Open Lending Corp Q2 FY2024 Earnings Call

Good afternoon, and welcome to Open Lending's Second Quarter 2024 Earnings Conference Call. As a reminder, today's conference call is being recorded. On the call today are Chuck Jehl, Chief Financial Officer, Chief Operating Officer, and Interim Chief Executive Officer, and Cecilia Camarillo, Chief Accounting Officer. Earlier today, the company posted its second quarter 2024 earnings release and supplemental slides to its investor relations website. In the release, you will find reconciliations of non-GAAP financial measures to the most comparable GAAP financial measures discussed on this call. Before we begin, I would like to remind you that this call may contain estimated and other forward-looking statements that represent the company's view as of today, August 8, 2024. Open Lending disclaims any obligation to update these statements to reflect future events or circumstances. Please refer to today's earnings release and our filings with the SEC for more information concerning factors that could cause actual results to differ from those expressed or implied with such statements. And now, I will pass the call over to Mr. Chuck Jehl. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. Thank you for joining us today for Open Lending's second quarter 2024 earnings conference call. I am pleased to report that in the second quarter of 2024 we were near or above the high end of our guidance range for certified loans, revenue, and adjusted EBITDA, excluding the negative change in estimate associated with our profit share. For the quarter, we certified nearly 29,000 loans, which represents approximately 3% sequential growth compared to Q1 2024, and we delivered total revenue of $26.7 million and adjusted EBITDA of $9.9 million. As I mentioned, our results for the second quarter of 2024 were negatively impacted by a $6.7 million profit share change in estimate. It is important to note that this downward revision is primarily due to elevated delinquencies and defaults associated with vintages originated in 2021 and 2022, the time of peak vehicle values. Lower performance from these vintages represents an industry-wide headwind and is not unique to Open Lending or our lending customers. As it relates to our more recent vintages, we are encouraged by the early performance of these certified loans due to actions we have taken to tighten our underwriting standards. The initial data reflects a decrease in 60-plus day delinquency rates from a peak of over 2% during the middle of 2022 to a range of 1% to 1.5% currently. With three consecutive quarters of delinquency rate improvement within our portfolio, we are optimistic about a return to normalcy concerning delinquencies. As you may recall, the actions we took over the past 18 months to 24 months principally include increased insurance premiums to appropriately price for the risk we take, implemented a newly enhanced lenders protection proprietary scorecard, which has further improved our ability to predict probability of default and price risk. The new scorecard has now decisioned over 1.8 million applications. We raised our minimum score cutoff to tighten our credit aperture and initiated targeted price optimization by leveraging our new enhanced scorecard and historical performance data to increase prices on lower-performing segments of our business. In this period of challenging macroeconomic conditions, we are committed to protecting the profitability of all stakeholders in our ecosystem by appropriately pricing for the risk and selectively saying no to loans that put unnecessary risk on Open Lending, our insurance carrier partners, or our lenders. As we continue to navigate past these lower-performing vintages, we anticipate that Open Lending's profit share revenue performance should be less volatile. Turning to market conditions. We continue to be encouraged by the trends we are seeing in the automotive industry, specifically improvement in inventory levels, retail sales volumes, and affordability, all of which have shown modest year-over-year improvement. However, our core credit union customers continue to be challenged with elevated loan-to-share ratios, low share or deposit growth, and low loan growth. First, on the automotive industry. New vehicle inventory levels continue to improve and are up 52% year-over-year, while used vehicle inventory levels have stabilized at approximately 2.2 million units. Both new and used inventory levels remain 20% to 25% below pre-COVID levels, leaving room for continued recovery. Used retail sales volumes were up 4.1% year-over-year, which as a reminder, makes up approximately 85% of Open Lending certified loan volumes historically. That said, new retail sales volumes have decreased 7.6% year-over-year. June showed some weakness in new auto retail sales compared to May. We believe June retail numbers for both new and used sales were negatively impacted by the CDK dealer management system software outage. Affordability improved on a year-over-year basis, primarily driven by declining auto prices, both new and used auto prices realized a year-over-year decline with new transaction prices down 0.6% and used list prices down by approximately 7%. However, average auto loan interest rates remain near recent highs, with new vehicle loans at nearly 9% and used vehicle loans at over 14%. These rates continue to significantly impact consumer affordability. Lastly, the Manheim Used Vehicle Value Index, a measure of wholesale used vehicle prices, is down nearly 9% from a year ago and down for the fourth month in a row in 2024. However, Per Cox Automotive, the index is projected to be down only approximately 2% at the end of 2024 compared to 2023. Now let's turn to our core credit union customers. Preliminary Q2 2024 data from Callahan & Associates, a leading third-party data provider within the credit union industry, suggests that industry average loan-to-share ratio, a measure of lending capacity, has declined from its recent peak to approximately 84%. To put this in perspective, historically the industry average has never exceeded 86%, so it is encouraging to see the industry loan-to-share ratio beginning to decline. On loan growth, loans across asset classes in the credit union industry grew at 3.8% year-over-year. Notably, this is the lowest level of loan growth since 2013, indicating our customers continue to face a challenging lending environment. On share or deposit growth, we are encouraged by the third consecutive quarter of improvement. Share growth of 2.9% was nearly 170 basis points higher than the lows seen in Q3 of 2023. To put this in perspective, prior to 2023, credit union share growth had never been below 3%. As we look ahead, we are encouraged by both the improvement in the auto industry and the positive signs that credit unions are well into the recovery process. We believe there is significant pent-up demand among consumers for the transportation they need to carry on with their lives. Recent third-party research showed that over 70% of consumers had a stated intent to purchase a vehicle, but almost one-third of consumers were putting off the purchase due to high interest rates and affordability. Additionally, senior lending officers have chosen to shift their focus towards prime and super prime consumers as demonstrated by the retail vehicle registration data. As inventory levels continue to improve, vehicle prices continue to moderate, and with the Federal Reserve interest rate cut more likely, we believe we are not far from seeing a more meaningful increase in vehicle sales activity. While we have been paying close attention to the challenges facing the auto lending industry, we have also taken thoughtful steps to maximize our eventual capture of the pent-up demand when market conditions inevitably recover. We aligned our sales and account management team's incentives to drive new customer acquisitions and certified loan growth from both new and existing customers. We are already seeing positive results from this aligned strategy. In the second quarter of 2024, we signed 13 new credit union customers. Year-to-date through the end of the second quarter, we have signed 24 new customers, including one new bank. I am pleased to report that of the 13 new customers signed in the second quarter of 2024, four of them were larger customers and in aggregate have almost $7 billion in combined total assets. As a further testament to our enhanced go-to-market strategy and our sales and account management team member's execution, we have already signed 10 new customers in the third quarter. We continue to believe the Lenders Protection program can help all lenders serving near and non-prime borrowers to minimize lender's risk and optimize their yield. We have also focused on further strengthening our partnerships with credit union leadership. We recently announced that Dan Berger, former President and CEO of the National Association of Federally-Insured Credit Unions, or NAFCU, had joined Open Lending as a strategic advisor. The partnership is off to a solid start as we are further driving customer engagement and expansion of relationships with credit unions across the country. Turning now to our product and technology. We are actively working on developing solutions that improve the experience of our lender customers and their borrowers. We are focused on assisting and providing solutions to our lenders to help mitigate day-to-day operating challenges, including increasing lenders' ability to automate decisioning, which allows our lenders to speed up the decision process, increasing their probability of capturing the loan, exploring solutions that automate proof of income processing, and other tools to minimize dealer and borrower friction, assisting lenders with capital markets efforts to provide lending capacity throughout economic cycles by accessing alternative sources of capital and evaluating opportunities to improve the value of our lenders protection product by expanding insurance coverages. As I previously noted, we have taken multiple credit and pricing actions with the expectation of optimizing results for our lenders, our insurance carrier partners, and ultimately Open Lending. Looking ahead, we will continue to leverage the capabilities of our enhanced proprietary scorecard to implement targeted opportunities to drive improved performance and results. Now, turning to our insurance carriers. We are excited to add Securian Financial Group as an insurance partner for our Lender's Protection program during the second quarter of 2024. With high financial strength ratings and a long history and familiarity with credit unions and other lending institution customers, Securian Financial is a great addition to our program and helps us expand our premium capacity in anticipation of our return to growth. While we have been focused on enhancing our product and operations to position us for future growth, we have also taken measures to control and reduce costs. We are taking a measured approach as it relates to our cost structure and are focused on only adding incremental costs that drive near-term revenue growth. Our expectation is we will be well-positioned to expand our profit margins as the business grows again by leveraging our existing cost structure. Before I turn the call over to Cecilia to go over our second quarter 2024 results in more detail, I wanted to personally thank our entire team at Open Lending for your continued support and dedication to our company and for delivering these positive results despite continued challenging market conditions. I am encouraged by the early signs of improvement in market conditions and remain confident in the long-term opportunities ahead of us. The underserved near and non-prime consumers need us and our lender partners now more than ever. With that, I'd like to turn the call over to Cecilia.

Thanks, Chuck. During the second quarter of 2024, we facilitated 28,963 certified loans compared to 34,354 certified loans in the second quarter of 2023. Total revenue for the second quarter of 2024 was $26.7 million, which includes an ASC 606 negative change in estimate related to historic vintages associated with our profit share of $6.7 million compared to $38.2 million in revenue in the second quarter of 2023, which included a negative change in estimate of $1.2 million. To break down total revenues in the second quarter 2024, program fee revenues were $14.8 million, profit share revenues were $9.3 million net of the previously mentioned negative change in estimate, and claims administration fees and other revenue were $2.6 million. As a reminder, profit share revenue comprises the expected earned premiums, less the expected claims to be paid over the life of the contracts and less expenses attributable to the program. The net profit share to us is 72% and the monthly receipts from our insurance carriers reduced our contract asset. Profit share revenue in the second quarter of 2024 associated with new originations was $16 million or $552 per certified loan as compared to $19 million or $553 per certified loan in the second quarter of 2023. The $6.7 million negative profit share change in estimate recorded in the current quarter is associated with cumulative total profit share revenue previously recognized of approximately $394 million for periods dating back to January 2019, the ASC 606 implementation date, and represents over 411,000 insured in-force loans in the portfolio. The cumulative profit share change in estimate since 2019 is a negative $2.2 million. Operating expenses were $17 million in the second quarter of 2024 compared to $16.3 million in the second quarter of 2023. Operating income was $4 million in the second quarter of 2024 compared to operating income of $15.7 million in the second quarter of 2023. Net income for the second quarter of 2024 was $2.9 million, compared to a net income of $11.4 million in the second quarter of 2023. Basic and diluted net income per share was $0.02 in the second quarter of 2024 as compared to $0.09 in the second quarter of 2023. Adjusted EBITDA for the second quarter of 2024 was $9.9 million as compared to $20.7 million in the second quarter of 2023. Excluding the profit share revenue change in estimate, we generated $16.6 million in adjusted EBITDA in the second quarter of 2024. There's a reconciliation of GAAP to non-GAAP financial measures that can be found at the back of our earnings press release. We exited the quarter with $382.8 million in total assets, of which $248 million was in unrestricted cash, $33.7 million in contract assets, and $66.3 million in net deferred tax assets. We had $166 million in total liabilities, of which $143.3 million was outstanding debt. I would now like to turn the call back over to Chuck to discuss our guidance for the third quarter.

Thanks, Cecilia. Now moving to our third quarter 2024 guidance. The following factors were considered in our third quarter 2024 guidance. Continued elevated interest rates and a modestly improving inflationary environment and its corresponding impact on the US consumer, uncertain macroeconomic conditions with rising unemployment rates and slower new job growth, lower than pre-COVID auto inventory levels and higher than historical vehicle prices continuing to present affordability challenges for consumers, new and used retail sales volumes that remain lower than pre-COVID levels despite year-over-year improvement, near-historic high loan-to-share ratios combined with historically low share growth that continues to limit credit union's lending capacity, and recent credit tightening actions that Open Lending has taken and the corresponding impact on volume. Additionally, we accounted for the normal course of seasonality that we see between the second quarter and third quarter. Accordingly, our guidance for the third quarter of 2024 is as follows. Total certified loans to be between 25,000 and 28,000, total revenue to be between $28 million and $31 million, and adjusted EBITDA to be between $11 million and $14 million. We have a strong balance sheet with no near-term debt maturities and generate positive cash flow, which provides us with the financial flexibility to make targeted investments to accelerate revenue growth and position us well to capture pent-up demand as market conditions continue to improve. Additionally, we continue to focus on optimizing our profitability by both accelerating revenue and controlling costs. We'd like to thank everyone for joining us today and we will now take your questions.

Thank you for joining us today. We will now begin the question-and-answer session. Our first question comes from Kyle Peterson with Needham & Company. Please go ahead.

Thank you for taking my questions. Good afternoon, everyone. I want to start by discussing the CDK impact. I understand there was an impact, and I'm curious if you could provide any quantification of that and whether it has corrected itself in July. Additionally, any further details you could share would be really helpful.

Yeah. Hey, Kyle. It's Chuck. As we've kind of watched the CDK outage and kind of that unfold, based on the data we've seen, the outage impacted new auto vehicle sales more, and that was in our prepared comments, really limited impact on used auto. And as we said in the prepared comments, we're historically about 85% used. So we didn't see a big impact in our Q2 volume related to that and don't expect any impact going forward, maybe on the new front, but not on used since it was mainly impacting new.

That's helpful. As a follow-up on the outlook for the third quarter, have you included a potential Fed rate cut in September in your guidance? Also, could you remind us how fluctuations in Fed funds or the yield curve could affect you, particularly regarding refinancing?

Yeah. As we think about the Q3 guide in the prepared comments, in our inputs there, continued elevated interest rates is what we've put in there in a modestly improving inflationary environment, Kyle, so we're hopeful just like everybody that the Fed's going to take action in September and begin lowering rates. The dot plot is calling for a 25 basis point reduction in September. I think the markets may be anticipating two 25 basis point reductions in Open Lending, and our consumers would welcome that and it could be a good opportunity for us as we move forward, as we think about our refi channel, and volumes going forward. But in the guidance, we put out continued elevated rates to answer your question.

Okay. That's helpful. Thank you, guys.

You bet. Thank you.

Thank you. Our next question comes from the line of James Faucette with Morgan Stanley. Please go ahead.

Hi, everyone. It's Michael on for James. Thanks for taking our question. I just wanted to ask on the profit share side, is there any make whole period with profit share, specifically with any of your financial partners, and if so, for how long and by how much?

If you consider the make whole on the profit share, there was a time in Open Lending when we didn't issue checks if the profit share went negative for a while due to high claims and defaults, but there is a recapture of that amount that returns to the carriers with us. I hope that answers your question.

That's helpful. Maybe just on the refi side, sort of take your comments just in terms of what you embedded into the outlook, but I guess how are you sort of thinking about refi over the near to medium term, particularly given where historical mix was sort of in the '21-'22 timeframe, sort of conscious of somewhat constrained credit union lending demand, which seems to be stabilizing/improving. Thanks.

For the second quarter of 2024, refinancing accounted for 3% of our volume. In February 2022, refinancing peaked at over 40% of our volume, which was before the Federal Reserve began increasing rates over the past 18 months. Looking ahead, it's important to note that our core customers, the credit unions, typically represent about 75% of our historical volume. We're seeing positive signs with improving loan-to-share ratios and growing share growth. These indicators are encouraging, as we've observed in past cycles that when credit unions are healthy, they start lending again. Lower rates are beneficial for our business in both the long term and short term, but we also need our credit union customers to maintain healthy lending capacity.

Appreciate that.

Thank you. Our next question comes from the line of Vincent Caintic with BTIG. Please go ahead.

Good afternoon. Thank you for taking my questions. My first question is about the profit share, specifically regarding the $6.7 million adjustment. I'm curious if you could discuss the negative adjustments we've seen over the past few quarters and what is currently included in the estimates. Additionally, what factors might lead to further downward adjustments in profit share? It appears there was a significant adjustment this quarter. Thank you.

Good to talk to you again, Vincent. When considering the stress on the portfolio, we approach it mainly through a loss ratio perspective, which involves three components of profit share: severity of loss driven by the Manheim Used Vehicle Value Index, default frequency which correlates to claims, and prepay speed. All of these factors play a role in the overall calculation. In the second quarter, we projected about a 60% ultimate loss ratio for the newer vintages, which we believe is a reasonable level of stress. The $6.7 million booked in the second quarter, as mentioned earlier, is primarily linked to the '21 and '22 vintages, and this trend is seen across the industry. Many in auto lending are experiencing these lower-performing vintages that coincided with peak Manheim and used vehicle values. We're addressing these issues, and the typical claim period for defaults is between 18 to 24 months, and we're reaching that timeline for the worst-performing vintages. There has been an increase in claims and defaults, and although Manheim declined more than we anticipated in the second quarter, Cox forecasts a 2% drop for the year while it was down 9% as of June. In fact, Manheim saw a rebound of about 3% in July, reaching 201, indicating that we believe it is stabilizing and vehicle values are steady, which bodes well for our business.

Okay. Thank you. And then just following up on that then…

Yeah. And we believe, as we work through these vintages that, in our prepared comments, our profit share will be less volatile. And in Cecilia's points about the cumulative effect, we can't lose sight that when we adopted this pronouncement in 2019, we've had $394 million in total profit share revenue. And, yeah, we've had some really good years there or during the pandemic and the stimulus to where we had really positive adjustments. We've had a few negative adjustments here lately based on those lower-performing vintages, but still all in, it's immaterial at $2.2 million negatives. So just don't want to lose sight of that.

Right. That's helpful. And to your point about, so these 2021 and 2022 vintages, you worked through them over 18 months to 24 months, so would it be correct to think that maybe by the end of this year, maybe by early 2025, after we got through 24 months, that we would have already gone past the issues of these vintages. Thanks.

That's correct. They're mostly – yes, those are mostly behind us. That's right.

Okay. Great. And then just one more for me. Switching to the certification volume, just sort of wondering if you can differentiate what you're expecting in terms of the OEM certification volume versus the bank and credit union volume. It looks like the banking credit union grew a little bit this quarter, OEM shrunk a little bit this quarter, so just kind of wondering if you can expand on sort of what you're seeing with your outlook going forward. Thank you.

Yes. I'd say, if you think about the guide that we put out there, I'd say a similar mix to Q2 between the credit unions and the OEMs that you saw in the second quarter.

Okay. All right. That's helpful. Thanks very much.

No. Thank you.

Thank you. Our next question is from the line of John Davis with Raymond James. Please go ahead.

Hi. This is Taylor on for JD. Thanks for taking the question. Maybe if I can just follow up on the last question. It looks like OEM starts to decline year-over-year for the first time in a while this quarter. So just any color you could provide there on what drove the year-over-year decline would be great.

On the OEMs, when comparing the second quarter of '24 to '23, it seems that the environment itself, along with some mix between the customers, played a role. However, the OEM incentives are returning. We implemented some credit tightening across certain tiers and made a premium increase to appropriately price for the risk. This could be contributing to the tightening actions we took, as we aim to place quality loans on the books for our partners, including lender partners, carriers, and Open Lending.

Great. Thanks for the color.

Thank you. Ladies and gentlemen, as there are no further questions, I will now hand the conference over to Chuck Jehl for his closing comments.

We'd like to thank everyone for joining us today and appreciate your interest and support. And I'd like to again thank all of the employees, the entire team at Open Lending for your hard work and dedication and all you do for our company. Thanks and have a great day.

Thank you. The conference of Open Lending Corporation has now concluded. Thank you for your participation. You may now disconnect your lines.