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Edited Transcript of SC earnings conference call or presentation 31-Oct-18 1:00pm GMT

Q3 2018 Santander Consumer USA Holdings Inc Earnings Call

Dallas Dec 13, 2018 (Thomson StreetEvents) -- Edited Transcript of Santander Consumer USA Holdings Inc earnings conference call or presentation Wednesday, October 31, 2018 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 Hecht

Jefferies LLC, Research Division - Equity Analyst

* Kevin James Barker

Piper Jaffray Companies, Research Division - Principal & 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 and 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 Third Quarter 2018 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, and thanks, everyone, for joining today's call. On the call today we have Scott Powell, President and Chief Executive Officer; and JC, Chief Financial Officer. Before I begin, 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 today, we may reference 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 today, issued October 31, 2018.

For those of you listening to the webcast, there are a few user-controlled slides as well as the full investor presentation on the Investor Relations website as well as a supplement for today. 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 first start off by addressing the 2 accounting issues that we highlighted in the press release. So again, the important point here is that neither of the changes are material and together, they are not material. So the revisions go back to January 2017, and they were errors that we made. And so, we are correcting those errors. The first item is regarding the treatment of partial payments that determine the past fee status for only a portion of our core portfolio. Second, the second relates to when we place certain TDRs in a nonaccrual status and how we apply payments for those accounts. And Juan Carlos will give you a detailed description and a very thorough walk-through in his presentation, and then obviously, as we go through Q&A, we're happy to explain it further because certainly in the case of the second change, it's a little complex.

But again, not material, and we have a supplement on our website which will show you the revised numbers going back to the first quarter of 2017. And just as an example, if you look at the second quarter of 2018, the changes would have increased our net income by $385,000. And that's against the reported number of $335 million. So just to put the impact of the changes in a little bit in context for you.

So let's turn to Slide 3 and talk about the business, because we had a very good quarter. And again, it's a reflection of the same initiatives that we've been talking about over the course of the last year. We feel our strategy is working and producing the results that we had hoped for. And our performance in the third quarter continues that theme and underscores the strength of the -- strength of the business.

So net income totaled $232 million or $0.64 a share, which is up 17% compared to third quarter of last year. Our return-on-assets was 2.2%, which is up from 2% in the third quarter of 2017. And on the regulatory front, the Federal Reserve terminated the 2015 written agreement in August. We've talked about that agreement in the past, it's a very comprehensive agreement. So we feel the termination of that kind of builds on the momentum we have. And another example of that is the termination of the 2014 written agreement last year. And we also have passed the Fed's capital stress test now 2 years in a row. So solid performance on the regulatory front with good momentum, so we feel really good about that.

On the capital front, we continue to execute on our $200 million share repurchase plan, and we're declaring a $0.20 dividend for the fourth quarter. Looking at originations. Third quarter, you can see was very strong in originations. The total originations were up $7.6 billion or 52%, and you can look down over the segment there and see where the increases came from.

Very importantly, our Chrysler penetration rate has been above $0.34 for the last 6 months, which is a record streak for us with respect to our very important partner, Chrysler. So we feel good about that progress as well.

Juan Carlos will mention the floor plan balance growth at SBNA, which is up 15% quarter-on-quarter. So that's also good progress supporting the business we do with Chrysler. We also launched our new flow program with SBNA. In that program, we did almost $700 million in the first quarter. And that's again, a very important part of our support for Chrysler. Over 80% of that program includes Chrysler prime loans. So we are seeing strong performance, and as I said, we're just continuing to follow through on the initiatives we discussed on prior calls. Continuing to improve our service for dealers, which means streamlining our underwriting and funding processes and just making it easier for dealers to do business with us. We continue to be very focused on expenses. You can see our expense ratio improved from last year. There's a little apples-and-oranges going on there, but if you kind of normalize for it, we feel really good about our expense ratio and it's essentially flat compared to a year ago. And then, we continue to spend a lot of time focusing on pricing for risk as that's a core part of our business.

And then, if you look at credit, you can see, we continue to have very steady credit performance. Again, thanks to our strength in risk management, operations and just the overall strength of the underlying economic environment. So you can see our 30- to 59-day ratio did increase 30 basis points. I would just point out that last year, it was a little lower than it would normally have been because we were providing a lot of short-term relief to the people that were affected by the hurricanes. So it was a little bit lower than -- last year's number's a little bit lower than it otherwise would have been. So the 59-day plus delinquency ratio improved by 30 basis points. Gross charge-off ratio decreased by 50 basis points, and very importantly, our auction-plus recovery rate improved 120 basis points to 50% in the third quarter.

You can see that net charge-offs were down $11 million and our net charge-off ratio decreased by 50 basis points. And then, we do benefit for being part of Santander Group and Santander U.S. Just a couple examples of that include, we did our last flow transaction with the Group. It was the sixth transaction since 2017. That is now being fully replaced by the program I just mentioned through SBNA. And again, first -- for the first quarter, we feel really good about the $685 million of originations in that program. So -- and again, the floor plan is also done through SBNA, so we feel good about that partnership as well.

And I'm sure you guys expect this answer, which is, where are you guys with your discussions with Chrysler on Chrysler Capital. Those talks continue. They are continuing to assess their plan and their alternatives to form a captive finance company in the U.S.

And then, we have a quick word about the macroeconomic in auto environments. Obviously, we have a very strong economy, low unemployment, benefits of lower taxes. So we are continuing to see good demand for new cars and very strong demand for used cars. And certainly, that demand for used cars is reflected in our recovery rates and also in our lease performance. We are very vigilant when it comes to the length of this credit cycle and thinking about how we would manage through the next credit cycle, so we're happy that it's -- the environment continues to be strong. I do think we're seeing a shift to used cars, certainly as manufacturers are more disciplined about their lineups, tariffs impacting the value of the price of cars, and then also interest rates is driving some of that demand for used cars. So happy to talk more about that on the Q&A as well. So I'll stop there and 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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Thank you, Scott, and good morning, everyone. If we turn to Slide 4 for some of the economic indicators that influenced our originations and credit performance, I think the slide pretty much reiterates and supports what Scott just went through. The overall macro environment remains supportive of our business, consumer confidence CVP remains strong and the job market, which is probably the most important for business, is steady, okay? Auto sales as well remain robust. So all in all, everything points to a favorable and healthy market for new vehicles.

On the Slide 5, there are few key factors that influence low severity and credit performance. As Scott mentioned, we've had a good recovery performance and lower auction-only and auction-plus recovery rates improved this quarter compared to Q3 last year. Our auction-only recovery rate ended the quarter at 50.1%, up from 45.3% at the end of Q3 last year. This is particularly strong, given the normal seasonality experienced during this time of the year.

We've experienced improved performance across most vehicles, notably in the Sedan segment, which have lagged earlier this year. Also, higher average payments made at the time of repossession continue to lead to lower outstanding loan balances at auction.

For next quarter, which is -- well, Q4 is a seasonally weak performance quarter at auction, we remain constructive from the comparison to Q4 of 2017.

Our auction-plus recovery rates, which include insurance, proceeds, bankruptcy and deficiency sales and dealer recoveries, were 50% in the quarter, up from 48.8% the same quarter of last year. The delta between this quarter's auction and auction-plus recovery is smaller than recent periods, as we were more opportunistic regarding certain portfolio sales in the quarter.

Turning to Slide 6, our origination strengths. This is the third consecutive quarter with year-over-year increases. Our total core retail auto loan originations increased 49% in the quarter compared to the prior year quarter. Total Chrysler capital loan originations increased 34% versus the prior year quarter, with a strong growth from the less than 640 FICO channel, and we do expect future originations greater than 640 FICO to benefit from a newly established SBNA channel. These originations continue to be strong, increasing 73% compared to Q3 last year.

As a reminder, the third quarter is a seasonally weaker quarter for auto originations as tax season benefits diminish, but we are encouraged by this quarter's results following our continued efforts to optimize our pricing and credit risk management as well as the steady enhancements for dealer and customer experience.

Our strategy remains to increase nonprime volume by targeting the appropriate risk-return profile, leveraging the Santander Bank origination program for Prime and maintaining a strong presence in lease.

Turning to Slide 7. With the increase in our Chrysler capital volumes across loans and leases, our average quarterly FCA penetration rate for the quarter was 31%, up from 21% in the prior year quarter. This marks the second consecutive quarter with a penetration rate of 30% or more, and we continue to optimize for full-spectrum lending and servicing platform across loans, lease, floor plan and third-party services.

This quarter's increase in dealer floor plan, and Scott alluded to this, that increase in balances is larger than prior quarters due to just good momentum with some of the largest FCA dealers. This floor plan relationship brings value to both SBNA and SC as the assets, remember, are both of SBNA as part of our overall FCA offering. Regarding FCA, I'll reiterate at this stage, we do not have a further update on those ongoing discussions as FCA continues to assess their plan and alternatives for a captive finco in the U.S. okay. We remain focused on serving our FCA dealers and customers and building on the progress we've made.

So turning to Slide 8. Service for others continues to be an important part of our strategy, generating $26 million in servicing fee income this quarter. During the quarter, we added the $685 million in originations to the SFO platform via our agreement with Santander Bank. Additionally, we completed what we expect to be the final flow sale with Santander Group, adding another $275 million, smaller size than previous deals, as expected. And that should conclude the flow sale with Santander Group.

As we mentioned last quarter, we expect our balance sheet from collaboration with SBNA to become a more efficient source of funding, replacing the flow program with the Group. And also remember that the loans originated through SBNA do not touch our balance sheet okay, but instead, we retain servicing rights.

So let's move to Slide 9 to review our financial results for the quarter. And before I walk through the numbers, I'll provide some further color to the items that Scott referenced during the opening remarks. As Scott said, the corrections we made to our financial statements were not material. The revisions were driven by changes we implemented back in January 2017. And these are changes or decisions we cover on prior earnings calls.

So first, regarding the treatment of partial payments. Remember, prior to 2017, we reported past year status using different minimum payment thresholds. We used 50% for our core auto loan book and 90% for Chrysler Auto loan book. This means that if a core borrower -- core nonprime borrower, at a monthly payment of 50%, the account would be considered current in our delinquency disclosures. In 2017, we moved all newly originated core loans to 90% as well, okay? The error was that we should have moved all loans to be reported on a 90% payment threshold. The impacts of these corrections are immaterial changes in delinquency ratios, interest income and provision expense. The second change was related to when we placed certain TDRs on nonaccrual status. Prior to 2017, we classified all loans as nonaccrual when they were 60-plus days delinquent. Beginning in 2017, we made changes to place additional TDR loans on nonaccrual status and applied payments received from those loans directly to principle. This quarter, management determined that those changes were made in error and reversed them with no impact to the bottom line.

Going forward, we will go back to classifying all loans as nonaccrual when they are 60-plus delinquent. So we posted a financial supplement on our Investor Relations website with more details. And again, the impacts of this change are immaterial. As you can see in our financial supplement, there is an increase in interest income, which is entirely offset by the increased provision expense. So we think about the Q3 reported financials are already corrected. The magnitude of that swing between interest income and provision expense for the quarter would have been approximately $62 million, okay?

So now let's go through our financials for Q3. I'm still on Slide 9. And again, this was a very good quarter from an operating point of view. Net income for the quarter of $232 million, up from $199 million during Q3 of 2017. Keep in mind that during Q3 2017, we sold the legacy pool of RV/Marine assets, which resulted in a pretax gain of $36 million. This gain on sale impacts various year-on-year comparisons.

Interest on finance receivables and loans were slightly higher year-over-year, driven mainly by higher average loan balances. Net lease vehicle income increased 64% due to continued growth in lease balances and good off-lease performance. Interest expense increased 14% versus the prior year quarter due to higher market rates over the period, partially offset by favorable derivatives, which decreased interest expense by $12 million compared to Q3 last year. Provision for credit losses increased to $598 million in the quarter, which is up $27 million versus the same period last year. Total other income was $25 million in the quarter and included $87 million of held-for-sale adjustments related to the personal lending portfolio, which comprised of $83 million in customer charge-offs and $4 million increase in market discount.

Again, the year-over-year decrease in total other income was driven by that onetime $36 million in RV/Marine gain on sale during Q3 '17.

If we move to Slide 10. Versus the prior year quarter, early-stage delinquencies increased 30 basis points, while late-stage delinquencies decreased 30 basis points. It's important to remember during Q3 '17 that we provided financial relief, primarily in the form of extensions to our customers in hurricane-impacted areas, including Texas and Florida. We have a high concentration of customers in those states and the extensions reduced earlier stage and overall delinquency during Q3 '17.

We also experienced hurricanes during Q3 '18. However, the exposure to the storms and the severity of the impacts were significantly less than 2017.

So moving now to the bottom portion of the slide on losses. The rate gross charge-off ratio of 17.6% in the quarter decreased 60 basis points from Q3 last year. The rate net charge-off ratio of 8.8% decreased 50 basis points from Q3 last year.

Okay so, if we turn to Slide 11 to review the year-over-year loss figures in dollars. Net charge-offs for RICs decreased $11 million versus prior year quarter to $613 million due to better credit performance and improving recovery rates, which offset greater balances. So let me address the components of the net charge-off walk from left to right, beginning with the $26 million increase in the other category, just primarily driven by the lower debt sales versus the prior year quarter.

The $27 million increase in balance is a result of higher average loan balances over the same period and, therefore, greater opportunity for losses. Then we have $39 million in lower losses due to better recovery rates and $25 million lower losses due to a lower gross charge-off rate.

Turning our attention to provisions and reserves on Slide 12. At the end of Q3 2018, the allowance for credit loss totaled $3.3 billion, decreasing $16 million from last quarter.

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represents an allowance to loans ratio of 11.7% at the end of the quarter. I'll go over the components of our reserve walk. The allowance increased $275 million due to new originations in the quarter, $46 million due to TDR migration, $64 million increase due to performance adjustments and these increases were more than offset by $401 million decrease due to liquidations and other, which includes payoffs and charge-offs in TDRs and non-TDRs. So we turn to Slide 13 to provide an update on TDRs. TDR balances decreased more than $300 million quarter-over-quarter. It is important to note that the nonaccrual TDR book -- TDR correction that we implemented as discussed increased the balances of TDRs because we're no longer applying those payments to principle. As the increase in provisions, which is once again offset dollar-for-dollar with interest income, revised the -- the revised numbers have changed, okay? But the declining trend in TDR balances remains.

Turning to Slide 14. Operating expenses this quarter totaled $272 million, a decrease of 9% versus the same period last year. This decrease was primarily attributable to a few one-time items, which occurred during the prior year quarter and the discipline around expense management.

So the ratio for the quarter totaled 2.1%, down from 2.4% the prior year quarter. Turning to Slide 15. Our funding and liquidity position remains strong, with total committed funding of more than $41.6 billion. SC continued to demonstrate consistent and deep access to the capital markets, having issued $4.5 billion of new ABS transactions in the quarter, including 2 DRIVE transactions and 1 SDART. We also continued to diversify our funding through private financings and lender commitments, which totaled $15.1 billion. And finally, turning to Slide 16. Our CET1 ratio for the quarter is 16.4%. During the period, we began to execute on our previously announced share repurchase plan, and we're also declaring a $0.20 dividend to be paid during Q4.

Now turning to our guidance for the fourth quarter. My comments will be relative to Q3 reported financials unless otherwise noted and will include the impact of personal lending. So we expect net finance and other interest income to be up 1% to 3% in the fourth quarter, primarily driven by higher loan and lease balances. Provision expense is expected to increase $45 million to $95 million, in line with seasonal patterns.

And remember that these 2 figures, net finance and other interest income as well as provision expense, are now off of the corrected higher base, okay, and that's why the numbers might look higher than you are used to. We expect, moving to total other income, we expect total other income to be $60 million to $70 million worse, driven by normal seasonality of the Bluestem held-for-sale portfolio. Keep in mind that the fourth quarter is the strongest volume quarter for Bluestem. So this increases are lower of cost-to-market adjustments, substantially negatively impacts the investments, gain loss and total other income lines. And further, as I stated earlier during Q3 2017, there was that onetime gain on the RV/Marine portfolio, so keep that in mind when you're looking at the variance from Q3 to Q4 '17 and comparing it to this year.

Operating expenses are expected to be flat to $10 million worse, in line with seasonal patterns, okay? And before we begin Q&A, I'd like to turn the call back to Scott.

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

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Thanks, Juan Carlos. So to sum things up, we think we're in a strong position after a good third quarter. Obviously, good strong originations across all channels and especially, Chrysler. We're continuing to make progress on the regulatory front and realizing lots of benefits for being part of Santander Group and Santander U.S. And, I would say again that our results are just continuing focus on the things we've talked about on prior calls, which is just continuing to focus on dealer and consumer experience and continuing to optimize our pricing and our credit risk management and running Santander Consumer at large U.S. financial institution standards. So with that said, let's open it up for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will take our first question from John Hecht of Jefferies.

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

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Scott, you talked about, kind of, improving volumes across channels, partially related to, I guess, the disparate relative valuation of new versus used cars. I'm wondering how long does that trend persist and what are the factors you're looking for, and how will that benefit you guys in the near-term?

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

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John, you mean the shift to used car demand more so than new?

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

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Yes, the relative shift, yes, correct.

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

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Yes, I mean, we're a significant player in both new and used cars. And so, it's a little bit of a recalibration, but not significant recalibration. It obviously, as we've said, has a significant impact on the performance of our lease portfolio as cars come off lease, and we've seen that improvement relative to residual values. And so, we look at it as more opportunity in the used car space. But that doesn't change what we're trying to do on the new car side, especially with respect to Chrysler.

It's a little bit of a shift, John. Not like a wholesale swing in strategy or anything like that.

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

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Okay. And then, obviously, you've carved out some of the information tied to the improvements in performance in the Chrysler channel. I'm wondering if you look at your core lending business, call it the subprime business, where are you capturing increased volume and what are, kind of, term trends in terms of pricing on loan to value in the various channels there?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [7]

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Yes, I mean, it's obviously a very -- continues to be a very competitive, very consistently competitive space that we operate in. And the good news for us is that, we have lots of experience and a lot of history, especially as you say, in the nonprime, subprime space. Yes, I mean, the trends are definitely -- there's always upward pressure on LTV and terms. We haven't made any -- in our case, we haven't made any significant shifts in the profile of the customers that we're booking with respect to LTV or longer terms. But yes, there's always pressure there. And as I was saying in the opening remarks, I do think this is the time for us all to be very focused on the lessons of past credit cycles, let me say it that way, and be really thoughtful -- given the length of this cycle that we should be really thoughtful about what we think is going to happen over the last couple of years. And I have no idea when it's going to turn but having been through this now a couple of times, this is the time to really -- when things are at their best, that's when people really start stretching. To your point, we're not going to do that.

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

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Maybe to add to that, Scott. Making sure that we continue to price correctly given the right risk-adjusted returns. So far, we've been able to pass along the higher rates to our customers. So continue to do that where appropriate.

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Operator [9]

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We will now take our next question from Moshe Orenbuch of Crédit Suisse.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [10]

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Could you just -- Scott, could you just give us a little bit of, kind of update on the SBNA program and how large could that be over time, like, how does -- how do you and your parent kind of think about that?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [11]

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Yes, happy to talk about that. So it's really not parents, it's with SBNA. And they have, of course -- the beautiful thing about this program is, they are able to leverage deposit funding and provide a much more competitive rate in the prime space. And so, it is -- we are originating loans with their credit parameters, and they are very much engaged in the definition of the credit buybacks, if you will. So the assets that we're flowing through to them are bank-type assets. And so, the program, and a bit about $700 million in the quarter, we think it will grow a bit from that. We haven't really laid on any crazy growth plans, but we do think the program will grow from the starting point as we refine that credit buy-box, and it's really defined by the bank. So it depends on their credit appetite. But we do -- we are hopeful that it will get bigger.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [12]

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Maybe one more thing, Moshe. As we transfer the flow agreement or flow program with Santander Group and move to SBNA, remember once again that with SBNA, those assets will not touch our balance sheet. So we won't see the growth in prime paper during the quarter, only to be sold later, right? Now it goes straight through to SBNA, so that will also remove some of the noise in the comps.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [13]

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Got it. And maybe, too, kind of just talk a little bit about the TDR flow, and you had some very, very solid improvement this quarter, but the -- I think 2/3 of the dollars are still from 2015 and prior. Like, how should we think about the ability to, kind of, work down that part and how should we think about the potential for inflows from the newer vintages?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [14]

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Yes, I think the trend that we've described in the past remains. Our expectation, that is, an expectation for a continued downward trend through 2018, early part of 2019, before we stabilize at a lower level as the larger 2018 vintage starts flowing through, right? At this point, because of the decrease in 2015 vintage, you have lower inflows into the TDR package, okay? So the expectation that we've described in the past remains. Lower balances for some quarters to come. One thing to keep in mind regarding -- no, maybe just one thing to keep in mind is that because of the corrections that we described earlier, right, there will be no principal payments to nonaccrual TDRs so the trend should be also a little bit steadier than it was before. But certainly, it remains in place.

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Operator [15]

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We will now take our next question from Chris Donat of Sandler O'Neill.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [16]

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I wanted to ask one on expenses. As you've terminated 2 Fed agreements and cleared the stress test twice, do you see any downward pressure on expenses or should we look at originations growing as a potential offset, like you need less capacity now? Just wondering if what we should be thinking about the next couple of years on expense trends?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [17]

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Yes, Chris, thanks for the question. I think -- well, I know, in this case, the less regulatory stuff doesn't drive any expense reduction opportunities. Building out the infrastructure related to capital stress testing, much of that infrastructure has been built and will stay in place. Resolving the 2 written agreements did require investments in places you would expect, like compliance, risk management, areas like that. But no, we didn't overbuild them to address the legacy written agreements that we have with the Federal Reserve. So no, I don't think that -- it's great, it's obviously great news for the business for a bunch of reasons, but no, it doesn't trade an expense opportunity for us. And yes, we'll be very disciplined, especially on overhead expenses. And then you can expect expenses to rise and servicing originations as the volume continues to increase. But we do also have -- just to remind you, we do also have one more written agreement with the Fed to close out. It's the 2017 written agreement on compliance, which was directed at the holding company but also includes Santander Consumer. And we feel like we're on the right road there, too.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [18]

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Okay. And then, just for my follow-up for JC, with the corrections you made to the prior financial errors, is there any impact to International Financial Reporting Standards or is this all a GAAP thing? I'm just wondering if this affects things as it flows up to the parent?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [19]

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So the -- this is a -- the numbers that we reported is a GAAP correction as reported. And then, as we roll up to IFRS accounts, the group determines how to apply them. And certainly, if it's immaterial for us, it's even less immaterial for us.

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

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Less material.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [21]

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Sorry, immaterial for us, it's even more so for the Group.

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Operator [22]

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We will now take our next question from Richard Shane of JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [23]

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One chart that we couldn't find was the vintage curves, and I'm curious, when we saw the second quarter vintage curves, the '17 pool was tracking a little bit more in line with the '15 vintage. I'm curious where that pool is tracking now, and I'm also -- I'll ask my follow-up at the same time, which is that with the seasoning of the portfolio and the '15 pool sort of rolling off and '16, '17 vintage is really driving credit performance. Should we expect to see charge-offs sort of flatten out on a year-over-year basis going forward?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [24]

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Yes, the 2017 vintage continue -- our expectation remains the way we've described it before, and we still expect it to come in between the '15 and '16 vintages. Especially, as we complete the year, right, as we go through Q4, remember that in 2017, a lot of the pricing initiatives were, kind of, back ended and so was the volume. So that will also drive our expectations that the line in that chart will continue to come in between the 2015 and 2016 vintages. The -- in terms of our expectation, as we go forward, the charge-off ratio, I think -- at a high level, I think your comment is correct. The downward trends in the ratio should start to stabilize because of the dynamics that you described.

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Operator [25]

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We will now take our next question from Arren Cyganovich of Citi.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [26]

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I just wanted to ask about the penetration ratios, they have been steady at a nicer clip here. Just curious as to what you can do to see that rise any further. Is there anything that -- a gauging factor to seeing that right into the 40% ratio or higher?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [27]

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Yes, it's a good question, especially I'm sure you've read the contract. It's going to be hard to push it higher, to be quite honest. We're always looking for opportunities to take it higher. You look at the growth we had in leases this year, which is really great and we feel good about that volume we've put on. The lending side is very competitive. So absent additional support from our partner, it's hard to see dramatic -- any dramatic -- we'll keep chipping away on it. So I would hope we would be able to put up improvements. But I wouldn't expect to see with the increase that we've -- from where we were a year ago today, going from the low 20s into the low 30s kind of year-on-year. I wouldn't expect that kind of improvement to continue. But we will keep chipping away at it and trying to make it a little bit better. But again, absent something changes in terms of support from Chrysler, yes, slow and steady improvements maybe.

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Operator [28]

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We will now take our next question from Steven Kwok of KBW.

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Wai Ming Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [29]

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Just the first one just around used car prices. Can you just talk about what your expectations are as we look into the fourth quarter and into 2019?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [30]

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Yes. So in terms of used car prices, we've obviously had a very good -- very strong year and particularly the summer. As we move into Q4, we would expect some normalization, some softening but it's still -- just because of seasonality. But is still a good year-on-year performance, okay? And then, as we look beyond that, all the other macro factors and industry factors that Scott talked about regarding the support for used vehicles, et cetera, even if we have some normalization, some softening, if you will, from where we are today, it should still mean a relatively steady performance in terms of used car prices.

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Wai Ming Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [31]

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Got it. And then, as it relates to, like, recovery rates just looking on Slide 10, where we saw a couple of quarters of good increase in the recovery rate and then, it came down a little bit this quarter. Can you just talk about -- are there any seasonal trends around the recovery rate and how we should think about that rate going forward?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [32]

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Yes. There is definitely a seasonality in terms of our recovery. So you tend to see pretty much what you see on that Page 10, right? It goes up during the first half of the year, and then it softens in the back end of the year. This particular quarter, remember my comment earlier, the recovery rate is somewhat lower because we were opportunistic about some portfolio sales, which we decided to postpone, right? So that put a little dampener on the -- on this quarter's recovery rate. But it's still significant -- a good year-on-year performance. And good underlying trend, I should say.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [33]

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Yes. And I would just add to what Juan Carlos said. When you look at what's happening at the auctions, it's not just one type of vehicle which is driving the improvement in recovery rates, the prices at auction across all types of vehicles, too. So that's nice to see, which to me says there is this underlying broader demand for used cars. It's not just SUVs and Pickups, for example, that are seeing improvements in recovery rates. So I think that, again, points us to the underlying strength of the economy and maybe the shift away from new cars to better-value used cars.

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Wai Ming Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [34]

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Got it. And then, just as a quick follow-up on that delay or the opportunistic, should we expect that to occur in the fourth quarter or could it be beyond that?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [35]

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It could be beyond that. We execute debt sales every quarter, and we're trying to -- we will always try to extract the best value and choose when we go ahead and conduct them.

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Operator [36]

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We will now take our next question from Betsy Graseck of Morgan Stanley.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [37]

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A couple of questions. One, let's assume that FCA buys out the Chrysler business. I'm just wondering how you think about structuring your business from here on -- from there on in. Do you stick with the origination of the near part of the Prime and have flow agreements with other institutions or do you bring it -- that kind of flow on your own balance sheet or do you just focus on the subprime? I just want to understand how you're thinking about that.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [38]

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Yes, so it's a little -- yes, Betsy, it's kind of a fun thing to think about. It certainly is speculative at this point. The talks continue. So yes, I mean, we think about what life, if a transaction happens. Chrysler is going to be an important partner of ours in some way, shape or form for many, many years to come. Certainly, in the case of a transaction, those things don't happen overnight, and I don't know what our relationship would be. So that -- they're going to be an important part of our world for a long time to come, in some way, shape or form. And then outside of that, our strength in the non-Chrysler part of our business is very much focused on nonprime, just because of the way our funding costs work, so we're always looking for opportunities to grow our business in that space, and we think we have a whole range of opportunities, and we're positive about those opportunities with a continuation of the Chrysler contract or a change in our relationship with Chrysler. So we feel -- yes, we feel pretty positive about where we're headed as a business and quite optimistic about the future for this business.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [39]

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Okay. And then, just a follow up on the funding side with obviously, interest rates having risen here. You've been able to pass that on to the customers. Do you have any sense as to at what point your customers are going to start feeling that higher rate and you get that, as you've indicated, a little late in the cycle and losses start to increase or are we really far away from that? Obviously, this cycle is a little bit different with an extremely strong consumer this late to the cycle. Just wondering how you're thinking about that. What's the tipping point in your modeling for when the borrowers can't afford the increased interest rates that you pass on?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [40]

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Yes, it's a good question. I guess what I would say is, year-on-year, the rates we've passed through to customers really aren't what I would describe as significant enough to cause them a payment shock to those consumers. Certainly, it builds over time. And I would say that, again, there's a little bit of shifting from new to used, the more affordable vehicles, which lowers payment those consumers have to make for their cars. So -- and we have lots of metrics that look at the percentage of our business that are booked with higher payment-to-incomes for our consumers, we're very vigilant when it comes to that. So I think the short answer to your question is, we don't see any dramatic shift yet in the payments to income. We look at it all the time. I think you're right, it's the early warning metric for change in the credit cycle. And so, we're keeping -- and we're very vigilant about it. But I can't -- I wish I did, but I don't know if it's going to change. But we do have lots of really good early warning metrics in place, and we are very reactive to changes to the market today. So we are definitely thinking about how we will manage our business when the cycle starts to change.

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

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They are not flashing us.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [42]

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And none of those are flashing as of today. It just looks great across the board.

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Operator [43]

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We will now take our next question from Vincent Caintic of Stephens.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst [44]

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Wanted to actually focus on the dealer floor plan side of things, so it's nice to see it's up 40% year-over-year. And so, you gave the penetration rates on the Chrysler loan on the lease side. I'm wondering if you have kind of same penetration rate when you think of your dealer floor plan versus the overall Chrysler dealer floor plan that be out there.

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

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Yes, no, we don't provide that. Obviously, our market share, when it comes to dealer floor plan with FCA, is much, much smaller, right? There -- most of these dealer floor plan lines stay with incumbent, and you only grind at them little by little, right? So the -- there's -- I will say that there is good momentum, particularly with some of the larger FCA dealers. This time of year is when some of the lines grow to prepare for the new inventory. And this is just the team working through the pipeline in a steady fashion. Okay. But our market share in that space with FCA is still very strong.

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

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It's small but it's also very important to our partner, Chrysler, that we continue to -- because we look at it as part of the overall package that we deliver for Chrysler. And so it is very important that we provide this for our partner and continue to grow it. And so Juan Carlos is right, it's small today but it's -- we think we've just got a ton of opportunity doing it that right way when things become available to grow the business.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [47]

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So although small but very important to the relationship and the partnership.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst [48]

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Right. Arguably the dealer relationship is the leading indicator here, so it's nice to see that the floor plan is growing, great. And the next one I have, and just a quick one, when you think about this so the penetration rate is increasing and the floor plan also increasing, so both loan lease and floor plan. Do you -- is there general area where you're seeing yourself taking share from so other competitors, or if there -- less competition in certain areas. Just kind of a sense of where your growth is relative to where you are taking that growth.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [49]

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Yes. I mean, there's lots of players in the market for sure. And we do look at changes in market share across competitors. And it always is changing. It's fascinating, as you probably noticed. So we've seen -- in some of those trends, we've seen some of the deposit funded prime guys move back into the market more strongly. Not in nonprime, that's really prime and near-prime space. And we just -- yes, there's some of that stuff going on, but we just continue to be very focused on pricing for risk on every transaction. And so, there are always people moving in and out in prime, real prime and subprime, but we're not focused on taking share from anybody. We're focused on originating assets and putting them on our balance sheet. That make sense for us, where we get the appropriate -- we get the appropriate returns.

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Operator [50]

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We will now take our next question from David Scharf of JMP Securities.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [51]

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I apologize but a variation on the question that's been asked in a few other ways before. But regarding the, sort of, subtle shift you're seeing from new to used, you had mentioned that often, that is an early warning sign, that no lights are flashing yet in terms of consumers' desire and need to reduce monthly payments. Can you maybe just list for us 2 or 3 of the biggest other, kind of, early warning sign metrics you track? I know you mentioned that there were several others.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [52]

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Yes, sure. So one thing we look at is -- because you're looking at our portfolio and our business all the time, it's a big portfolio with lots of vintages in it. So one of the best things to do is look at vintage performance. You look at the early defaults on a vintage. So best example is, we'll look at loans we originated just in July of this year, right? And say, how many of those customers missed their first payment, like, what percentage of loans that we booked missed their first payment. And then we can compare that metric to all the prior periods, same aging, what percentage of people missed their payments a year ago, and we can see if that's changing. Now we make changes to our underwriting up and down all the time, but if we see significant shift -- like the percentage goes up compared to a prior period, that is a really good early warning that the subsequent performance on that book is going to be worse. So we look at that metric, we look at people we have in collections, the percentage that are moving from delinquency bucket to delinquency bucket, so if we see a higher percentage of customers in early stage buckets not being able to pay, that's a very good indicator. When we have -- a third one might be when the percentage of loans we're asked to restructure by consumers starts to go up, that's another good one. And then there are lots of origination metrics we look at, like if the incoming apps, if the profile of the average score of those incoming apps is changing, then that's a good indicator too. I can do 25 for you if you'd like.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [53]

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But it sounds like early payment defaults have or first payment defaults haven't increased notably?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [54]

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That's exactly right. So that's what we look for. That's the -- when you get old you kind of learn it's one of the most predictive.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [55]

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Got it, got it. And hey, as a follow up, more just housecleaning. I thought I heard maybe the figure $60 million was thrown out in the prepared remarks. But JC, I was trying to understand, the provision expense in the quarter relative to the guidance that was provided, I guess, was on the pre-restatement accounting. Was $60 million the additional delta in the quarter, is (inaudible).

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [56]

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Yes, approximately $62 million or so. So one more thing that might be useful. So if you deduct our number from this quarter and then you go to the supplement and do the correction that was pointed out in the supplement for the same -- for Q3 2017, which is around $34 million, you will see that provisions basically are flat year-on-year.

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Operator [57]

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We will now take our next question from Kevin Barker of Piper Jaffray.

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Kevin James Barker, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [58]

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The increase in the 30-day delinquency rates year-over-year roughly 30 basis points. You mentioned the 2017 finish. Was there anything else that may have caused the increase in delinquency rates this time around even though you're putting higher FICO score loans on your balance sheet today?

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [59]

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No, the year-on-year comparison is -- or the uptick is largely driven by the impact of the hurricanes and the significant increase in expansions that we provided back then, which drove down delinquency in Q3 '17. The number probably would be either flat year-on-year or slightly down, if it wasn't for the hurricane's impact.

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Kevin James Barker, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [60]

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So that was purely a hurricane impact. And you mentioned there was a going to be a plateauing going forward due to -- on net charge-off rate, primarily due to the impact of 2017 vintage as we look forward into 2019. But given that you've increased -- it seems like you're putting higher FICO score loans on your balance sheet going forward, would you expect it to plateau and then start declining thereafter as the 2018 starts to become a greater portion of the overall portfolio?

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

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It should be, if anything, so we're up 8.8%, if anything a slight down but pretty steady as we go forward.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [62]

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Yes, I mean, that's generally the steady-state loss rate we're targeting, it's kind of where we're at today. So down a little bit maybe from there. So yes, that's kind of what we would expect, all things being unchanged in the environment.

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

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One more thing. Now as we go forward, and you think of the SBNA, the new originations that you -- the FICO from the new originations held for investment will be truly what we hope here at SC. We felt the noise of higher FICO originations for the group that were later sold.

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Kevin James Barker, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [64]

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And then, are your expectations are that recovery rates remain where they are today or do you expect some softness as you discussed about earlier about used car prices.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [65]

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Yes, when we do our forecasting, we do include some normalization, some softening from current levels. Still a pretty steady performance, softer than what we've seen this quarter.

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Operator [66]

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That was the final question, and we have no further questions at this time. 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 [67]

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Thanks. Thanks, everybody, for joining the call today. Appreciate the questions. As always, our Investor Relations team is available for follow-up questions, and we look forward to talking to you at the end of the next quarter. Thanks very much.

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Juan Carlos Alvarez de Soto, Santander Consumer USA Holdings Inc. - CFO [68]

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Thank you.

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Operator [69]

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Ladies and gentlemen, this concludes today's call. You may now disconnect.