Consumer Portfolio Services - Q4 2023

Transcript

Operator (participant)

Good day, everyone, and welcome to the Consumer Portfolio Services 2023 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, are also 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 is Mr. Charles Bradley, Chief Executive Officer, Mr. Danyal 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 Fourth Quarter and Full-year Earnings Call. You know, thinking about this call and what I should say, the real thing was 2023 probably, in retrospect, was what we'll loosely call a transitional year for us, and in terms of where we want to go with the company, somewhat of a neutral year. It harkens back to, I think, in late January of 2023, when we were looking at our credit performance, we were somewhat surprised and/or dismayed, if not shocked, that the 2022 vintages weren't performing as well as we thought they would. At that point, we decided we needed to slow things down and figure out what was going on, and so we did. So really, unfortunately, at some level, we spent I mean, there's good news, bad news.

bad news is we spent most of 2023 evaluating the 2022 performance and figuring out what went wrong and how to make it better so that we could then move forward. It took some time. One of the things we did immediately was we tightened the credit, re-improved the model, beefed up the collection team, and kind of went after making that 2022 paper perform as best as we possibly could. So, unfortunately, at some level, we spent most of 2023 waiting to see how 2022 would do rather than try and grow real fast in 2023 and not really know how we were gonna improve.

So what we did find out as the year went on, and actually just the first or second quarter, as much as we were somewhat dismayed in our performance and how our credit was performing, we found out that almost everyone else in the industry was doing far, far worse. So that was a bit of an interesting sort of revelation that as much as we didn't like our paper, our paper was doing way better than almost everyone else's, and that is true today. So the question we get all the time is why. Why did that happen, and why did we do better? So as much as it's kind of difficult, I'm not gonna go through the whole thing.

I'll just go through a couple of highlights that we've determined probably are the cause of why 2022 wasn't as good and 2023, you know, ended up being better, or things we fixed in 2023. One of the first things was somebody in our industry came up with a not-so-brilliant idea of guaranteeing backend profit to all the dealerships. Being that we have been along kind of forever, around forever, we realized right away that was kind of stupid. However, we looked at it a lot, and it turns out most people in the industry followed along that path, and eventually, we came up with a much tighter, scaled-back version of what we call the backend profit program. In the end, that probably helped us. One of the things that that program did is it boosted LTVs, loan-to-values, significantly when you were guaranteeing the profit to the dealer.

Obviously, it was a good program in terms of the dealerships 'cause the dealership loved making all this money for sure no matter what contract they were writing. We were obviously very skeptical, and so we did it a little bit differently, and, you know, didn't do it as dramatically as everyone else, and we certainly did it a lot slower than everyone else. That turned out to be very significant in helping us do better in the whole process of the 2022 paper. The other thing that happened is everybody started growing a lot. The rates were really low. Business was booming. The auction values were great.

And for some unknown reason, a lot of our friends decided to stop fully verifying stipulations, things like proof of income, meaning, like, I don't know, they had a job, things like, where do they live, how long have they had a job. And, you know, dealerships being wonderful folks, sort of, maybe, tend to take advantage of dealers or lenders who don't check things. One thing we've always done, and we will continue to do no matter how much work it is, is we verify everything. We make sure our customers have a job. We make sure that they're living where they live. We do a full credit check on everything. And we do it verbally over the phone. And for whatever reason, that tends to protect us dramatically in terms of some of the problems that happen in our industry.

So if you look at those few things, you know, we went much slower into the guaranteed backend than everyone else. We did it much more cautiously than everybody else. And we also continue to check all of the steps that you normally would have. And some of our friendly competitors did not. We also realized things weren't what we thought they would be much quicker, maybe quicker, but certainly very quickly. And so we were pulling back much faster than some other folks. So as a result, and this is, you know, in the 30 years I've been with this company, we've never had a time where our company stands out so much better than almost everyone else in terms of credit performance and in terms of how we run our models and manage our portfolio.

So as much as 2023 was kind of a, you know, not the best year in terms of being able to grow and succeed and expand, you know, being able to say that we did it pretty much better than everyone else is kind of a pretty cool way to say that's how 2023 went. Hopefully, now that 2022 is getting behind us, 2023 performance is certainly much better. All the changes we've made have been very good. It looks like we're kind of ready to go again, so. But, you know, looking at 2023, that's the story of, you know, how we did it. Fourth quarter, you know, it's sort of the end of when we're beginning to get things going again. So we'll see how it goes.

I'll talk more about that and sort of what we think's gonna happen next after Mike and Danyal go through their pieces. So I'll turn it over to Mike to do the operations review.

Michael Lavin (President and COO)

Thanks, Brad. To sort of follow up on what Brad was talking about in terms of portfolio performance, since that is the number one priority at the company right now, I'll also add that there were some macroeconomic issues that were sort of weighing on the vintages, 2022 and early 2023. Obviously, inflation and rising interest rates were headwinds that we could not control, along with the guaranteed backend problems that Brad talked about. It jacked up the amount financed and jacked up the car payments, putting stress on the consumer. But in fairness, that's been balanced out with fantastic unemployment numbers. That is probably the most critical metric to judging the viability of our business, and that is near a historical low. And also, the other bullet that can really hurt the business is a recession.

And I think that most economic pundits are opining that we are going to avoid a recession, soft or hard. So low unemployment, no recession, still means that our business is quite viable. As Brad alluded to, the 2022 vintages started off challenging but seemed to have leveled out at the end of 2023. Our servicing practices definitely helped that. I'll talk about that in a minute. Likewise, the first half of 2023 vintages are equally challenging. But again, we've seen steady improvement on those vintages, and we expect them to be more in line with our historical C&Ls. Anecdotally, we were recently at a major asset-backed securities conference, and we routinely heard from investors and bankers that our 2022 vintages and 2023 vintages far outweighed our competitors' performance in the space.

So even though we aren't quite thrilled with the challenges that 2022 and 2023 early 2023 had, we're very pleased with our performance in our space. For the fourth quarter, DQ, including repossession inventory, ended up at 14.55% of the total total portfolio as compared to 12.68% in the same quarter of 2022. The all-important annualized net charge-offs metric in the fourth quarter was ended up at 7.74% of the portfolio as compared to 5.83% in the same quarter, in 2022. Extensions were up slightly in the quarter but well within our historical numbers. Our extensions to active account ratio is actually a little bit below our historical numbers. On the recovery front, we generally want to see recoveries in the low 40s. They've dropped a bit into the high 30s as used car prices dropped, hurting us at the auction.

There remains a dearth of repo agents who left the industry during COVID. This affects the timing of our repair, repo and sale. With that being said, in canvassing and benchmarking the market, we believe our repo and sale timing remains the best in the industry, regardless of where we're at, in the recoveries. Another great collection trend for us that we saw towards the end of the year is our POTS group. That's our potential delinquencies, 1-29-day bucket, had its best performance in two years. This is important because the better you do in the POTS, the better you do in the later buckets as the roll rate is consequentially affected. Another good trend we saw in our collection practices is our right-party contact has gone from 4%-8%. This correlates to more promises to pay.

The more promises to pay you have, the more dollars you collect. That's a very good trend. We also put in a new outreach program early in the collection stage where we introduce ourselves to our customers. The main thing we're trying to do in this introductory is to get our customers to sign up for recurring payments. This has been an initial success as we've seen a 25% increase in our recurring payment signups. This very much helps our collection performance. As Brad alluded to, we definitely beefed up our collection staff in 2023. We took it from 287 collectors to 423 collectors. This has lowered the accounts per collector from 675 to a much more comfortable 515. This allows the collector to have more time to work the accounts and equally important skip trace problem accounts manually.

One of the final things we did is we also beefed up our nearshore operation. We didn't necessarily add more nearshore collectors, but we reassigned our strategies. So what we're doing is we're putting the nearshore collectors on the power dialer, which frees up our domestic collectors to do more manual collecting. All of these servicing tactics are unique to us. And we think that, you know, but for the unique approaches we've taken, our servicing performance would have been slightly worse. So we're happy with our servicing performance. Switching to originations, the fourth quarter remained solid as we purchased $301 million of new contracts. That compares to $322 million in Q3 of 2023 and $428 million during the fourth quarter of 2022. For the year, we did $1.3 billion in new contracts, which compares to $1.8 billion in 2022.

The pullback from 2022-2023 was purposeful and intentional and definitely a function of our consistent credit tightening, which we think we began first in the market in March of 2022. We continued that tightening in 2023 and actually continued tightening as we head into 2024. Specifically, we tightened the LTV. We capped payments, which is important in certain program segments. We tightened job stability and residence requirements. We made less exceptions on deals that were declined. While this has lowered our overall approval percentage, more significantly and more importantly, we've knocked down the LTVs, which is a leading metric to predicting losses. While 2022 was a record year for us, and certainly we were excited and pleased, despite the pullback in 2023, it actually ended up being the second-best originations year in our 30-plus history.

So all things considered, quite a good year on the originations volume. To that effect, and again, despite the pullback, we were able to grow the total managed portfolio, which now stands at $3.195 billion, which is an increase from $3 billion at the end of 2022. So we're pleased with that. The slight uptick quarter over quarter reflects strong demand in the subprime auto business space. Actually, we received more applications in 2023 than we did in our record year of 2022. One of the worst things that we could say in this call is that subprime auto market is downsizing. That's just not true with our applications volume. The subprime auto market is certainly very strong. One of the things that we're looking at in terms of portfolio performance and in our originations is affordability for our customer.

We continue to hold firm on our payment to debt or I'm sorry. Our payment to income and debt to income ratios remain the same and have remained the same over the last 5-7 years. That's good. Our monthly payment remained relatively low for our space at around $535. This compares to the average subprime payment of around $600 and, of course, the new car payment around $775. So we're keeping an eye on affordability in our space. We continue to hold a strong APR in the fourth quarter as we registered an average APR of 21%, which is about on pace for where we were at the end of 2022. In terms of competition, there's more than enough business for everybody in our space.

One interesting thing that we see is we don't necessarily lose, lose business to our direct competitors that sit on top of us in the space, but we actually lose business to credit unions. But what we've seen is a wave of credit unions come into the space. They see that with their low interest rates, they don't get they don't make money. They get killed on C&Ls, and then they exit the space. And then a whole new wave of credit unions come in and learn the same thing. But what we have seen in the last, you know, three months is more and more credit unions are actually leaving the space, which is freeing up more business for the rest of the normal competitors in our market.

Turning to a couple technology updates, we put in our brand new Generation 8 machine learning-based AI model in October of 2023. This model is a fresh update and a refresh of our Gen 7 model that launched in 2021. We remained on schedule with refreshing our model every 18 months or so. This model relies and is based on the last two years of originations, obviously taking into account the COVID-related portfolio performance, and utilizes new alternative data. We've got a new fraud score that we think will save us hundreds of thousands a month in synthetic fraud avoidance. And we believe that this is our best buy box yet. The initial results from this model are quite positive. We also continue to infuse our business with AI platforms to increase efficiency and accuracy.

This is not a new this is not a new thing for us. We've been we've been sort of on the AI bandwagon for the last 5 years. Obviously, we, we use machine learning in our in our originations model. We have, a new well, we've been using it for about a year. It's an AI machine learning-based, document, document, review, AI in our originations, which is increasing efficiency. We are testing new AI voice bots and new AI text bots. What we've learned in the last 7-8 years is texting is probably the best collection tactic. We believe we've found the best voice bot in the market. And, you know, connecting that voice bot to, to our texting platform, should certainly help our collections performance. One other thing of note, is our, real estate platform.

We were lucky enough to have most of our leases come up for renewal post-COVID. So we were able to leverage the softening commercial real estate market. We renewed or moved 4 of our 5 leases within the last quarter, believe it or not. We're looking at a $10.8 million savings in that real estate footprint over the next 4 years. We've also leveraged what we think a best-in-class work-from-home platform to reduce our space as well. So with that, I'll turn it back to Danyal.

Danyal Bharwani (CFO)

Thanks, Mike. I'll go over the financial results. For the revenues for the fourth quarter, $92 million. That's an 11% increase over the $83 million from the fourth quarter of 2022. For the full year, revenues were $352 million, is a 7% increase over the full year revenue of $329.7 million in 2022. Of course, our largest component of revenue is interest income. The fair value portfolio is now up to $2.7 billion. And that portfolio is yielding 11.3%, remembering that that yield is net of credit losses. Also included in revenues for the quarter and for the year are marks to our fair value portfolio. In the fourth quarter, we booked a markup of $6 million to that fair value portfolio. That's compared to or for the full year, it was $12 million in markups for the fair value portfolio.

That's compared to $15.3 million in fair value markups for the prior year 2022 period. The markup is a result of better-than-expected performance in that fair value portfolio. Looking at expenses, $82.1 million for the fourth quarter is 27% higher than the $64.7 million in the fourth quarter 2022. For the full year, $290.9 million in expenses is 36% higher than the $213.5 million in 2022. A couple of things of note under expenses, we continue to see reverse negative loss provisions from our CECL portfolio. That's the portfolio that we originated prior to 2018 that's not accounted for under fair value.

We booked a lifetime loss reserve on that portfolio, and the results are coming in on that better than we expected. So we're able to reverse any loss reserves that are no longer required. That number was $1.6 million in the fourth quarter, $22.3 million for the full year.

Those numbers compare to $4.7 million in the fourth quarter of 2022 and $28.1 million for the full year 2022. Also, another large mover in terms of expenses is interest expense. That has increased to $40.2 million in the fourth quarter from $28.9 million in the fourth quarter of last year. For the full year, interest expense is $146.6 million compared to $87.5 million in 2022. Largely, those increase in interest expenses largely attributable to higher rates, but there's some smaller component of that that can be attributed to portfolio growth. Pre-tax earnings, $9.8 million for the fourth quarter compared to $18.3 million. It's a 46% reduction from the prior year, fourth quarter. For the year, $61.1 million is a 47% reduction from $116.2 million in 2022. Likewise, net income follows those same trends, $7.2 million for the quarter compared to $14.1 million a year ago, quarter.

For the year 2023, $45.3 million of net income versus $86 million in 2022. Moving over to the balance sheet, a couple of things of note here are finance receivables at fair value, now at $2.7 million, like I said earlier $2.7 billion, excuse me, is 10% higher than the $2.5 billion, where we were at the end of 2022. Looking at our debt balance, the one thing of note here is our securitization debt is $2.265 billion at the end of 2023 versus $2.1 billion at the end of 2022. Doing the math, that's a 7% increase on the debt compared to a 10% increase on the fair value assets. So we're able to manage with, with lower leverage, on and building up our balance sheet is certainly a sign of strength for our balance sheet.

Looking at shareholders' equity at the end of the year, $274.7 million is the highest in our history. That's 20% higher than the $228.4 million at the end of 2022. And that's driven by 49 consecutive quarters of pre-tax profit that we've been able to, to generate over the last 12 years and change. Looking at other metrics, our net interest margin of 51.7 is 4% less than the 54.1 a year ago. For the year period, our net interest margin is 205.4, is 15% lower than 2022. Core operating expenses are $43.5 million, is 7% higher than the $40.6 million in the fourth quarter of 2022. For the year, core operating expenses is $166.6 million for 2023 versus $154.1 million in 2022, is an 8% increase.

Our annualized core operating expenses, that's a percentage of the managed portfolio, is now 5.9% for the fourth quarter of 2023, is flat from the fourth quarter of 2022. But on the annualized basis, the 2023 period came in at 5.7%, is a reduction from the 6.1% we saw in 2022. So we're starting to see some operating leverage improvement as the portfolio grows. Our return on managed assets for the quarter, 1.3%. For the year, it's 2.1%, versus 4.6% in 2022. That's it for the financial results. I'll turn the call over to Brad.

Michael Lavin (President and COO)

Thank you, Danyal. As you can hear from both the reports that, as much as 2023 or 2022 wasn't the best of the years, we've done quite well through it in many different areas. Looking at the industry, it's kind of about that. Everyone's still struggling with the 2022 paper. And even in some cases, some people's 2023 paper has not started out particularly well either. But, you know, our since ours is, we're kind of happy where we sit there. And I think it's going to create some opportunities for the company in that, you know, people are certainly going to be kind of conservative going forward, at least until they understand that their models are working again or they've corrected their models sufficiently to where people can grow again.

So we might have a little bit of a head start in terms of getting back in the game than some of our friendly competitors. You know, there certainly will be some opportunities that probably one or two of the folks won't make it. That might be interesting opportunity-wise. But also the fact that we can start growing again and sort of put 2022 behind us and be proud of what we did in 2022. But again, in terms of our what we want the company to do, we'd like to get back to that game much more than we have been. Also, you would think at some point down the road, they'd have some lower rates. And with a lower rate environment, obviously, our margins improve. Our performance will be great that way.

So, you know, towards the end of this year in 2024, that might be a benefit as well. In terms of the overall economy, you know, who knows whether we'll have a hypothetical soft landing, but certainly, you know, looking like we might get somewhere there. But, you know, generally speaking, we think it's going to be a decent economy, if not a good economy. So we're happy along those fronts. Almost most important by far in any of that is unemployment. Unemployment looks great. You know, unemployment's the one thing that can cause our industry problems. It does not appear to be a problem at all. It shouldn't be a problem for a long time, or at least a, you know, significantly amount of time so we can get growing again and, really take advantage of the position we're in. So having said that, 2022 was tough.

2023 was sort of that transition from making 2022 go away and getting things ready to go for 2024. So now that we're into 2024, you know, hopefully, it's all full steam ahead and a bright future. And again, so it's still kind of remarkable that through all that, our company has done so well in terms of how our paper performed in 2022 and even 2023. So we were super, super proud of our people and what we've done to do it. And certainly think 2023 and everything we've done during 2023 has well positioned us for 2024 to be a very good year. I want to thank you all for joining us today. And we'll be back to you rather soon with our first quarter report in a month or two in a month or so. Thank you.

Operator (participant)

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.