now, and going forward, we're at scale. In terms of our office leases, we've been fortunate to have four of our five leases come up for renewal post-COVID. So we've been able to leverage the sort of commercial real estate crash to renew or relocate four of our offices. We believe that will save us between $6 million to $7 million a year to the bottom line. In sales, our record-setting year continues, albeit with a slight slowdown in Q3. In Q3, we originated $468 million, which compares to $548 million in Q2. That's a 14% drop. But I think, as Brad noted earlier, the more interesting thing and the good news is that demand is still strong for our product. We had 653,000 applications in Q3, which compares to 615,000 applications in Q2. So it's a sequential increase of 6.2%. So the demand is still strong. Despite that dip, I think when you look at the year-over-year analysis, you'll see that we're in the middle of a record-setting year. In Q2 2022, we did $468 million; that compares to $326 million year-over-year, which is a 43% increase year-over-year. And in applications, you can see that we did 653,000 again in Q3 2022, which compares to 436,000 year-over-year, marking a 50% increase. So, as Brad also mentioned, the slight drop in our sequential originations Q-over-Q was due to the aggressive nature of our raising rates and the fees. When you look at our originations for the entire year of 2022, you can really see the growth we've had. So far in 2022, we've originated $1.4 billion, which compares to $818 million over the same time period in 2021, representing a 71% growth rate year-over-year, which is a record for us. Some of the initiatives we're focusing on going forward include maintaining our rep force of 108, which we think is around the industry standard. We're still working to increase our dealer base, currently sitting at 7,717, which we've grown 15% so far this year, with our ultimate goal being 10,000. We're also looking to increase the number of funding dealers we have, which currently sits at 2,740, marking a 30% increase year-over-year. We're concentrating on large dealer groups this year as another lever for growth. Switching to servicing, our delinquencies for over 30 days, including our repo inventory, for Q3 2022, ended up at 10.85%, which compares to 9.44% in Q3 2021. For annualized charge-offs, we ended up at 4.93% of the average portfolio, which compares to 2.82% for Q3 2021. It's important to note that, as Brad mentioned, many experts have indicated that our competitors are at pre-pandemic levels, and we're just not there. Pre-pandemic, we were running at 12.5% delinquency, and we're currently running at 10.85% in Q3, which shows that we're significantly beating those pre-pandemic levels. In terms of our extensions, we are well-positioned as they are flat year-over-year and actually below pre-pandemic levels. Those extensions are driven by artificial intelligence. In terms of our repos, they also ticked up a bit sequentially, but we're still running 30% below pre-pandemic levels. In terms of the recovery market, we've seen a drop, but we're still above historical levels. The Manheim Vehicle Value Index dropped in Q3 by about 10.6%. Our net recovery in January 2021 was 41%. It climbed to a height of 64% in November last year and seems to be normalizing back into the mid-40s at the end of Q3. A couple of miscellaneous things: We continue to build on our artificial intelligence and machine learning platforms in the quarter, entering into several partnerships that will allow us to further leverage robotic process automation that we've focused on over the last three to four years. This includes using bots to extract information from dealer packages instead of requiring processors to do that. We think that will reduce processing time and allow us to fund packages quicker to dealers, providing a more frictionless experience. We're also expecting to use bots to listen into collection calls and populate collection notes, which we believe will significantly reduce the wrap time that collectors use, allowing them to make more calls per hour and collect more dollars monthly. These initiatives further bolster our platforms and improve our overall performance and efficiencies. So with that, I'll kick it back to Brad.

Charles Bradley, CEO

Thanks, Mike. So obviously, we're doing a lot of things well. We've taken a lot of time; we've been doing this a long time, so one might expect we should be doing things well, and we are. Looking at the industry, certainly with the things going on—the Fed is raising interest rates, and we are, of course, keeping up with that. I think we've done a pretty good job of moving along. Given how our credit performance has been very strong, we're in a good position. All of our pools are doing great, but nonetheless, you just don't know what the next six months or year will evolve into. So it's much safer to scale back, tighten credit, and raise rates, and we're executing on all those fronts very efficiently and quickly. What's interesting is we're continuing to see a fair amount of volume. With the CPI coming in positively today, the market seems to be picking up, and one might hope that we soon reach the peak and maybe rates start to level off. Nonetheless, we can't predict anything about that. All we can do is what we can to stay ahead of the curve. A couple of things to keep in mind: many in our industry used forward flow agreements to sell loans to others looking for more yield. Back when the basic yield was a couple of percent, those forward flow parties would pay 5%. Those arrangements are all over now. Some companies that relied on forward flow commitments for significant capital may be struggling to raise that capital. We haven’t relied on that in decades, which is a plus for us compared to others. Also, we've heard that many bond investors are concentrating their purchases on seasoned long-term players like ourselves with solid records rather than supporting new issuers or players in the market. Again, this supports where we are, and all these factors suggest that the industry will tighten up. There are many strong players, and I think we and many others are doing the right things. Some weaker players may face challenges in raising capital or dealing with the cost of it. We haven’t seen any of that yet, but we will keep our eyes open for any opportunities that might arise. Overall, we've seen three very strong quarters in 2022. We're looking forward to closing the year strongly and being all set up for next year. Thank you all for attending, and we look forward to speaking to you probably in February during the year-end call. Thank you.

Operator, Operator

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