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Edited Transcript of SC earnings conference call or presentation 26-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Santander Consumer USA Holdings Inc Earnings Call

Dallas Apr 28, 2017 (Thomson StreetEvents) -- Edited Transcript of Santander Consumer USA Holdings Inc earnings conference call or presentation Wednesday, April 26, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Evan Black

* Ismail Dawood

Santander Consumer USA Holdings Inc. - CFO

* Jason A. Kulas

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

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Conference Call Participants

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* Charles Nabhan

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Christopher Roy Donat

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

* Eric Edmund Wasserstrom

Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst

* Jack Micenko

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

* Jeffrey David Adelson

Morgan Stanley, Research Division - Research Associate

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* Mark C. DeVries

Barclays PLC, Research Division - Director and Senior Research Analyst

* Moshe Ari Orenbuch

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

* Shih-Wei Ho

Deutsche Bank AG, Research Division - Senior Research Analyst

* Steven 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 First Quarter 2017 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, [2]

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Good morning, and thank you for joining the call. On the call today, we have: Jason Kulas, President and Chief Executive Officer; and Izzy Dawood, Chief Financial Officer. Before we begin, and as you are aware, certain statements made today such as projections for SC's future performance are forward-looking statements. Actual results could be materially different from those projected. SC has no obligation to update the information presented on the call. For further information concerning factors that could cause these results to differ, please refer to our public SEC filings.

Also, on the call our speakers may reference to certain non-GAAP financial measures that we believe will provide useful information for investors. A reconciliation of those measures to U.S. GAAP is included in the earnings release issued today April 26, 2017. For those of you listening to the webcast, there are few user-controlled slides to review, as well as the full investor presentation on the website.

Now I'll turn the call over to Jason Kulas. Jason?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [3]

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Thank you, and good morning, everyone. Today, I'll discuss our first quarter highlights and provide an update on our key strategic priorities. I'll then turn the discussion over to Izzy for a detailed review of the quarter's results and then open the call for questions.

Turning to Slide 3 to share some of the key highlights from the first quarter of 2017. We are pleased to report solid results for the first quarter of 2017. Our assets are producing strong risk-adjusted cash flows. Our capital base is solid and our focus on keeping our business simple, personal and fair is positioning us to for continued success. During the quarter, SC earned net income of $143 million or $0.40 per diluted common share. Net income was impacted by a few unique items this quarter including accrued interest related to TDR loans, write-downs on loans in bankruptcy and expenses. Izzy will discuss these items during his more detailed commentary on Q1 performance.

Return on average assets for the quarter was 1.5%. Auto Originations including loan and lease totaled $5.4 billion this quarter, down from the prior year quarter due to our disciplined underwriting standards and a competitive market. During the first quarter, we executed an agreement to flow prime retail loans to Banco Santander. We expect this strategy to further strengthen our relationship with FCA and positively influence Chrysler capital by providing a stable framework for Originations. Our track record of rating agency upgrades continued. Demonstrating the strength of our ABS platforms. In total, 49 ABS tranches were upgraded this quarter, positively impacting more than $4 billion in securities.

Turning to Page 4. Here are some key economic indicators that influence our originations and credit performance. U.S. Auto Sales remain elevated further ticking down versus recent highs and consumer confidence remains high. U.S. GDP growth is in line with the recent historical range, and unemployment levels continue to be very low. These metrics are strong indicators of the health of the economy and the U.S. consumer.

On Page 5, there are a few key factors that can influence our loss severity and credit performance. As expected, our auction only recovery rates are trending down and in line with NADA trends. However, auction plus recovery rates, which include insurance proceeds and bankruptcy and deficiency sales, are only slightly down versus the first quarter of 2016. We continue to model lower recovery assumptions in current experience and believe we are adequately reserved. Additionally, nonprime industry securitization data including delinquency and loss, show these trends are relatively stable to moderately higher. In either case, SC auto ABS remain structurally sound.

Turning to Page 7. In March, we executed inaugural transaction for approximately $700 million prime retail loans with Banco Santander. We expect this strategy to support Chrysler Capital by providing a more stable framework for Chrysler Capital originations. This will in turn also be supported to our service for other strategy through more prime asset sales. The 2-year agreement will also provide SC with $750 million in additional capacity to fund originations between transactions. This warehouse agreement close in April. Bringing our related-party funding commitment to approximately $7.7 billion up from $7 billion as of March 31, 2017.

Turning to Page 8. Auto Originations during the quarter totaled $5.4 billion, down 21% from the prior-year quarter. Originations with FICO scores below 640 in our core and Chrysler Capital channels decreased 16% and 33% respectively, versus the prior-year quarter. Core originations increased 9% quarter-over-quarter, and Chrysler Capital loans about 640 decreased 42% and leases were flat versus the prior-year quarter.

Regarding our direct to consumer platform, volume to our RoadLoans channel totaled $53 million this quarter, up slightly versus the prior-year quarter. This online portal has been added into application volume and we expect RoadLoans to be incremental to our originations as the market evolves.

We are committed to booking loans with attractive risk-adjusted returns that will perform through cycles and create shareholder value. In our efforts to find pockets of value, we saw a moderate increase in nonprime Originations in both our core and Chrysler channels quarter-over-quarter, which is continued into April.

Turning to Slide 9, and further drilling down into originations mix. In the first quarter, the mix of our originations was relatively constant on a percentage basis. Loans with FICO scores below 640 decrease approximately $840 million to $2.7 billion from $3.5 billion during the prior-year quarter. In addition, the average loan balance has decreased due to a larger percentage of used vehicles and lower loans to values reflecting credit discipline.

Now moving to Slide 10. The Chrysler Capital penetration rate as of March 31, was 19% up from 17% in December. We remain the largest finance provider for FCA. Chrysler Capital is a focal point of our strategy and we continuously seek out ways to enhance and grow our relationship with FCA. We remain focused on 3 key strategies. Including first, we've increased the number of Chrysler Capital dealers in our VIP program, we are still on track to roll this program out to all FCA dealers in 2017. And this improves our ability to book standard grade transactions. Second, our dealer full-time strategy with Santander Bank NA continues to grow. We have increased our dealer receivables originations by 44% compared to the prior-year quarter. After a year of strong originations growth in 2016. And finally, the Banco Santander flow agreement as I mentioned previously. It's also important to note that our Chrysler Capital volume and penetration rate are influenced by strategies implemented by FCA including product mix and incentives.

Turning to Slide 11. While still a differentiator for our business, our service for others balance continues to decrease due to lower prime originations and lower asset sales. Servicing fee income totaled $32 million this quarter, as we continue to deliver value to this capital efficient platform. Moving forward, we expect to drive the service for others platform by increasing our Chrysler Capital penetration through the execution of flow agreement with Santander.

I would like to turn now to Izzy for a review of our financial results. Izzy?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [4]

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Thank you, Jason, and good morning, everyone. As Jason mentioned, there are some specific items that I will discuss in more detail, which I also mentioned in our call last quarter. As we continue to remediate our material weaknesses and invest qualitative findings in CCAR and the [Fed Rate] agreement. We are also aligning several practices to reflect FFIEC guidelines and performance of certain vintages. One of these changes related to bankruptcy accounts increased our net credit loss by $24 million, which is offset by $9 million lower allowance for credit loss, and decreased our pretax income this quarter by approximately $16 million. This impact is timing related by which I mean, it would have been incurred in future periods but was accelerated into this quarter. Separately, we are taking a more conservative approach to the accrual of interest for certain TDR loans. This change does not impact the bottom line but reduced net interest income by $26 million, and was completely offset by lower TDR impairment and is reflected in allowance for credit loss. I will cover these points again in the respective slides.

Let's turn to Slide 12 to review this quarter's results. Net income for the first quarter was $143 million or $0.40 per diluted common share. Net leased vehicle income increased 18% as we continue to see growth in our leasing portfolio with FCA. Total other income this quarter was $55 million, which is net of approximately $65 million of lower of cost or market adjustments related to personal lending. And $12 million in other losses that I will detail on a subsequent slide.

Moving on to Slide 13, which highlights our performance excluding the impact of personal lending. Further details can also be found in the appendix of the presentation. Interest on finance receivables and loans decreased 6% year-over-year due to a mix shift in the portfolio towards higher credit quality assets with lower APRs. And lower interest income accruals of specific categories of TDR loans. During the first quarter, we shifted to a more conservative approach related to the accrual of interest of certain TDR loans. And the approximate impact of top line was $26 million. As I mentioned previously, this is completely offset in our allowance for credit loss, as it reduces the carrying value of the loans and therefore, requires low impairment. This is also reflected in a lower TDR allowance ratio this quarter.

Interest expense increased 25% versus the prior-year quarter driven by the increase in benchmark rates. One month LIBOR increased more than 50 basis points from March 2016 to March 2017. Cost of funds in third-party amortizers and warehouses increased approximately 50 basis points versus the first quarter 2016. Cost of funds in newly issued term ABS improved approximately 30 basis points due to spread tightening, partially offset by benchmark rate increases. Similar to last quarter, these increases were partially offset by interest rate derivatives.

Servicing fee income decreased 29% year-over-year due to lower balances and a change in the credit mix of the service for others portfolio. Average gross retail and installment contract balances were flat year-over-year. Lease assets were up 20% year-over-year and are expected to remain flat for the foreseeable future as our new originations are in line with lease terminations.

Turning now to Slide 14, we will further drill down into total other income. Reported total other income was $55 million in the first quarter 2017. The impact of lower of cost of market adjustments for personal lending of $65 million include $111 million in customer defaults offset by a net reduction of market discounts of $47 million as balances decreased versus prior quarter in line with seasonal patterns.

Normalized investment losses for the quarter were $12 million, primarily driven by losses on asset sales and customer defaults associated with auto assets held for sale. After including servicing fee income and fees, commissions and other normalized total other income was approximately $120 million.

Turning our attention to provisions and reserves on Page 15. At the end of the first quarter 2017, the allowance figure totaled $3.5 billion up $31 million from the end of the prior period. Drivers of the increase include $171 million associated with new originations, $128 million due to trouble debt restructuring or TDR migration, meaning the additional allowance coverage required for loans has now qualified for TDR treatment, per our definition, which are not classified as TDRs during the prior period. And $10 million due to performance adjustments. These are partially offset by $278 million in liquidations, which includes pay downs and charge-offs.

As we've discussed at our Investor Day, TDRs are an accounting classification for assets that means certain loan modification or extension criteria. Our loan servicing team uses loan modifications and extensions on a case-by-case basis to offers assistance to some customers experiencing temporary financial hardships. Under GAAP, the allowance requirement on an asset classified as a TDR takes into consideration lifetime losses. And even if the loan performs, it will continue to be classified as TDR for the remainder of its life.

The allowance to loans ratio was 12.7% as of the end of this quarter, up from 12.6% at the end of the prior period. The primary drivers were increases in TDR balances and the denominator effect of slower portfolio growth. As I mentioned earlier, the allowance of credit loss includes: The reduction of approximately $26 million related to TDR interest accrual; and $9 million related to accelerated charge-offs.

Continuing to Slide 16. Delinquency rates including the 31 to 60 and 61 plus buckets increased 40 and 80 basis points respectively, from prior year quarter. Retail installment growth charge-offs increased 180 basis points and net charge-offs increased 120 basis points. The net charge-off ratio increased to 8.8% this quarter, up from 7.6% during the same period last year. The increases in both of these ratios were driven by aging of the more nonprime 2015 vintage and overall portfolio aging.

As an example, in the current quarter, the 2015 vintage was approximately 30% of our loans outstanding, but contributed 35% of our losses. Additionally, portfolio aging driven by lower originations decreases the denominator of this ratio and decreases the balances of loan to the numerator that are newer, and have not yet experienced delinquency or charge-offs. Losses were also impacted this quarter due to write-downs of loans and bankruptcy, which I will cover further on the following slide.

Recovery rate as expected increased from prior quarter but decreased year-over-year. We continue to see bifurcation in performance between sedans and larger vehicles such SUVs and trucks, which have performed better but still continue to face declines in value.

Turning to Page 17, to review the loss figures in dollars. Net charge-offs in our auto loans portfolio for individually acquired retail installment contracts increased $59 million to $599 million. This quarter, we accelerated approximately $24 million in losses attributable to assets which are written down upon receive of a bankruptcy notice. The majority of these losses would have otherwise occurred later in the year, and do not alter our overall view of losses for the year, but rather represent a timing impact for Q1.

Another $19 million of the overall increase is due to portfolio growth, aging and mix shift. The primary driver was portfolio aging at the average unpaid principal balance was relatively flat versus prior year quarter. Recoveries were also lower this quarter by approximately $19 million, and bankruptcy deficiency sales increased versus the prior-year quarter by approximately $15 million.

Turning to Slide 18. Operating expenses this quarter totaled $305 million, an increase of 5% versus same period last year. This increase was driven by continued investment in compliance and control functions and severance expense related to efficiency efforts. The expense ratio for the quarter totaled 2.4%, up from 2.2% in the prior year quarter.

Turning to Slide 19. Total committed liquidity increased 5% to $41.4 billion at the end of the quarter versus prior quarter end. During the quarter, we executed 2 drive and 1 SDART securitization totaling approximately $3.1 billion. As with our other drive and SDART nonprime securitizations, these typically remain on our balance sheet and we retain the first loss position. Also, during the quarter, 49 ABS tranches were upgraded positively impacting more than $4.2 billion in securities.

Also, this quarter we increased unused capacity in our revolving facilities by approximately $1.9 billion and remain confident in our overall liquidity position. After sales in the quarter, totaled $931 million, driven by our near agreement with Banco Santander.

Briefly turning to Page 20. Our CET1 ratio for this quarter is 13.8%, which is 170 basis points higher than first quarter 2016. During the same time, our assets also increased demonstrating SC's ability to generate capital and support growth.

Looking ahead to Q2, my comments will be relative to Q1 unless otherwise noted -- relative to Q1, 2017, unless otherwise noted. And will include the impact of personal lending. Unlike prior quarters, when we excluded personal lending. The personal lending assets remain on the balance sheet and are still classified as held for sale. We will update our comments, if necessary, based on any developments in our sale process.

We expect net interest income to be down 5% to 7% in the second quarter due to credit mix, lower interest accrual on TDR loans and a smaller balance sheet. Also, lease assets are expected to be flat next quarter relative to first quarter 2017. We expect our allowance of credit losses to be down $20 million to $40 million. Net charge-offs expected to be $130 million to $150 million lower as of second quarter is seasonally our best performing quarter. Therefore, incorporating the outlook on net charge-offs and allowance for loan loss overall provision expense is expected to be $180 million to $220 million lower than Q1, 2017.

Other income is expected to be $30 million to $40 million lower, primarily due to customer default in Bluestem, held for sale assets, lower servicing fees driven by lower managed assets and changes in consumer practices. Operating expenses are expected to be down $5 million to $10 million.

Before we begin Q&A, I would like to turn the call back over to Jason. Jason?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [5]

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Thanks, Izzy. During the quarter, we continue to make progress on strengthening our culture of compliance and enhancing our consumer practices with several notable changes, which Izzy briefly referenced regarding fees. In order to be more simple, personal and fair with our customers, SC now provides more freeways to pay or methods for our customers make payments without payment fees. In addition, beginning on April 1, in an order to align with industry best practices, SC will no longer accept credit cards, which in the past, carry higher fees. We've also reduced the fee to pay with debit cards.

We're also focused on continuing to improve our customer experience. With the pipeline of other consumer initiatives, including a look at our customer statements and more financial educations for our customers so they can have more insight into the status of their loan and how late payments impact their status. We look forward to sharing updates on these topics in future discussions. Finally, during the quarter, we launched a new complaint management strategy, which we expect to enhance our ability to identify and address root causes of complaints. And put us in a position to better serve our customers.

Finally, in response to several investor inquiries regarding dealer management and monitoring, following the recent settlement with Massachusetts and Delaware, we've included 2 slides in the appendix of our presentation this quarter. These slides provide additional color on our dealer services team, and the evolution of enhancements to our dealer performance management program over the past several years. These slides will predict the timeline of our dealer oversight and monitoring efforts.

As the industry continues to focus on this area, we are committed to being leaders in dealer management, moving beyond the traditional methods of monitoring credit performance. We believe there is a direct connection between strong consumer practices, a cultural compliance in the creation of shareholder value. Simply stated, the company will embrace and execute on these concepts, will be more successful than those who do not.

In 2017, SC will drive value through enhancing compliance, controls and consumer practices, continued credit discipline, diverse and stable sources of liquidity, industry-leading efficiency in technology, a focus on recognizing upside in Chrysler Capital through dealer VIP, floorplan and the Santander Flow Program. And finally, being simple, personal and fair, with our customers employees in all constituencies.

And with that, I'd like to open the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from John Hecht with Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [2]

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Real quick question. Sorry guys, I thought I was on mute. Just there are a lot of moving parts with respect to the trajectory of your allowance. You've got TDR migration with the 15 vintage that should be alleviating over the year, you got a tightening credit book with new originations. How should we think about the trajectory of the ALL over the year given those factors?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [3]

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Yes, sure. John, I'll take that and then Jason will chime in. First of all, I think we're seeing what we expected. That the growth in TDRs, even though it is occurring is growing at a slower pace. We remain comfortable saying TDRs will peak late 2017, early 2018 based on everything we are seeing. That's the first item. The second item, if the credit mix of origination holds true in what we see overall timing of provisions -- by math and intuition, provision should come down. It's just a timing of that decrease in provision can't be exactly pinpointed. But I think, as I said, if everything continues the way we've been seeing, and what we've been experiencing, we should see that allowance level get lower.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [4]

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Okay. And is that sort of 1 year down little tick or is there some seasonalities we should think about there?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [5]

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Like I said, John, from the quarterly basis, it's tough to pinpoint it's really not seasonality it's more about the overall -- 2 things, one the overall change in credit mix of our portfolio at 2015 more nonprime vintage runs off. And second, just over the last several quarters overall portfolio growth has slowed. That's the other driver of the overall allowance level.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [6]

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Okay. That's helpful. Second question, is we heard some banks talk about pulling back -- you guys have alluded to some improvements in certain components of the comparative market. I wanted you to give us a little bit more deep dive there, what you're seeing? What point you think your deal ups in both tightening and take back shares? Where we are versus where we're in the overall cycle?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [7]

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Okay. So what we typically talk about is kind of the top 20 or so when there is versus the rest of this fragmented market that we operate in. And couple of observations there. If you look at the [all-in] retail market, what we're seeing is the top 20 lenders are still incremental in losing shares to everyone else. But if you drill down into prime versus nonprime, that story is still true for prime, but the prime and near-prime parts of the business remain extremely competitive, and the top lenders are continuing to incrementally lose share to everyone else. But it's not true in nonprime, where we've seen -- again these are seeing incremental shifts but an incremental pickup in the top 20s overall share of nonprime versus everyone else. And I think you see that reflected in our originations where -- we're factoring in what we see to what we originate, and we're getting incrementally more relative to the past couple of quarters. First into this time last year we're still getting significantly less. So we're still in a very competitive market. And that's the reason we just keep stressing this word incremental. But we are seeing that competition has declined maybe slightly in nonprime allowing some of the larger lenders to get a little bit more of that share on terms that a larger, more sophisticated lender would think make sense. And so, I say again, these shifts are very minor shifts. What we see is what we have been the same, which is it's a very competitive market. Cost of funds is still very low, availability of liquidity is still very high, and we are factoring in everything we see in the originations, and I think you see that reflected in the quality of what we're putting on the books right now.

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Operator [8]

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Our next question is from Jack Micenko with SFG.

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Jack Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [9]

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First question follow up on the first 1. We've seen certainly the prime loan and then maybe a few on the nonprime. So modest uptick in pricing over the last couple quarters. I think, Jason, it's consistent with what you're saying, but I guess my question would be, are you seeing less competition through more rational pricing of the loans? Or you just seeing less providers out there?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [10]

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We haven't seen rationalization in numbers of competitors. We do talk from time to time about how longer term we actually expect that to happen. This is more about how people are pricing and structuring loans. Different ways to put in price not just APR. I mean you can advance more or less in those kind of things. And what we -- I can speak, obviously the most about what we do and what we are seeing is that we are being more conservative on payment-to-income ratios, we are more conservatives on loan-to-values. Our terms, our contractual terms are relatively flat. And with that approach, we're getting volume that we think makes sense. Seemingly down year-over-year but little bit more sequentially. In terms of pricing going up in the market, that's not a big surprise given the fact that benchmark rates have migrated the way that they have. For us, what you see is more than that, right? We migrated our APRs more than what would be needed to make up for increases in cost of funds. Because we're still focused on this trade-off between losses in risk-adjusted yield. We're not looking for lower losses, we're just looking for the relationship between losses and risk-adjusted yield could be at the right level. And we are pretty please with what you're seeing. We showed a slide in the Investor Day, where we look at '16 versus '15, and talked about those concepts of yield versus loss. And what we're looking at now is Q1 versus Q1 versus Q1 we're kind of looking at '17, '16 and '15. And we really like that relationship between risk-adjusted yield and loss and what we put on the books in '17, even more than what we did in '16. So we feel good about where we are in this competitive environment. Yes, price is going up, people are doing that to different degrees, and not everyone is holding the line as much on PTI and LTV as maybe some others are.

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Jack Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [11]

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All right. That's helpful. And Izzy, I know the expenses were up this quarter, you guided I think, down $5 million to $10 million sequential. I think you talked about some investment in compliance offset with some severance. Is there an investment cycle that we are in perhaps falls off? Or is that sort of down $10 million from here sort of a new run rate?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [12]

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Yes. Jack, good question. So the investments basically in our run rate, I think we are going to the point what's pretty mature. The reason I got it down for a lower expense for next quarter is, there just several nonrecurring one-time items that had this quarter. Not really compensation, 1 of them was severance, obviously compensation. But we have some higher legal and professional services fees in this quarter that are offset by other efficiencies elsewhere. So you would think about our guidance next quarter as kind of the run rate and kind of where we feel comfortable and then we'll update that going forward.

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [13]

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Just a little bit of additional color on the expense side. We are making -- we're continuing to make investments in our risk and control and financial areas. And some of that's headcount but some of it's also just cost per person. We make some really key additions to the company, and these are people who understand -- the way we talk about it internally is they understand what good books like in a highly regulated bank type environment. And we think that's going to continue to service very well as we work on improving a lot of those control areas of the business. Even with those additions though, we are proud of our relative efficiency. We're always focused on it, severance expense was related that with an opportunity to outsource some functions in a very specific area of the company. But we want to be efficient, even while we're making those very key investments that we think will differentiate us going forward if that make sense.

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Operator [14]

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Our next question is from Mark DeVries with Barclays.

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Mark C. DeVries, Barclays PLC, Research Division - Director and Senior Research Analyst [15]

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(inaudible) you, you got another written agreement from the Fed. And while it seems to address a lot of issues that you are already remediating, also seems to reflect growing impatience on their part. I was just interested, Jason, give me a comment on NII what this may reflect in terms of their willingness to prove any kind of capital returns for the upcoming CCAR year?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [16]

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So, Mark, thank you. First of all for the acknowledgment that these are items that we've been working on for some time, and talking about for sometime, and we are very optimistic about our ability to meet regulatory expectations. We think that level of dialogue and the level of progress we're making is very encouraging. At the same time, we do have this written agreement. And I think an important distinction we need to make is that, when we talk about distributions, in the past we talk about CCAR, but then we've also expanded that to include the written agreements that were in place from 2014 and '15, that do restrict capital actions and cover a lot of the qualitative aspects that you've also seen in CCAR. And we're still very cautiously optimistic that we are on the right path on all of those items. And obviously, we don't want to get ahead of the process and say exactly when we'll be able to resume distributions. But we're focused on all of the actions that will get us there. We don't feel like this new written agreement in any way is a step back for us in that regard. Our ability to pay dividend at some point in the future is not changed by the presence of this new written agreement. And I'll come full circle back to your initial comment, which is as you said, these are topics we've been discussing for some time, and we feel really good about our ability to get where we need to be.

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Operator [17]

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Our next question is from Betsy Graseck with Morgan Stanley.

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Jeffrey David Adelson, Morgan Stanley, Research Division - Research Associate [18]

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This is actually Jeff Adelson speaking for Betsy. I just wanted to follow up on the guidance you gave for the next quarter. Sounded like NII was down 5% to 7%. Just wondering what the bigger driver was there. Is it more just the loan growth? Is it more the credit mix? Or the accrual on TDRs you've mentioned?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [19]

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Yes. Actually it's primarily the change in the credit mix that we see. 50 portfolio that we have generated last year is of lower APR but higher credit quality. And that -- even though this last quarter we do have higher APR, it will take a while for that to run through the income statement. So that's a partial driver, I won't say primary but a big part of it. And the other 1 is the noninterest accrual on the PVR loans.

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Jeffrey David Adelson, Morgan Stanley, Research Division - Research Associate [20]

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Okay. And then just one more question. With regards to that you flow agreement with Banco Santander, you've obviously done the $700 million already. Just wondering if you can help us think about the benefit that you may already had through originations. Like is that $700 million you wouldn't have done otherwise and then, maybe the second part of the question how big could that flow agreement eventually get?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [21]

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Well, that's a difficult question to answer because, as we mentioned before, we still think the upper parts of the credit spectrum are the most competitive parts of the market. So what we know for sure is that what we're doing, what we're originating for flow agreement with Banco Santander is we're better off with that agreement than without it. And so it will produce incrementally more volume. In terms of how much of the $700 million would not have been originated without it. It's, again, kind of difficult to say. It's even more difficult to say going forward how much we'll get. What we do know is that we'll be competitive. And depending on what the rest of the market is doing and how they're pricing and structuring loans, we're going to try to get as many of them as we can. The reason this is so encouraging for us is we want to focus on the things for Chrysler in that relationship that we can control. And that's the reason we continue imaging those 3 items because we can control those, right? We can control this relationship we have with our ultimate parent and becoming more competitive in prime originations. We can control how much dealer floor plan we put in place to a certain extent. And obviously we're active in that market and we're seeing big increases year-over-year in our originations, which is where we want to be. And we're also actively rolling out this dealer VIP program with the goal -- a continued goal, and we're on progress -- on track for this, of rolling it out to the entire Chrysler dealer network by the end of the year. And all of those efforts will bring us incrementally on volume, we think all else equal. But unfortunately for us, all else is not equal and we don't know what the migration of the competitive market will be. Perfect role for us is that we do those things and at the same time, the market continues to get maybe incrementally more rational and we get a multiplier effect. But we can't count on it.

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Operator [22]

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Our next question is from Steven Kwok from KBW.

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Steven Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [23]

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So I wondering if you could talk about the lease portfolio and what are your assumptions around the used car prices. And any sensitivities on changes to that?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [24]

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Yes. Steven, it's Izzy. Let me address that. So as we talked about Investor Day, on an economic basis, we're still seeing what we saw in Q1. Our lease terminations came in slightly above our CRLIT, or residual less incentives and taxes. And we continue to see that in Q1. And we do expect, obviously, residual prices to adjust as expectations for prices come down. Though the same time, we do benefit from the residual risk agreement that we have with FCA. So if there's significant drop in residual prices, there's a loss share agreement that protects us. Furthermore, we are also -- you'll see through our depreciation, we are also adjusting any meaningful changes in residual prices by -- through depreciating that lower value over the remaining life of the asset. But net-net, even though prices are coming down, residual values are coming down, we are not seeing a significant dislocation in the marketplace that would pertain to anything nearly meaningful from an impact perspective.

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Steven Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [25]

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Got it. And just around your practice on no longer accepting credit cards, do we know how -- what percentage of your customers were using credit cards and debit cards to pay?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [26]

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We haven't disclosed the percentages. But we feel like -- we're doing because we think it's the right thing to do. It's -- as we sort of look out in the market at the benchmark competitors and large banks, who are actively competing up and down the credit spectrum in consumer finance, we tended to be a little bit of an outlier in that regard. And so what we've done with our customers as we've -- as we mentioned given more ways to pay without a fee, which we think is a good practice. We've also had a ramp on this where there's a notice period. And anyone relying on making payments by credit cards had time to pay with a different means. But in terms of disclosing the actual percentage, we've not given that breakdown.

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [27]

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And, Steven I'll try -- I mean from an economics perspective, obviously, we have introduced multiple options where it doesn't cost the customer anything. In the past, we do pay the fee. And we believe we currently get about $3 million to $4 million a month in fees associated with those practices, and that's been incorporated into the other income guidance I provided that we -- assuming there is a full pickup of that, we will see a lower amount in our fees commission and other line item.

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Steven Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [28]

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Got it. And I was just wondering if there's any thoughts around like the -- your product quality as a result of maybe customers that can no longer use their cards to pay?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [29]

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No, we don't expect that. We don't expect to see that.

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Operator [30]

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Our next question is from Eric Wasserstrom with Guggenheim Securities.

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Eric Edmund Wasserstrom, Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst [31]

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Just -- I have a question, but just one quick point of clarification, Izzy, on the other income guidance, the sequential delta that's relative to the 55.5 reported figure. Is that right?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [32]

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That is correct. Exactly.

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Eric Edmund Wasserstrom, Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst [33]

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Okay. And then my question also goes back to the allowance. Does the -- given all of the dynamics that I'm moving through it currently, is there any significant change to the historical pattern of seasonality?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [34]

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To some degree, seasonality's almost gone away from an from allowance perspective. And the reason I say that is the allowance is now broken into basically 2 meaningful buckets. One is TDRs and the impairment on TDRs is completely dependent on the cash flows expected from that asset. And so there's no real seasonality there. And the non-TDRs, especially performing loans, there's a loss emergence period that we look at. And again, that is just in the 12 months or so of losses that we put in non-TDR. So we're -- we probably had seasonality in the past before we changed the allowance methodology. That's really gone away.

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Eric Edmund Wasserstrom, Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst [35]

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Got it. So from that perspective, you've given guidance on the TDR trend and therefore anything -- the other effects will really be a function of credit experience in the non-TDR portfolio on growth?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [36]

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Exactly. Right. That's really a good way to think about. I think that change has made our allowance much reflective of the portfolio we have as opposed to any seasonal elements associated with it.

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Operator [37]

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Our next question is from David Ho with Deutsche Bank.

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Shih-Wei Ho, Deutsche Bank AG, Research Division - Senior Research Analyst [38]

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I just want to talk about how aggressively -- kind of gauge your tone on -- in terms of how aggressively you would pursue incremental opportunities if the market presented itself to you in the nonprime space. Just trying to gauge your confidence on terms of how much you believe the mix is mostly stabilized from here just given the competitive outlook?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [39]

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So Dave, thanks for the question. I think the first part of the answer of that question is right now, we're focused on the other elements that we discussed, making sure we're fully realizing the upside potential of the Chrysler relationship. Looking at the control areas of our business, compliance, consumer practices, those kinds of things to make sure we're playing for 20 years from now as much as we are in the near-term financial performance of the company. Having said that, I think the reason you asked the question is that we've done more of these kinds of acquisitions than anyone else. So we've got a team that is very experienced in acquiring and converting assets and taking it from other people's systems and consolidating them into our very scalable system. We would certainly hope that, in future, we'd see more of those types of opportunities. We don't see a lot of activity on that front. You'll see some from time to time. And when it's out there, it tends to get shown to us. But I think in order -- that's the order we'll take it. And we'll focus on our business first and the upside opportunities we already have. And then, over time, as those thing happen, and they're likely to happen in conjunction with a shift in the economy, in the sort of state of the economy. As those opportunities happen, we would certainly help to be in the mix and get involved.

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Shih-Wei Ho, Deutsche Bank AG, Research Division - Senior Research Analyst [40]

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And then separately, in terms of the mix of originations and kind of your incremental shift a little bit towards subprime again, is that a function of what the competitive environment is giving you? And how do we have confidence that you won't pursue deeper subprime, kind of what we saw in 2015? Those vintages, in a meaningful way, kind of, what -- depending on the competitive environment?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [41]

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That's exactly what it is, it's taking with the market gives us. We always want to maximize our capture with all applications that we get. The issue we always have is that -- is a lot of -- many times, in different parts of the credit spectrum, at different times, what we think is the right pricing structure, the market may have a different view so we get less. Our cash rates are nonprime even though they're up sequentially, are still in the high single digits, which, historically, is the range we've been and that's the range that has served us well through several cycles. So for us, it's -- we don't -- we track competitive factors, we track market share, we look at volume. But what we really want is the right risk-adjusted return for every single asset we book, and that's where we're going to be focused. Not on doing more or less of any certain part of the credit spectrum. I will say, being specific about comparing 2015 to what we've originated so far in 2017, there are some very key differences we feel are -- going back to the other comments about the trade offer and risk-adjusted yields versus loss. We feel like there's a much better trade-off in our early 2017 vintages on those 2 factors than what we had in 2015. There are certain pockets of what we originated in 2015 that we are no longer originating. So just by definition, in terms of our approach to the market, it'd be different. And we saw that same thing, by the way, when we went through '06 and '07. When you go through those types of situations, you learn from them. You leverage your data, you makes decisions based on what you're seeing. And some things you never do again, some things you just make sure you price for. And for us, it's a little bit of both. So that's what we're doing. We're learning from what we see, we're factoring in to the new originations. And we would expect that, for example, if we were sitting here on our second quarter call talking about incremental growth and nonprime originations that we will be getting more than paid for those originations and we feel very good about them or we won't do them.

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Operator [42]

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Our next question is from Moshe Orenbuch from Crédit Suisse.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [43]

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At the risk of asking a version of the originations question again, can you just talk a little bit -- you had alluded to, Jason, the fact that there's still some things that need to be done from a process standpoint, and will that -- as those get done, will that, in fact, improve your ability to originate loans and -- any way to kind of think about that?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [44]

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Well -- so let's -- I guess -- let's talk in general about credit trends. So -- because that's really what is the driver for what we're getting relative to the market. We're not in control of how competitors react to it but obviously we can put this one in place ourselves. So in '16 -- is what we're talking about, 2016 vintages are performing better than '15. We're expecting, in terms of the overall migration of TDRs in the company, that, that will peak, as we've said, some time in 2017. Of course, as you look at the consumer, the consumer is still strong. And that's a fairly consistent story where unemployment is low and gas prices are still relatively low. And one aspect of the consumer we're watching is consumer debt. We talked about this in the past and that continues to sort of inch up. So nonmortgage consumer debt is still increasing. That's something we watch because over time, that does contribute to higher delinquency and you've got to factor that into your underwriting. But in general, the consumer is strong, the economy is strong. We're pricing the trends that we're seeing in delinquency and loss in the originations. We feel good about that, and that's reflected, as I mentioned earlier, in what we're seeing in some of the credit trends, PTI, LTV, those type of things. As you look at recoveries and auction, we are seeing a gradual decline. If you look at all on recovery rate, it is gradual. So it's 53% down to 51%, if you look at Q1 versus Q1. And we would expect that to continue. We don't see the bottom falling out of recoveries. We expect to continue to be gradual. But the reason I go through all of those items, those are the items that really influence our originations more than anything else because we react to them. When we see them, I add cost of funds to it. When we see those things happening, we react to them and we factor them in. And different companies do that at different rates and that's kind of normalizing flow of people taking share, giving share. For example, in Q1, domestic OEMs picked up some share based on some incentive strategies that were being put in place. But as you look at what happens post Q1, they're giving some of that share back. So there's the natural ebb and flow, and we just -- what we're trying to do is maintain a consistent approach, factoring in what we see to what we originate and just making sure what we did is good no matter how much of it we get. In terms of the question about these other areas of the business we're focused on, I think that's more about long-term success. We know that whether you're a highly regulated banking institution or you're a non-bank finance company licensed in all 50 states. The regulatory environment -- our operating expectation is that it's not going to change. We actually believe that a highly regulated environment benefits players like us who are making real investments in those areas. But we have to continue to focus on those areas. Those areas are -- they made themselves through the written agreement that we had with the Fed. They're very key front and center items for us that, I think, are more about long-term opportunity cost for the business than they are about short-term ability to originate assets.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [45]

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Just a follow-up. The $700 million that you did with your parent for Chrysler, that's something that they will do that how often? I guess. And maybe a few -- to kind of just put that in context, if that agreement had been placed as of the beginning of the quarter, what would you think your penetration for Chrysler would have been versus that 19%?

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [46]

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Moshe, it's Izzy. Let me answer that. So 2 questions. One, I mean we expect right now based on what we see to at least execute a transaction quarterly, it just is a matter of how quickly we can "fill up the bucket." But at least quarterly, to get your size that efficient and cost-effective to execute on. The second, we've been talking to the parent obviously since the middle of last year. So we had to incorporate as many of these elements before we finalized the agreement. So we've been working in the last couple of months to fill up the bucket so we can execute in Q1. So I don't -- the penetration, I think, where we have is what we can offer to the marketplace, keep our profitability, take advantage of strategies that FCA has in place. So no meaningful difference in terms of the timing of when that agreement was executed.

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Operator [47]

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Our next question is from Chris Donat from Sandler O'Neill.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [48]

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Jason, wanted to revisit something that came up at the Investor Day in February. There's the issue of the delay in federal tax refunds and you had said there's kind of a timing issue with originations. I was just wondering if you could give us a sense of the pace of originations by month in the quarter, like was January below normal? February, above? March, above? And can you give a sense on what's going on in April or -- just give us -- I'm looking for what's going on if that was just a blip or something more lasting?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [49]

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What's really interesting about tax returns is as more information comes out on that, it appears that a lot of the delay was based on filings with earned income tax credits. Those earned income tax credits are more kind of lower income type returns, which would fall more squarely in nonprime originations and trends. What we've been tracking more closely than volume -- I do think it did impact volume somewhat. We've been tracking more closely than volume is performance. So we actually think that as these returns have come in being a little bit later, April versus March in that timeframe, that we've seen maybe some incremental benefit or at least not incremental detriment given the fact that those returns are coming. We're talking about billions of dollars of refund that were held up, that fell on that earned income tax credit category. So I don't know that we have a definitive answer to the question. It's something we watch very closely to look for trends and performance and how that factors in to new originations. For us, the origination story is really about our own credit at this point, and about what competitors are doing. And we have to be careful about how we talk about what it's related to, right, because while it's certainly true that we've done more nonprime originations in the last couple of months than we did in a couple of quarters that preceded it. We also are doing substantially less than this time last year. So it's -- we're constantly looking for ways to do more up and down the credit spectrum. The impact of tax refunds, the impact of gas prices, performance in different areas of the country, those kind of things, are one of -- I guess few of many things we look at and try to figure out that very complicated answer.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [50]

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Okay. I appreciate the complexity of what you're working with on it. And then at the risk of maybe taking a comment you made 2 moments ago out of context. On recoveries, you said you expected to see a gradual decline. There's been a lot of focus on used car prices and what's going on there. Just any comment so far on April trends?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [51]

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We're seeing more of what we've been seeing. We're not seeing anything that's concerning as we look at really performance year-to-date. It's all very gradual and all, we think, still driven by supply-demand factors. It's -- there's -- what I would say, I guess, just to answer that question is we're not seeing anything that really sticks out and causes any great concern.

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [52]

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And I will just add, Chris, is that as we mentioned, we expect recovery rates to come down, used car prices are coming down. We continue to see that again but not away from the curve that we expected.

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Operator [53]

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Our last question comes from Charles Nabhan with Wells Fargo.

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Charles Nabhan, Wells Fargo Securities, LLC, Research Division - Associate Analyst [54]

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I understand a lot of factors go into the pricing and structure of loans, but could you talk about how your ability to pass on rate increases changes over time as the tightening cycle proceeds? For example, is it -- does it become incrementally more difficult to pass on a pricing increase when the Fed funds goes from 150 to 175, for example, versus 75 to 100 bps?

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [55]

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So the answer to that question is different for the different parts of the credit spectrum. At the lower end of the credit spectrum, it's really about affordability. And so you have the ultimate ability to pass it on. At just ultimately at some point, you're capturing -- it's more impacted by affordability and people just sort of falling out of the system and buying an older car at a cheaper price point that's hurting out our market than it is about a competitor taking a loan from you. As you move up on the credit spectrum, there's a lot more elasticity there where the affordability is not as much of a factor. And then it just comes down to what you're doing versus what competitors are. I will say for us because we are looking at things from a market's perspective and looking at benchmark rates versus deposit basis, what we see is we'll -- in the situation where there's a rising rate environment for prime originations, we'll tend to react more quickly to that than the rest of the market. But over time, those lines converge again. And over time, in a rising rate environment, deposit costs go up inevitably and that gets passed on when it goes up. But for us, we'll sort of, in a rising rate environment, as you move up the credit spectrum, we'll see detriment before things catch up.

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [56]

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And I'll add, on top of that, especially in the nonprime segment where it's now getting back to affordability, that's the key item. We do pass on the rates pretty quick. But most of the competition there is also from marketplace funded lenders. And we believe we truly have an advantage there. We will see our rates go up but probably not as fast as some of the others. So that will be kind of the offset as well.

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Charles Nabhan, Wells Fargo Securities, LLC, Research Division - Associate Analyst [57]

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Got it. And as a follow-up, I was hoping to get your comments on the demand environment in the nonprime space. And specifically, whether you're seeing any softening in the used vehicles market, any drop off in application volumes that -- there's been some press about softening of demand in new vehicle sales. I was wondering what you're seeing in the used vehicle markets as well.

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Ismail Dawood, Santander Consumer USA Holdings Inc. - CFO [58]

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Yes. So we've definitely seen some of that. Not to any great degree overall, but we've seen some of that. The good news for us is we are operating in both markets. So you see that in our trends. The mix of new versus used for us has shifted a little bit the other direction where we're doing more used than new. And so you'll see that reflected in the average amount financed and those types of metrics. Another influencing factor also is the mix of the vehicles available. And so certainly [factors] are going to have lineups that are maybe more conducive than others at price points that are more conducive to nonprime originations and others. And so that's another factor to watch. But for us, we definitely see that -- we've seen that some of the demand has shifted from new to used. And you've also seen it in (inaudible), right? You've seen people in general maybe shifting slightly away, only slightly, but slightly away from new car purchases. Still at very high levels relative to where we've been historically but down from the recent peaks. But again, for us, we operate in both markets. I do think it's very interesting if you look at -- there was a sort of belief for some time that because the average age of cars on the road is at an all-time high, at some point, that would cause this windfall of demand. And while I think generally, at some point, that does maybe fall incrementally, what we're really seeing is that cars last longer. If they're made better, they last longer. And so the idea of trading off new for used, depending on where the prices are, is not necessarily a negative thing for performance. That's the reason why you're seeing some extended term business being done. And if it's structured the right way, it makes sense because the asset will be -- will have value and will run for a good period of time.

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Operator [59]

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There are no further questions at this time. I'll now turn the call over to Jason Kulas for final comments.

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Jason A. Kulas, Santander Consumer USA Holdings Inc. - CEO, President and Director [60]

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So thank you everyone for joining the call today, and for your interest in SC. Our Investor Relations team will be available for follow-up questions. And we look forward to speaking with you again next quarter. Thank you.

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Operator [61]

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Thank you. This conclude today's conference. You may disconnect your lines at this time.