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Edited Transcript of SC earnings conference call or presentation 24-Jul-19 1:00pm GMT

Q2 2019 Santander Consumer USA Holdings Inc Earnings Call

Dallas Jul 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Santander Consumer USA Holdings Inc earnings conference call or presentation Wednesday, July 24, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Evan Black

Santander Consumer USA Holdings Inc. - Head of IR

* Juan Carlos Alvarez de Soto

Santander Consumer USA Holdings Inc. - CFO

* Scott E. Powell

Santander Consumer USA Holdings Inc. - President, CEO & Director

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Conference Call Participants

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* Arren Saul Cyganovich

Citigroup Inc, Research Division - VP & Senior Analyst

* Betsy Lynn Graseck

Morgan Stanley, Research Division - MD

* Christopher Roy Donat

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

* David Michael Scharf

JMP Securities LLC, Research Division - MD and Senior Research Analyst

* John Gregory Micenko

Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* Mark C. DeVries

Barclays Bank PLC, Research Division - Director & Senior Research Analyst

* Moshe Ari Orenbuch

Crédit Suisse AG, Research Division - MD and Equity Research Analyst

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Vincent Albert Caintic

Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst

* Wai Ming Kwok

Keefe, Bruyette, & Woods, Inc., Research Division - VP

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Presentation

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Operator [1]

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Good morning and welcome to the Santander Consumer USA Holdings Second Quarter 2019 Earnings Conference Call. (Operator Instructions) It is now my pleasure to introduce your host, Evan Black, Vice President of Investor Relations. Evan, the floor is yours.

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Evan Black, Santander Consumer USA Holdings Inc. - Head of IR [2]

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Thank you. Good morning, everyone, and thanks for joining the call today. On the call, we have Scott Powell, President and CEO; and JC Alvarez, CFO. Certain statements made today on today's call may be forward-looking. Please refer to our public SEC filings and Risk Factors with respect to these statements. We also may reference certain non-GAAP financial measures that we believe will be useful for our investors. A reconciliation of those measures to U.S. GAAP is included in the 8-K issued today, July 24, 2019.

And now I'll turn the call over to Scott Powell. Scott?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [3]

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Thanks, Evan. Good morning, everybody. Thanks for joining the call. So let me start with a few positive announcements before we get into the second quarter results. So I'll start with the leadership changes that we announced this morning. So if you look at Slide 3, you can see those laid out.

So let me start with Juan Carlos Alvarez, our current CFO, sitting across the table with me this morning. Juan Carlos is being promoted. He's getting a bigger job. He is going to be the SHUSA SBNA's CFO effective September 16. So congratulations to Juan Carlos. We're going to replace Juan Carlos with Fahmi Karam, who is sitting next to me here. So Fahmi will be our new CFO effective September 16 as well. Fahmi's been with us since 2015. He's done a whole range of things here. He's currently responsible for our pricing function. Prior to that, he led our strategy and development team, and he's been responsible for overseeing other things like asset acquisitions, sales and other strategic initiatives. Fahmi also played an important role in the amended MPLFA with FCA, which we'll talk about in a second. So it's great to have Fahmi moving into that new role.

The other thing we're announcing is that Rich Morrin is leaving the company. Rich has been President of Chrysler Capital and the Head of Other Relationships. We're sad to see Rich go. Rich has been an important part of our company for a long time. Rich is going off to do something completely different. He's got a great opportunity outside the auto finance space. So we wish Rich well in that new endeavor. So we're replacing Rich with Shawn Allgood. Shawn is currently the Head of Chrysler Capital. So he'll step into Rich's role and take responsibility for not only Chrysler Capital, but our other auto finance relationships as well.

Shawn joined us in 2017 after spending nearly 3 decades at Ally Financial. So Shawn is well qualified to step into Rich's role. So I want to congratulate those 3 folks on their new roles, thank Rich Morrin for everything he's done for us here at Santander, and I'll certainly miss Rich personally.

So the good news about all this is these are internal promotions. We feel really good about the strength and depth and maturity of our organization. It's great to have well-qualified successors lined up to take these very important roles. And as I said, this is a sign of our maturity, and we certainly wouldn't have this depth readily at hand couple of years ago. So happy for the promotions, and we feel good about the depth and quality of the organization.

So that news comes on the heel of our announcement with respect to Chrysler -- Fiat Chrysler that we announced a few weeks ago. And then we also made some announcement on capital distributions that I'll get to.

So you'll recall that back in June 2018, FCA announced their intent to buy a U.S. finance company. And so fast-forward to where we are today, it's great to be able to say, we've reached a mutually beneficial agreement with FCA through the amended MPLFA. We're excited because it establishes an operating framework going forward for our 2 companies that'll allow us to grow together and continue to work as partners. And when you look at our results over the last year with FCA, you can see clear evidence of that strengthening partnership.

So in the second quarter of this year, our penetration rate is 36%, that's up from 32% last year, and it's really the highest level of penetration we've achieved since 2014. You can also look at our growing originations with the FCA. That's a reflection of that strong relationship as well. You've heard me saying on prior calls, we are working really hard on improving the dealer experience and operations. And again, that's part of what you see in that improved penetration rate.

The other big news for us is that we announced a $1.1 billion share buyback a couple of weeks ago, and we're also announcing an increase in our dividend to $0.22, up from $0.20. And again, another demonstration of our continued maturity and progress towards the goal that we've talked about of having a more efficient capital base, which has been one of our long-term objectives.

So if you look at Page -- Slide 4, I'll hit some of the quarterly financial highlights. So net income is $368 million, which is up 10% from the same quarter a year ago. Earnings per share during the quarter were $1.05, which is up 13% from a year ago, and our ROA is 3.2%. It was another strong quarter on originations. We did $8.4 billion in total volume, which is up 5% from a year ago. Our core business at $2.6 billion was down 7% from a year ago. But just keep in mind that we had a really, really strong quarter a year ago.

Chrysler loans. Here again you can see the strength of the relationship, up 25% from a year ago. And the other thing is that reflects the strong partnership we now have in place with Santander Bank, N. A. So in the quarter, you'll see that we originated -- or Santander Bank originated $1.9 billion of loans through Santander Consumer. And you'll recall that we rolled that program out a year ago, and so a really strong quarter for Santander Bank, and again, that helps us support the prime portion of the business with FCA. Leases were down a little bit, down 4%, but a strong quarter overall for originations.

In funding, we continue to execute successfully in the securitization market. We did $3.4 billion of ABS. In July, we executed our second lease ABS transaction of the year. And credit performance, you'll see our credit performance remains stable and continues to reflect a pretty benign credit environment. So our 30- to 59-day delinquency ratio was down a little bit, 59-plus was up a little bit. Net charge-off ratio was up a little bit, 30 basis points. Recoveries were really strong, especially when you look at the auction recovery rates, which Juan Carlos will take you through in detail.

Also another really positive sign is the decrease in TDR balances, down almost $400 million from the prior quarter, which is a little more than we actually expected, which is positive. And that's really driven by the fact that we're doing fewer modifications, and our net charge-off ratio was slightly higher.

Just a couple of comments about the macroenvironment. Obviously, as I've said before, the radar is fully switched on when it comes to tracking what's happening in the broader environment. Job creation and consumer confidence remains strong, which is obviously very, very important to our business. And then when you look at new car sales and used car sales numbers, they climb up and down a little bit, but pretty consistent over time. And I'd say a slight positive is that used vehicle prices has not shown some year-over-year improvements kind of across the board, so including sedans, so it's not just SUVs.

I'll stop there, with that, I'll turn it over to Juan Carlos.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [4]

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Thanks, Scott. And good morning, everyone. We'll start with Slide 5 for some key economic indicators that influence our originations and credit performance.

As mentioned earlier, the overall macroeconomic environment remains supportive of our business. Consumer confidence is high and job creation remains robust. Environment continues to support the resilient consumer-lending environment. And with Q2 now behind us, industry experts are forecasting only a moderate decrease in new vehicle sales for 2019, which is still indicative of a stable market.

If we look at Slide 6, there are a few key factors that influence our low severity and credit performance. Our auction recovery rate, which represents all auto-related recoveries from the auction lanes is 50.8%, up from 46.5% during the prior year quarter. Our recovery rate, which includes nonmetal proceeds, bankruptcy and deficiency sales was 60.3% in the quarter, which is stable versus the same quarter last year. Additionally, nonprime industry securitization data points to relatively a stable net loss and delinquency trends compared to last year.

Turning to Slide 7 for origination trends. Overall, we saw a healthy level of originations across the board, more than $8 billion in total volume. Core loan originations decreased 7% in the quarter compared to the prior year quarter. However, the first half of the year, volume is up 3% year-on-year. Chrysler Capital originations did increase 25%, and the SBNA program combined with our FCA partnership drove strong growth in prime loans. This was a particularly strong quarter for that SBNA platform in which we expect volume to be closer to the 1 billion per quarter level for the remainder of the year.

Switching to lease originations, volume decreased 4% versus Q2 last year. Looking ahead, we remained disciplined with respect to the risk-return profile of our nonprime originations. We also expect to continue to support FCA prime loans with our SBNA program while maintaining a strong presence in lease.

Turning now to Slide 8. Again, we are pleased to reach a mutually beneficial agreement that strengthens our partnership with FCA going forward. The amendment sets us up well for the remainder of the contract and positions us to continue to help FCA succeed. As part of the announcement, we announced that we made a onetime payment of $60 million to FCA and the amendment also terminates the tolling agreement.

Moving to our performance in the quarter, our average quarterly FCA penetration rate in Q2 was 36%, up from 32% last year. We continue to optimize our full spectrum lending and servicing platform across loans, leases, floor plan and third-party services. We're really excited about our new agreement. During the coming quarters, we aim to build on the progress made by remaining focused on optimizing the relationship, continue to drive improvement in dealer satisfaction scores in collaborating under our updated agreement. This will bring renewed vigor to our relationship going forward.

Looking to Slide 9. The service for others platform generated $25 million in servicing fee income this quarter. Now, in addition to those servicing fees, $12 million of SBNA origination fees are in our fees, commissions and other line item. During the quarter, we added $1.9 billion in originations to the SFO platform via our agreement with Santander Bank, which drove these SFO balance increase as our previous flow programs' assets runoff.

Moving to Slide 10, to review our financial performance for the quarter versus the prior year quarter. Net income for the quarter of $368 million, up for -- up from $335 million. Interest on finance receivables and loans increased 4%, driven by higher average loan balances. Net lease vehicle income increased 31% due to continued growth in lease balances. Interest expense increased 20% due to the increase in benchmark ranks compared to Q2 of 2018 and by a lower contribution from our derivative portfolio. Provision for credit losses increased to $431 million in the quarter, up $24 million, driven by a combination of higher balances and lower modification levels offset by the lower TDR balances. Total other income was $30 million in the quarter, and included $85 million of held for sale adjustments related to the personal lending portfolio, which is comprised of $97 million in customer charge-offs, offset by a $12 million decrease in market discount.

Continuing to Slide 11. Versus the prior year quarter, early stage delinquency decreased 20 basis points while late stage delinquency increased 20 basis points.

Moving now to the bottom portion of the slide on losses. The RIC gross charge-off ratio of 16.1% in the quarter increased 90 basis points from Q2 last year. The RIC net charge-off ratio of 6.4% increased 30 basis points from Q2 last year. And as we referenced last quarter, loan modification levels are lower relative to prior years. And again, less modifications impact delinquencies, charge-offs and lower inflows into TDRs.

Turning to Slide 12 now to review the loss figures in dollars. Net charge-offs for RIC increased $56 million versus prior year quarter to $462 million. $45 million of losses were due to a higher gross charge-off rate, another $20 million is attributable to higher average loan balances which were up more than $2 billion from last year. These were slightly offset by better recoveries and other items.

Turning our attention to provisions and reserves on Slide 13. At the end of Q2 2019, the allowance for credit losses totaled $3.1 billion, decreasing $54 million from last quarter, which represents an allowance ratio of 10.8% at the end of this quarter. Going over the components of our reserve work. The allowance increased $234 million due to new originations in the quarter, $61 million increase was due to unfavorable performance adjustments. And these increases were more than offset by fewer inflows into TDR migration, which drove a benefit of $10 million, and $339 million decrease due to TDR and non-TDR payoffs and charge-offs.

Let's now turn to Slide 14 to discuss TDRs in more detail. This quarter, TDR balances decreased nearly $400 million versus the prior year quarter, continuing their downward trend due to the lower TDR inflows given the strength of the consumer and the lower modification levels. As we mentioned last quarter, this is slower generation of TDRs to allow reserve balances to trend lower through the rest of the year.

Turning to Slide 15, the expense ratio for the quarter totaled 2%, down from 2.2% the prior year quarter, which is important as expense -- dollars are relatively flat compared to last year with a strong growth in our expenses.

Turning to Slide 16, our liquidity position remains very strong with total committed funding of more than $46 billion. SC continued to demonstrate consistent and deep access to the capital markets. Our treasury and capital markets teams got busy doing one transaction of each active ABS shelf in the quarter for a combined $3.4 billion. And we also continued to diversify our funding through private financings and lender commitments which totaled $17.3 billion. Subsequent to quarter-end, we also closed a $1.2 billion lease ABS transaction, SRT, and this is the fourth transaction since the inception of this new lease platform in late 2017, which is important for funding diversification.

Finally, turning to Slide 17, our CET1 ratio for the quarter was 15.7%, down from 16.9% versus prior year. As Scott mentioned earlier, we are excited to have the opportunity to return more capital in this cycle with the announcement of our increased dividend of $1.1 billion repurchase program.

Now turning to our guidance for the third quarter. My comments will be relative to Q2 unless otherwise noted and will include the impact of personal lending. We expect net finance and other interest income to be up 0% to 2% in the second quarter primarily driven by higher loan balances and lower swap rates.

Provision expense is expected to increase $185 million to $235 million in line with seasonal patterns. We expect total other income to be flat to $10 million worse, driven by normal seasonality of the Bluestem held-for-sale portfolio. And operating expenses are expected to be flat to $10 million better in line with seasonal patterns.

Regarding our full year guidance, this quarter, we have no changes to 2019 guidance ranges that we provided on our last earnings call. And before we begin Q&A, I'd like to turn the call back to -- over to you, Scott.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [5]

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Thanks, Juan Carlos. I would just come back to 4 key points. So Santander Consumer has made significant progress over the last few years creating a better dealer experience, fine-tuning our pricing engine and making sure our risk management and operations are running smoothly. Number 2, we've remained disciplined on expenses with positive operating leverage. Number 3, we spent a lot of time building and deepening our management team, and you see that reflected in the management announcements that we've made this morning, and we continue to focus on running Santander Consumer at large U.S. Financial Institution Standards.

And then number 4, FCA. We continue to work very hard to support our partner. I think our results reflect progress we've made. We're very happy to announce the amended MPLFA, and we really look forward to continuing to do a better job for FCA over the remaining life of the contract, and we look forward to the opportunity to kind of win the opportunity to have a longer relationship with FCA past the end of the contract. So with that, I'll stop there, and we'll go to questions. Over to you, operator.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question from Jack Micenko with SIG.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [2]

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Congratulations on the new role. Scott, looking at the penetration rate, obviously a big jump. You're running 36% and the SBNA flow is helping that. The move this quarter, was that the new contract agreement? Did something specific change there? Or is it just really more of the harvesting of the ongoing efforts? I know you had Rich focused on this for a long time prior to this, just want to understand the step-up here in the big origination number. And what's incremental versus what's sort of been in process internally?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [3]

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Yes. Jack, there wasn't any particular thing that happened. Yes. SBNA had a particularly good quarter driving the prime originations, but no, it's really -- it's the byproduct of a whole bunch of different things that we've been working on kind of on the pricing and execution side that I touched on with respect to dealers. And then just kind of improving the relationship that we have kind of at the operating level and the senior levels in the company. And obviously, sales incentives that they put in the market are an important part of that volume, but it also reflects the confidence that they have in us, the growing confidence they have in us to deliver for them. So it's a reflection of all those things together. And you're right, having SBNA, Santander Bank, N.A., in the game with a different funding structure is really helpful with the FCA relationship.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [4]

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Okay. And then my follow-up on the balance sheet, I think you historically run some of the liability-sensitive position on the balance sheet, and with the fed contemplating going in the direction here, I guess: a, is that still true; and then b, is there a way to sort of come up with the sensitivity around 25 bps per and sort of the lag effect that could be on the funding costs.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [5]

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Yes, the -- so yes, we're still liability sensitive. I mean over the years, we've neutralized that position somewhat. It's disclosed in our filings, but disclosure is always references to parallel movements, that's how you tend to measure it. I think what will be particularly important for us is up until now, we have -- we're already seeing the benefit, gradual benefit of lower swap rates, right? Which help us every time we do a securitization. We're doing the FCA rate cut, [prices] are starting to finally push down like 1 month LIBOR, and that benefits us on warehouse lines, for example. Okay? So we will get some additional help if that materializes. Okay? What you'll see for the quarter or NII sensitivity to a 100 basis points parallel move downward is $35 million in a year, but, again, that will be for a parallel move, right? And that's not exactly what we're seeing.

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Operator [6]

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And we'll take our next question from John Hecht with Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [7]

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JC, congratulations. A little bit of a follow-up from the step-up from the Chrysler partnership. If these trends with volumes persist, what does that do to kind of base rate NIM and loss rates? Is there any effect over time in those?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [8]

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No. Not necessarily. I would say, the new agreement we described earlier gives us the ability to solidify our relationship going forward. It will give us the ability to do better business together, okay? But it doesn't necessarily represent a drastic change in strategy, so bigger and better.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [9]

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Okay. And then second question pertains to the allowance level. Number 1 is, do you have any comments on CECL; and number 2, should we expect the -- for CECL aside, should we expect the ALLL to continue to decline at the similar pace as a percentage of loans given what's going on with the TDRs.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [10]

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Thanks. So in terms of CECL, we are running the parallels, so exactly in line with the guidance that -- or the discussions we've had the last several quarters. Those parallel runs are going now, we expect to be able to come back with better guidance of the impact in the Q3 earnings call. So all of that is going according to plans. Your other question was related to the allowance ratio. I think right now, the downward trend, sort of, as you highlight is impacted mostly by the lower TDR balances, right? Because if you look at the non-TDR allowance ratio, this has actually been very steady. Okay? So yes, I think it would be the same answer we've provided in the past. The allowance ratio should stabilize -- apples-to-apples should stabilize once the TDR balances stabilize.

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Operator [11]

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We will take our next question from Mark DeVries with Barclays.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [12]

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So the $1 billion repurchase authorization is obviously quite large relative to the current flow. Is there anything you can share with us around how you might look to go about repurchasing those shares, if you're considering anything on an accelerated basis?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [13]

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Yes. We're very pleased about having announced the both increasing dividends as well as the -- up to $1.1 billion repurchase program is -- as you all know, has been able to distribute more capital is something that we've been pursuing for quite a while, so this is a very positive step. In terms of how we'll go about it, as we move forward, we're going to evaluate -- as we have in the past, evaluate market conditions and consider all execution strategies as we move forward. Okay? We'll also consider any other potential alternatives for capital deployment, always to make sure that we're generating value. Okay? So I think right now, what we are looking at is flexibility in terms of how we execute our repurchase program over the next 12 months, really.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [14]

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Okay. Got it. And then is there anything you can share with us about just kind of specific substantive changes that were made to the Chrysler agreement, and whether you considered extending that?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [15]

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Yes. The FCA agreement, you have a redacted contract is out there. And you'll see looking at it that there is a update certain performance metrics, sharing practices, that sort of thing. So that's, again, the importance about the agreement is that it will solidifies our partnership going forward and gives us the ability to do better business, right? And better partnership.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [16]

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Yes and Mark, the only thing I would add to what Juan Carlos said is, it was important for both sides that we have an operating framework that works given the current relationship. So obviously, the tolling agreement they put in place at the end of the year froze their ability to essentially continue to dispute some elements of the contract. And so I would just tell you, the new contract, we're happy with it, the amendment -- sorry, the amendment to the contract, they're happy with it, we're happy with it. It frames up the relationship in a way that both sides can operate for the future without concern about creating the default situation. So it's -- that's one of the reasons we're very excited about it because it creates a framework that really works for us, and lets FCA do what they need to do as well.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [17]

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I think specifically to your question about an extension, okay, the contract -- the amendment does not extend the contract, but I think as we said earlier, it gives us the ability to have this enhance relationship and gives us the opportunity to fight for the opportunity to do more business even beyond that, Santander will have to work.

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Operator [18]

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And we'll take our next question from Steven Kwok with KBW.

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Wai Ming Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [19]

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Just the first one is around the originations. It seems to be strong year-over-year, but just wondering if you could touch upon the competitive landscape. And then also can you provide some color around your outlook for used-car prices that's been holding up really well.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [20]

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Yes. I mean it's -- the competitive landscape hasn't changed. It's super competitive, continues to be super competitive. Yes, it's -- I do think it's one of the most competitive lending spaces out there in the U.S. market. So yes, there's no let off in the competitive framework going on there. And the outlook for used car prices, I think is actually pretty good. Obviously, there are people who say it's going to go down, and -- but it's obviously strong in the quarter. The outlook for the consumer and the economy remains good.

One of the things that's interesting is, as I mentioned, I think, that strength in used car prices isn't just trucks and SUVs, Sedans were strong as well, which to me says it's a bit of an across-the-board kind of phenomenon driving that. So we're not changing our strategy because we think used car prices are going to continue to rise. But I don't have any -- I don't think we have any reason to believe that decline in used car prices, a significant decline, is on the horizon.

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Wai Ming Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [21]

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Yes. And just given your ability to increase the origination year-over-year, are you guys taking share from others and then if so like who are the ones that you're taking share from?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [22]

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Our market share is up a little bit year-over-year, but it's -- I don't think we can see where that's coming from and we're up a few percentage points on market share, I think.

No, it's kind of grinding that out application-by-application on the non-Chrysler side, and then working hard on the Chrysler relationship and improving our service to dealers, which is very big.

I mean we haven't really talked about the specifics but we've invested a lot in delivering better for dealers, things like putting better staffing in place, which drives down our contract inventories, which means we're funding deals faster. And when I say faster, we're significantly improved from where we were last year. We set up things like regional credit teams, and we're increasing our auto-decisioning rate, and we're not done. I mean that's -- those are all -- we made progress across all those issues. But we'll continue to focus on how Santander works inside the dealer because that's critical for continuing to get good volume from dealers, and so it's just a combination of all those things and like -- and also optimizing our credit and pricing engine. No magic, it's just a combination of all those things together.

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Operator [23]

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And we'll take our next question from Moshe Orenbuch from Crédit Suisse.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [24]

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Congratulations, JC, on this jump as well. And maybe talk a little bit about the better integration with your parent with respect to the funding transactions that you've done this quarter? And whether that has an impact on how you think about where your volumes going to be in the next few quarters?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [25]

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The funding, you mean the SBNA platform?

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [26]

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Yes.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [27]

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Okay. Sorry. Yes. Yes, so it's almost like the previous one, it's not new. If I remember, we've fully launched -- last year, we talked about how we were working on it, and we worked on it for a number of months to make sure that this platform wasn't like the previous flow agreements where we would originate warehouse and then pass on the -- or sell the loans to our partners. This case with FCA, we have a platform that not only meets their buy box, their credit box, but also allows us to originate directly onto SBNA's balance sheet. Okay? And in return, we get origination fees and servicing fees. So this was fully launched exactly a year ago, Okay? And we've seen the gradual improvement there with really a very strong quarter this year as was discussed earlier. As I change our strategy -- I think it's your question. That was your question, right? Not sure because you were fading out a little bit.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [28]

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Well I guess, what I saw is that they -- Santander sold some credit with notes that maybe makes their appetite a little bit larger for the product.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [29]

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Oh, okay. No, no, no. Totally -- I got you. I got you. Okay. No totally unrelated. Those notes that you're -- credit-linked notes that you're referring to are part of the old flow program that we've had with the group, with head office, basically. Remember, we use that as a bridge until SBNA came on board. We originate and sell those loans to head office. Recently, the transaction that you're talking about, the group decided to securitize them and basically distribute some of the tranches. So that's entirely unrelated to an ongoing -- to our ongoing platform with SBNA and not recurring from the SC standpoint. Thanks for the clarification.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [30]

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Just separately. Any kind of update on the written agreement. We're, I guess, past the 2-year point since that has -- was -- since you've been working on it.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [31]

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Are we past the 2-year point?

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [32]

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It was from 2017. I guess we're in the second year maybe.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [33]

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It was in the spring.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [34]

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In was in spring, yes. I mean it sounds like you've read it. I mean it's pretty wide-ranging for everybody's benefit, 2017 written agreement at the Federal Reserve is on compliance issues at the holding company level and then into Santander Consumer here. And I would tell you that like the other written agreements that we closed out, and you'll recall that we closed out one from 2014 on paying of dividends, and then we closed out a very comprehensive one from 2015 on overall risk management framework. And so just like those 2, we're heads down. We've committed significant resources and management effort to address those issues raised by the Federal Reserve, which we don't agree with, by the way. It's all, when I say operating at large U.S. financial institution standards, that's exactly what I'm talking about. So I can't really tell you when we closed out, otherwise I'd get in big trouble, Moshe. But just working super hard on it, and we have good plans, and we know our plans are good. It's just a matter of following through and executing on those plans and it'll get closed out.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [35]

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Great, well, certainly don't want you to get into trouble.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [36]

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Sometimes it's fun to get into trouble, but not with the Federal Reserve.

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Operator [37]

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And we'll take our next question from David Scharf with JMP Securities.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [38]

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First, I wanted to maybe just clarify or make sure I heard correctly. Regarding the SBNA origination volume, did you suggest that in the second half, we should be thinking about a level closer to $1 billion, down from the close to $2 billion in Q2?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [39]

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Yes, I mean -- so we've talked about it in the past that for this year, a more normal cadence would be about $1 billion a quarter, okay? So this quarter was particularly strong, okay? Some of -- because of some of the drivers we talked about earlier, right? So we're not expecting the platform to keep originating close to $2 billion every quarter. It should be somewhere between that and $1 billion a quarter.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [40]

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Got it. And JC, when I look at the -- both the FICO and the new versus used mix on Slide 19, I'm assuming that the material shift to greater than 640 FICO and the big increase in the new vehicle mix, what was driven primarily by the SBNA volumes. If that were back at the $1 billion level in the quarter, would these relative mixes look pretty consistent with the last couple of quarters?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [41]

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Yes. It's definitely. So the answer to the first question is, yes. The mix in the FICOs are -- shifts are largely driven by the increase originations of the SBNA platform. So if we were to have a more normal quarter, still strong but somewhat off the level we've seen, you would see these percentages shift downward as well.

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Operator [42]

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And we'll take our next question from Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [43]

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JC, thank you for all your hard work over the last several years, really appreciate the conversations. Scott, I think this is really a question for you. When we look at things, one of the factors that's contributed to the strength across the sector is strong used car prices and I think the thesis has been that off-lease was going to create supply/demand pressure. As we look forward, can you talk about what you see as the sort of supply/demand for used cars in the context of off-lease tariffs and also the ongoing [UAW] negotiations?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [44]

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Yes. Maybe. I'll take a shot. Yes, I mean certainly -- yes, I don't think -- well, it's just you guys. I don't think I'll get myself in trouble on this one. Yes, I mean I think it's the relative value between used cars and new cars. And yes, there's been comments made about increasing volumes of off-lease cars and what impact that might have. I mean again, maybe I'm not smart enough, I actually -- I don't get into the details in a way because I just think the overall kind of what's happened in the economy, the strength of the consumer, the demand for cars, the relative attractiveness of used car prices is still there.

And again, I -- when we look at what happened in the second quarter, I think it reflects that because it's not just people who like SUVs, buying SUVs and driving up SUV used car prices. So I think there is an underlying macroeconomic effect here that has a big impact on it and the trade-off versus new car prices is real. So I think that will continue, that's my best view of it. And yes, I mean a lot of the conversation about increasing volumes of off-lease cars hasn't really had that big of an impact. So...

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [45]

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We've had those, sort of, tsunamis, right? Almost every year in the spring and at the end of the month, have dealt with it very well.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [46]

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Yes. It's a very efficient system. It probably wasn't very helpful.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [47]

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No, it is. I mean look, it's obviously one of these things where eventually everybody will be right about declines in used car prices, timing is a little bit trickier. You alluded to something I find interesting, which is the commentary on SUVs and that ties in with something we've considered as well. Do you think some of this has really been a function of U.S. consumers becoming pretty complacent about low gas prices and their increased penetration of SUVs as a result?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [48]

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Yes. I mean I think that has an effect, sure. Yes, I think, again, I can't -- I wouldn't even try to say how big of an effect it has, but sure it does. But again, there's so much going on in the market that has an -- just good old fashion consumer preference can do it, it has a big influence. And so -- and like I've said in this call many times, I think the forecasts to your point are not usually accurate and my forecasts are not usually accurate, so it's somewhere down the middle.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [49]

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I think probably the thing to highlight more recently, the SUV trend was the driver for quite a while, right? And we benefited from having the mix of very good SUVs and trucks in our portfolio. But more recently, sedans are also doing very well. So it's not just complacency on gas prices, right? It's probably wider than that -- broader than that.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [50]

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Yes.

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Operator [51]

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And we'll take our next question from Chris Donat with Sandler O'Neill.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [52]

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I have one about the FCA agreement because you mentioned the $60 million payout that you would make to FCA. I'm just curious, it doesn't seem like I saw it in the second quarter, and I didn't hear JC mention it for the third quarter. So how does that show up? Is it one time or is it amortized or does it show up at a later date?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [53]

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It's amortized over the remaining life of the contract.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [54]

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Okay. So there will be some in the third quarter then?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [55]

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There's already some in the second quarter, and you will see the same proportion over the remaining life of the contract.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [56]

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Got it. Okay. And then just one more question on TDRs. I thought I heard you say that the reduction in TDR balances was partly a function of a decision on your part to do fewer modifications. Was that sort of strategy change? Is that driven by the economy or just the take on fewer TDRs? Just trying to understand why the balances are coming down or less is getting put on to replace what comes off?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [57]

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Yes. Remember, this is something we've discussed in the last couple earnings calls, and we highlighted at that time that we -- starting in the first quarter, we were seeing less modifications and generating less inflows into TDRs. And that's a result of our continues -- continued process to evaluate servicing practices, okay? And that trend, you can see, I'll just point you to some of the information that we put on our cues, where you have the trend of what has been never defer for once or twice. If you plot that out, you'll see that the trend for less deferrals has been pretty consistent since starting really after the big spike that we saw coinciding with the hurricane season, right, in late 2017. And we're just seeing more of it now. I don't know, Scott, if you'd like to...

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [58]

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No. I think you said it right, which is the governing principle here is consumers have to demonstrate ability and willingness to pay before we can do either short-term or long-term modifications and determining that is a subtle and complex process, and so we're always looking to optimize that -- our criteria for doing that to make sure we're applying those very important tools when it's appropriate. And as Juan Carlos said, when there's a hurricane or flooding, we do hardship modifications, occasionally then. And so yes, when you look at the combination of less hardship modifications and then a consistent refinement to improve what we're doing every day to help people is what's really driving it. And the only other thing I was going to add is, and I think there's less demand for it from consumers when the economy is good too. So a combination of all those factors takes it down.

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Operator [59]

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And we'll go to the next question from Vincent Caintic with Stephens.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst [60]

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Thanks for the color on the sensitivity to -- from rates to your funding costs. I was just wondering if you could also talk about the asset side. I just look this quarter a big yield, didn't drop that much even though benchmark rates dropped significantly. I did see dealer receivable yields drop a bit. I was just wondering if you could talk maybe a bit about the sensitivity. It seems like you do have pricing power. If you can talk about what -- why that is and if that maybe changes your appetite on different parts of the risks spectrum?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [61]

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Yes. So one thing to note, though, you mentioned that dealer -- the yield on receivables from dealers, right? And I think you're referring to dropping from 3.4 a year ago to 1.6. That yield right there from dealers is really just on a very, very small balance that you have down in the press release. At the bottom of Page 8, you'll see there is only like $30 million balance is -- that's a legacy loan, really. So doesn't really get baked into equation.

But more to your point, your question about pricing power, you're right. Yields on the acquired RICs dropped 10 basis points only, right? Despite the move down in swaps. Really, at this point, we do retain, we talked about it already, it's still competitive out there, right? So this has -- it's not like we've lost pricing power, but it's not as if we've gained more of it either. It really has to do with the mix that we originate each particular quarter. If we happen to retain a little bit more of the near-prime or prime paper that doesn't quite go or fit into the SBNA buy box, the yields for the originations that month will drop a little bit.

All in all, I would say, our ability to pass higher rates to the consumers while rates were going up was evident, we were able to do it. Now swap rates come down, we'll also pass that along to the consumer because we have to compete. Okay? So really, our key driver in terms of pressuring NIM, right, which we've seen, is how quickly we can benefit from the lower trend in rates that we've seen this year, right? So to the earlier point, we're starting to see that benefit as we securitize, but to really turn the cost of debt around, we'll also need a cut in the short term that will help LIBOR go down and then as we reprice the entire stock of debt, that will help our income for it.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst [62]

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Okay. That's helpful. Is it not just necessarily for pricing, but do you have any view on a change in sort of the risk here as you want to play with a notice that there's been more DRIVES securitizations versus SDART. Any thought of change there or are you kind of just following the market with that?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [63]

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No. No significant change in the strategy at all. This is more of the [grind], right, you call it a grind , this is just singles, right? As we go along, we revise our pricing. We look at the market where pricing models, we look at the market where there are pockets of opportunities. And no drastic change in originations here or in underwriting, but one thing to keep in mind, when you compare DRIVE and SDART, remember that we used to fund DRIVE through private deals, right? And the DRIVE is a more recent -- we brought it back more recently. So that also might impact the number of one platform versus the other. But there's really no change in underlying strategy.

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Operator [64]

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And we'll take our next question from Arren Cyganovich with Citi.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [65]

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Just kind of getting back to the TDR balances, I think last quarter, you talked about that normalizing maybe at the end of this year, kind of continues to get better as the new formation is coming in like, as you talked about before, a bit slower than it had in the past. Do you still expect that to be kind of towards the end of the year, when do we get more kind of a leveling off of that TDR balance?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [66]

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Yes. If you remember, even a little bit further back, we used to expect it to level off earlier in the year, and we said sometime in the early part of the year. As we sold a lower generation of TDRs, lower TDR inflows, our updated expectation is exactly what you said, we now expect it to continue through the end of the year.

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Operator [67]

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And we'll take our next question from Betsy Graseck with Morgan Stanley.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [68]

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A couple of questions. One, just a clarification on the NII outlook. I know you mentioned 100 bps, $35 million. Is that a spot move and is that an immediate $35 million or that's a spot move with the $35 million over the course of 12 months, is that right?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [69]

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Yes, it's a parallel move of 100 basis points over the course of a year.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [70]

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Yes, so you don't -- like, it's not based on the forwards. And then I guess the other question is, does it matter if it's a 50 bp cut all at once versus 25. Does that change the numbers materially at all, the $35 million?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [71]

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Yes. No, it does. The most -- to be more upfront definitely would help, right? And it being whatever we do on the very short end, right? If one month LIBOR drops instead of 25 to 50, we get the benefit -- immediate benefit on the average balance for the period.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [72]

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Yes. Okay. And then the flip side is, how do you expect lower rates are going to impact the consumer in your business. Do you think they are going to -- going out for bigger exposures? Do you think your loan growth will pick up? Do you think it's less probability of default or something else?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [73]

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Yes. I think it's all of those things. Certainly, it reduces -- for the average American, certainly reduces their monthly payments that they have to make on the same kind of debt. So yes, I think it will be good for the consumer. I think it will be good for the industry too.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [74]

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Yes and I guess the question is, like what have you been seeing in your probability of default over the past couple of quarters here? Has it changed that much given the length of time that we've been sitting here at like 240 on the front end or not really?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [75]

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No. Not materially.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [76]

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No. And we do look at it. We try to isolate similar segments and cells and see if there's changes and no, we don't really see any plus or minus to the performance given what's happened so far.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [77]

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Okay. And then just lastly, separate topic, but the parent is obviously increasing their share of ownership, and we know that it's a go over 80.1%, that's a benefit for them from an accounting perspective, but I'm wondering, does it impact at all how you operate or is there anything different that happens if -- when they go over an 80% ownership stake?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [78]

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So I think the short answer is, no. We have -- I mean first of all, the parent has increased their ownership and this closed just as a function of us having executed repurchases since last year, right? And so the 80%, which we in Santander Holdings have disclosed, that highlights that there are additional benefits to if and when the 80% ownership threshold were to be reached. But our planning, the analysis that supports our repurchase program is based on our benefits or the benefits for SC and its shareholders. So there doesn't necessarily mean that there will be anything different going up to 80% or beyond 80% for us here in SC.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [79]

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Yes. I just wanted to make sure I understood, like operationally, was there anything that changed with that threshold getting crossed, if and when that threshold got crossed. Really, your answer is no.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [80]

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Not operationally.

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Operator [81]

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This will conclude our Q&A session. I will now turn the call over to Scott Powell for final comments.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [82]

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Thanks, everyone, for joining the call. Thanks for your questions and your interest in our company. As always, our investor team will be available for any follow-up questions you have and they look forward to speaking with you. And we'll see you next quarter. Thanks very much.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [83]

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Thank you.