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Edited Transcript of SC earnings conference call or presentation 30-Oct-19 1:00pm GMT

Q3 2019 Santander Consumer USA Holdings Inc Earnings Call

Dallas Nov 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Santander Consumer USA Holdings Inc earnings conference call or presentation Wednesday, October 30, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Evan Black

Santander Consumer USA Holdings Inc. - Head of IR

* Fahmi Karam

Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics

* 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

* James Ulan

Crédit Suisse AG, Research Division - Research Analyst

* John Gregory Micenko

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

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* Kevin James Barker

Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst

* Mark C. DeVries

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

* Richard Barry Shane

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

* Robert Henry Wildhack

Autonomous Research LLP - Analyst of Payments and Financial Technology

* Vincent Albert Caintic

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

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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 2019 Earnings Conference Call. Today's conference is being recorded. (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, Adra. Good morning, and thanks, everyone, for joining today's call. In the room, we have Scott Powell, President and Chief Executive Officer; and Fahmi Karam, Chief Financial Officer.

As you're aware, certain statements made today may be forward-looking. Please refer to our public SEC filings and risk factors with respect to these statements. We'll also reference non-GAAP financial measures that we believe will be useful for investors, and a reconciliation of those measures to GAAP is included in the 8-K today, October 30, 2019.

And with that, I'll turn it over to Scott Powell.

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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 our call to discuss our third quarter results. I do want to say how pleased I am to be sitting here with Fahmi Karam, our new CFO at Santander Consumer. As you all know, Juan Carlos Alvarez is now the Santander U.S. CFO and continues to work with us. I know you all miss him already, but Fahmi, I know, will do a great job in his current role. Fahmi has been working here for many years. He has had a number of different roles, including Strategy, Corporate Development and was most recently our Head of Pricing and Analytics. So he knows the business inside and out. He's absolutely the right person for the job. That's great to have him here, and I think you all will like getting to know Fahmi. So great to have you here, Fahmi.

So let's turn to Slide 3 in the presentation, and I'll give you a quick overview of our highlights. So net income came in at $233 million. Earnings per share for the quarter totaled $0.67 per share. Our after-tax ROA was 2%. We had a very strong quarter on originations. Originations came in at $8.4 billion in total volume, which is up 11% year-over-year. We remain really focused on improving the dealer experience, especially in our origination operations and focusing on the process.

Our non-FCA core business was -- came in at $2.6 billion, which is up 11%. Chrysler loans were $3.6 billion, up 52%. And that's really driven by the program we have with Santander Bank, where our prime volume -- they did prime volume of $2.1 billion during the third quarter.

Chrysler leases were $2.2 billion, which is down 23% year-over-year and were down year-to-date 12%, and we can talk more about that in Q&A, for sure.

Total Chrysler originations though were up 9% year-over-year. And during the third quarter, our penetration rate with Chrysler came in at 36%, which is up from 31% a year ago, which, again, continues to reflect the strength of our relationship with FCA and all the work we're doing to help them be successful.

We're also pleased to report on the J.D. Power results, which were recently released. Chrysler Capital increased nearly 5 percentage points versus the previous survey, which was a year ago, and we were the second largest mover compared to peer group. So that demonstrates our continued progress because we continue to focus on this very important area of improving dealers' satisfaction and improving our service to dealers.

On the funding side, we continue to execute successfully in the securitization market. We did $3.5 billion of ABS from 3 transactions, one from each of our active platforms. And I think what's really interesting is our portfolio's credit performance remains very strong, supported by benign credit environment and a very healthy consumer. So I'm sure you've looked at this already, but our 30- to 59-day delinquency ratio decreased 100 basis points year-over-year. And what's interesting is kind of the quarter-on-quarter comparison, too.

So in 2018, quarter-on-quarter, we were up 90 basis points. This year, we're pretty flat. We're up 10 basis points. And if you look at the 59-day plus delinquency ratio, year-over-year, we're down 80 basis points and quarter-on-quarter, again, a year ago, we're up 100 basis points just because what you'd expect seasonally. This year, we're basically flat to the second quarter. So I think that reflects kind of the inherent current quality we have in our portfolio.

Our gross charge-off ratio is up 70 basis points to 18.3%, very strong recoveries in the quarter at 55%. Net charge-off ratio is 8.1%, which is down 70 basis points, obviously driven by that very strong recovery rate. And also another very positive is sign our TDR balances are down 27% year-over-year.

We do remain very disciplined on expenses here. You'll see our expense ratio is up from 2.1% to 2.3%. But all that increase is really driven by a series of one-timers, so if you back those out, our expense ratio would be flat.

And then on the macroeconomic environment, as we remain super focused on that. You can track of all the trends. Used car prices continue to exceed people's expectations at the beginning of the year. New car sales were down a little bit compared to last year, but still at a very healthy level. And just looking at the economy itself, obviously, it's very strong. Everybody understands the connection between consumer unemployment and defaults in this particular industry. So all of that remains very strong, consumer confidence remains strong. So we're feeling pretty good about the macroeconomic environment.

So with that, I'll turn it over to Fahmi. Fahmi?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [4]

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Thanks, Scott, and good morning, everyone. Turning to Slide 4 for some key economic indicators that influence our originations and credit performance.

Building on what Scott just said, the macroeconomic environment remains supportive of our business. Consumer confidence is still high. The labor market is strong, and household balance sheets continue to improve as saving rates increase. The environment continues to support a resilient consumer lending environment.

In regards to new vehicle sales, industry experts are forecasting a moderate decrease and we've seen some of that play out in the third quarter, but we are still at historically high levels. The used car market continues to be stable as demand consumers remains robust.

On Slide 5, there are a few key factors that influence our loss severity and credit performance. Our auction recovery rate, which represents all auto-related recoveries from the auction lanes was 51.5%, up from 50% during the prior year quarter. Our recovery rate, which includes nonmetal proceeds, bankruptcy and deficiency sales, was 55.9% in the quarter, also up versus the same quarter last year.

While overall auction trends are positive, we did begin to observe some softening in the auction lanes in September. Some of this is expected based on typical seasonal patterns, but we'll be watching for any trends very closely in the coming months. Additionally, nonprime industry securitization data points are relatively stable net loss and delinquency trends compared to last year, consistent with our overall portfolio.

Turning to Slide 6, for origination trends. Overall, we had another healthy quarter of originations across the board, with more than $8 billion in total auto volume. That's an 11% growth from last year, driven by our Chrysler prime loan business. Core loan originations increased 11% in the quarter compared to the prior year quarter. Chrysler Capital loan originations increased 52%. Similar to last quarter, the increase is coming from the greater than 640 segment, which is driven by Chrysler Capital exclusive offers and our SBNA flow program.

On lease originations, volume decreased 23% versus the third quarter last year due to competition and a strong quarter last year.

The growth in volume is due to our continued progress with FCA, our dealers and our origination processes. Chrysler Capital volumes are indicative of the strength of our partnership with FCA and our ability to execute. We remain disciplined with respect to the risk return profile of our nonprime originations while maintaining our competitive position. We expect to continue to support FCA prime loans with our SBNA program, while continuing to maintain our strong market share in lease.

And to that point, you can see the results with FCA on Page 7, which shows our average quarterly penetration rate in the third quarter at 36%, up from 31% last year. We continue to work together to fund mutually beneficial ways to increase our volume and drive sales for FCA.

Turning to Slide 8. The service for others platform generated $21 million in servicing fee income this quarter. In addition to those servicing fees, $13 million of SBNA originations fees are in our fees, commissions and other line item. During the quarter, we added $2.1 billion in originations to the SFO platform via our agreement with SBNA, which drove the SFO balance increase as our previous flow programs continue to run off.

Moving to Slide 9 to review our financial performance for the quarter versus the prior year quarter. Net income for the quarter of $233 million, flat versus the prior year quarter. Interest on finance receivables and loans increased 4%, driven by higher average loan balances. Net leased vehicle income increased 29% due to continued growth in lease balances. Interest expense increased 17% due to higher levels of outstanding debt, relatively in line with the increase in our loan and lease receivables and a lower contribution from our derivatives portfolio. Provision for credit losses decreased to $567 million in the quarter, down $31 million driven by lower TDR balances.

Total other income was $31 million in the quarter and included $87 million of held-for-sale adjustments related to the personal lending portfolio, which is comprised of $102 million in customer charge-offs, offset by $15 million decrease in market discount.

Continuing to Slide 10. Versus the prior year quarter, early stage delinquencies decreased 100 basis points, while late-stage delinquencies decreased 80 basis points. As we have referenced in the past, lower loan modifications have an impact on delinquencies, charge-offs and lower inflows into TDRs. Over time, as modification levels have normalized, delinquencies have improved and a cleaner portfolio remains.

Regarding losses, the RIC gross charge-off ratio of 18.3%, increased 70 basis points from the third quarter last year. The net charge-off ratio of 8.1%, decreased 70 basis points from the third quarter last year, driven by strong recovery rates. Our credit metrics have been stable and are consistent with the mid 8% net charge-off guidance we've provided at the beginning of 2019.

Turning to Slide 11 to review the loss figures in dollars. Net charge-offs for RICs decreased $20 million versus prior year quarter to $593 million. Breaking down the change, $29 million in losses were due to a higher gross charge-off rate, another $35 million is attributable to higher average loan balances, which were up $1.4 billion from last year. These were more than offset by better recoveries and other items, which combined contributed $84 million.

Turning our attention to provisions and reserves on Slide 12. At the end of Q3 2019, the allowance for credit losses totaled $3.1 billion, decreasing $5 million from last quarter, which represents an allowance ratio of 10.5% at the end of this quarter. In regards to the reserve walk, the allowance increased $188 million due to new originations in the quarter, higher inflows in the TDR migration, which increased the reserve by $8 million and $3 million increase due to unfavorable performance adjustments. These increases were more than offset by $204 million decrease due to payoffs and charge-offs.

Now let's turn to Slide 13 to discuss TDRs in more detail. TDR balances decreased $292 million versus the prior year quarter, continuing their downward trend due to the lower TDR inflows, given the strength of the consumer and lower modification levels. As we mentioned in the past, this slower generation of TDRs could allow reserve balances to trend lower throughout the rest of the year.

Turning to Slide 14. The expense ratio for the quarter totaled 2.3%, up from 2.1% the prior quarter, driven by onetime expense in our legal reserve. Excluding this expanse, our expense ratio would have been in line with prior year quarter.

Turning to Slide 15. Our liquidity position remains strong with total committed funding of nearly $49 billion. SC continued to demonstrate consistent and deep access to the capital markets. Our treasury and capital markets teams continue to be active, issuing one transaction of each active ABS shelf in the quarter for a combined $3.5 billion. We also continued to diversify our funding through private financings and lender commitments, which totaled $18.3 billion. Subsequent to quarter end, we also closed a $1.2 billion lease ABS transaction, SRT. This is the fourth transaction since the inception of this new lease platform in late 2017, which is important for our funding diversification in leases.

Finally, turning to Slide 16. Our CET1 ratio for the quarter was 15.4%, down from 16.4% versus prior year. We continue to execute our previously announced $1.1 billion share repurchase plan, purchasing approximately $141 million or 5.5 million shares during the quarter.

Before going into our Q4 2019 guidance, I'll provide a brief update on CECL. As a reminder, our TDR portfolio is already reserved for lifetime losses. In 2020, with the adoption of CECL, the non-TDR portfolio will also be reserved on a lifetime basis. Accordingly, we expect our allowance for credit loss to increase 55% to 70% at CECL implementation. We also expect to phase in the impacts with respect to regulatory capital amounts and ratios over 4 years on a straight-line basis. Given our strong capital base, we do not expect CECL to impact our previously announced capital distributions.

Now turning to our guidance for the fourth quarter. Remember, the fourth quarter is seasonally the weakest-performing quarter and is also the quarter that is most heavily impacted by the held-for-sale personal lending portfolio. The balances of the personal lending portfolio seasonally increased from third quarter to the fourth quarter, and we are required to mark the portfolio accordingly. Additionally, during Q4 2018, we resolved some legacy legal matters that benefited the period, which we should all keep in mind when comparing to this quarter.

So my comments will be relative to Q3, unless otherwise noted and will include the impact of personal lending. We expect net finance and other interest income to be down 0% to 2% in the fourth quarter in line with last year's quarter-on-quarter trend. Provision expense is expected to increase $90 million to $140 million in line with seasonal patterns.

We expect total other income to be $65 million to $75 million worse, driven by normal seasonality of the Bluestem held-for-sale portfolio. Operating expenses were higher than anticipated this quarter due to some onetime expenses in the period. We expect expenses in the fourth quarter to be $20 million to $30 million better.

Regarding our full year guidance, all of the metrics we previously guided to are relatively in line with our ranges we provided on our Q1 2019 earnings call, with the exception of our effective tax rate. So let's go through those points once again.

For the full year 2019, we expect mid-single-digit growth in net finance and other interest income versus 2018 and a mid 8% net charge-off ratio for the full year, a stable expense ratio around 2.1%. And regarding that tax rate, we currently expect the tax rate to be in the 25% range due to higher state taxes and lower electric vehicle tax credits.

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

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

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Thanks, Fahmi. Well, I'd like to come back to 4 key points that I made on prior calls. Number one, we continue to make significant progress, creating a better dealer experience, really by fine-tuning our pricing and credit risk management operations and then making sure our operations on the funding side and servicing side work smoothly. We're not done. We're constantly seeking to do better and improve what we do in pricing and risk as well as our operations. But we feel good about the progress we've made because I think this quarter shows how those changes has had a substantial impact on our results.

Number two, and Fahmi mentioned it, as did I in my opening remarks, we remain very disciplined on expenses with a positive operating leverage.

Number three, we spent a lot of time building and deepening our management team, having Fahmi here today is a great example of that. Our results speak to the broader point that we continue to run this business at large financial institution standards as we've built out our management team and improved our depth. Another good example of that, which we recently announced is Sandy Broderick, who's been the Head of Operations here at Santander Consumer. She's taking -- she's also taken on a broader role in running Santander U.S. operations. It goes to the depth of the management team that she's built in operations.

And then number four is our relationship with Chrysler. We continue to work really hard to support our partner. Our originations performance reflects the strength of that partnership and we continue to work every day to find new ways to create mutual value with them.

So with that, we'll open it up to questions. Operator, over to you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll go first to Moshe Orenbuch at Crédit Suisse.

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James Ulan, Crédit Suisse AG, Research Division - Research Analyst [2]

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This is actually James Ulan on for Moshe. First, congrats, Fahmi. Good to see you there. And I wanted to ask about capital. You had the $1 billion buyback, and you did about $140 million in repurchase. Just given what the market is allowing you to repurchase with that 20% outstanding float? What you think is reasonable to do in 2020 as far as share repurchases?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [3]

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Yes. Thanks for the question. As you stated, we did purchase around $140 million or 5.5 million shares during the quarter. As we did highlight last quarter, the previously announced $1.1 billion is an up to amount. And we continue to be very thoughtful in our approach as we continue to monitor the market conditions. And all of the buyback execution strategies are available to us as well as we continue to look through other investment opportunities to deploy capital that's accretive to our shareholders. So I'm not going to comment on what we're going to do in 2020. We are going to continue to be very thoughtful in our approach and deploying capital to our shareholders.

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James Ulan, Crédit Suisse AG, Research Division - Research Analyst [4]

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Got you. Great. And just a quick follow-up that's related. You've got CECL phasing in first for us in a quarter or a couple of months. Any thoughts on how you think that would impact approvals on capital returns or just your ability to do capital return?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [5]

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Yes. And I think we said during our prepared remarks that we do expect the CECL impact to impact any of the previously announced share buybacks. We have a very strong capital base. We're confident that we can absorb the impact of CECL, still execute on our strategic priorities, including the accretive growth opportunities and deploying capital to shareholders. The ultimate impact on CECL be a function of our portfolio credit mix and trends that we are seeing in the portfolio at that time and our forward-looking view on the macro environment. So we have a little bit of work to do before day 1 implementation. And as we get closer to implementation day, we will also be able to give you a little bit more details as we give 2020 guidance. I also think it's worth mentioning on CECL that we do not have -- we do not believe that CECL will fundamentally change the way we price or underwrite our deals. The underlying risk and lifetime economics of loans are not changed. So it's more of a timing thing than anything.

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Operator [6]

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We'll go next to Jack Micenko at SIG.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [7]

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Looking at the NIM and thinking about some of the inputs there. Historically, I thought of you guys is somewhat liability sensitive, obviously, rates have come down, but you're also remixing the portfolio a little higher quality. So just thinking through where rates have gone, maybe we get something this week. Does the NIM begin to reflect in 2020? And if it were or were not to, sort of -- what are some of the drivers today versus historically that may change that?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [8]

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Yes. Thanks for the question. Part of the NIM story is, as you mentioned, the mix of the portfolio, as lease is continuing to grow as being a bigger part of our balance sheet, lease is a relatively prime -- it is a prime product, and therefore, a lower yield than our typical nonprime assets. The cost of debt has ticked down throughout the year. Believe, we're about 20 basis points better than we were in Q1. We will be able to see some of that impacts further as we reprice our credit facilities, and we continue to do new securitizations. So I do think the trend will continue to improve as we get through the end of the year and 2020.

On the new origination front, as interest rates fall, we generally are able to hold the yield. Obviously, in some segments, we may choose to take share and reduce price. Of course, we have to be mindful of where the competition is and be competitively priced. But generally speaking, as rates come down, we're able to generate higher margins.

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

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Okay. That's -- so directionally, still pretty much the same. And then on the recovery rate, really impressive increase year-to-year. How much of that is used prices holding in better than people think? And how much of it is the way you've changed the modifications in the TDRs, I think you moved to doing less TDRs, which I'd assume would give you better recovery rate at auction because of the time frame has compressed them when you're taking the car backward. Curious if you could parse out that 600 basis points, how much is just straight pricing and how much is changed methodology?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [10]

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It's a part of all of the above, to be honest with you. The big increase in our overall recovery rate has a little bit of timing impact on deficiency sales quarter-over-quarter. So I would point you to just the auction-only growth, and that's pretty consistent with what the industry is seeing. As far as specific to us because we do have a newer vehicles in the portfolio, as far as mix goes, you do see a little bit of a benefit to the recovery rate. But I think our portfolio is very reflective of what the industry is seeing.

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Operator [11]

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We'll move next to Mark DeVries at Barclays.

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

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Yes. I was hoping to get a little more color on kind of what's driving the decline in the servicing fee income as you grow the service for others portfolio? I think you indicated in the press release, it's mixed. But if you could give us a little more sense of why that is and what kind of an impact maybe that declining fee is having on the overall profitability of that business?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [13]

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Yes. I think the service for others platform is a mix of several different partners. As we get further along with SBNA, you will definitely see the portfolio grow as our volume grows. Just want to remind you that as part of the fees and commissions line item, there is a $13 million origination fee, which based on our other flow programs, we haven't charged an origination fee. But due to the nature of the flow agreement with SBNA, we do have the benefit of the origination fee.

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

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Okay. Got it. And then to the extent of which you're willing would be really useful to get some color on your thoughts on what we can expect on charge-offs as we look into 2020?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [15]

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Yes. I mean gross charge-offs are a little bit higher year-over-year but in line with our expectations. As we've communicated in the past, the lower modifications that we've talked about over several quarters, does have an impact on charge-offs. I would say, if you look at some of our more recent vintages and our more recent monthly vintages, really across all of our channels and across most of our segments, some of the month-to-month vintages in 2019 are some of the best-performing early performance indicators that we've seen in quite some time over the last 4 or 5 years. So we're not seeing any red flags that would give us any pause or be less optimistic on the opportunities we have in the market. We'll be focused on pricing for the risk that we put on our balance sheet. But as we sit here today, we're very positive on the assets that we're booking.

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

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Yes. Mark, I would just add to what Fahmi just said that I think we feel pretty positive about what next year looks like given what Fahmi said, which is quality of our originations this year have been really good from -- as Fahmi was saying, from a credit perspective based on early delinquency reads, and we also feel good about the profitability of that vintage. So yes, we are pretty positive as we look to next year in terms of overall credit trends and including the gross loss rate. Obviously, that's subject to what happens in the broader environment, but all things being equal there, and there isn't any reason to believe yet that all things won't be equal there that we feel pretty positive about next year.

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Operator [17]

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We'll go next to John Hecht at Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [18]

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First question is, can you quantify that onetime legal expense, just so we know what kind of core run rate earnings were in the quarter?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [19]

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We're not going to comment on the legal reserve. I will point you to our disclosure coming up in 10-Q. What I will say, John, is that we -- it is a legacy matter. It is not a new matter. And I'd also point you to as we take that onetime expense off, our ratio is consistent with our guidance and the prior quarter.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [20]

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Okay. And then there wasn't -- looking at your origination trends, it's down year-over-year in leases, but very strong in other factors, particularly the Chrysler partnership. Maybe can you talk about that? What's going on in the end markets that's driving that change? Or is that more based on -- focused on return of capital and where the best margins lie?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [21]

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Yes. No, I think it's an indication of where we are with our FCA partnership, coming off the amendment that we had last quarter that we announced last quarter. You've seen strong originations really all year along. So it's a function of our relationship with FCA. But also -- a big part of it is also the SBNA flow program, which we've touched on over the last several quarters. The SBNA flow program, obviously, we're very pleased with that. It helps us -- it helps the bank, it helps us, it helps our -- support our FCA partnership, and it helps us be more competitive really across the full credit spectrum. So as I look at originations growth, it's really a good story of Chrysler and our core channel.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [22]

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Okay. And then last question, so we've just seen used car volumes sustained modest growth this year. Scott, you commented on this in the past relative value. Where do we -- where do you think we are in that cycle? Or do you think there's some persistence in this constant growth coming into next year?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [23]

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Yes, I think it's just what you said, which is -- I think it's a continuation of that same theme. I don't think we see much change in there. Especially given the strong consumer and strong demand and relative value to new cars, we got a knitter hanging in there pretty well despite all the people out there calling a significant downturn. It's down -- new car sales are down a little bit, but still a very healthy level. And used cars -- value for used cars, you see it in our recovery rate and you can see in the demand for used cars. So I think it will continue. Again, barring some change in the macroeconomic situation will continue. I don't think there's any reason to see a big change there.

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Operator [24]

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We'll move next to David Scharf at JMP Securities.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [25]

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I wanted to just return to the recovery rate and sort of expectations going forward because obviously given gross charge-off trends, you won't want to get a better sense for sort of the sustainability of the recoveries. And I'm wondering the gap between just sort of the pure auction to your total, is there an increasing market? Or are you finding yourself increasingly going to market to sell deficiency paper and sort of other nonauction recoveries? Just trying to get a sense for whether there are more purchases out there, whether this quarter's recovery represented may be a bit of an anomaly in terms of how much deficiency paper and otherwise you may have sold?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [26]

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I think the answer is no. I mean it's -- we're consistently doing those kind of things. There are many change in strategy with respect to deficiency balance sales or other items that drive that number. So I think it's -- again, that -- those things will happen periodically, and the underlying recovery is -- should hang in there. Used car prices will hang in there, I think. And so I think it will continue to hang in there. And Fahmi was making this point about delinquency rates and the connection to gross loss rates as delinquency rates continue to fall, eventually, you'd expect to see that flow through to our overall gross charge-off rate too. So...

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [27]

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Got it. No, understood that. It's helpful. And then just as a follow-up. It's interesting, Scott, regarding your comments about the mix in the service for other portfolio, notwithstanding the impressive SBNA volumes and how that program has performed. It's been a while since we've kind of heard much about whether there were kind of broader longer-term plans for growing that service for others portfolio? In to the -- in the sense, is there a pipeline being developed of other lenders that may be coming on to that platform? Or should we be viewing this pretty much as a proxy for SBNA volume?

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

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It's a great question, very timely, David, because it is an area where we are in the process of adding staff that can be focused on more service for others business outside of the SBNA program. The SBNA program, as you said, has been a very huge success for us for a whole bunch of reasons and a success for Santander Bank. And it's important, as Fahmi said, for our Chrysler relationship. But yes, we will be looking for -- we are in the process of building out the team and we will be looking for other opportunities in that space because we're really good at it. We're efficient, and we think there'll be opportunities in the future to do more of that.

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Operator [29]

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We'll go next to Arren Cyganovich at Citi.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [30]

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On the CECL side, have you thought about the potential for volatility and how that's going to change the provisioning each quarter? And whether you might consider some non-GAAP measures from consumer finance companies have highlighting some potential changes to how they might report going forward?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [31]

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Yes. On an ongoing basis kind of post day 1 implementation, the impacts will be really determined by -- or the volatility will really be determined by how fast or how slow we grow the portfolio as well as any shifts in our kind of macro view. And so that will dictate the volatility going forward. If the market -- if we're stable as we grow and the market is stable, we won't have as big of an impact. As far as any new metrics that we will consider really haven't gone that far in the process to be able to comment.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [32]

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Okay. You mentioned that there were some softening of auction trends in September, has that flowed through into October? Or is it kind of stable at that point?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [33]

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Yes. No, we've seen that recent trend in September, into the first part of October. As a reminder, it is kind of your -- we're heading into the fourth quarter, which is the -- we had some seasonal pressures really across the board. So it's really just one data point at this point in time. It's not a trend. And it's not enough data to call it a trend yet, but it's something that we're very mindful of, and we continue to watch.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [34]

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Okay. And then just lastly, the Bluestem portfolio, it seems like that's been in held-for-sale for a very long time now. Is there any update in terms of potential to sell that?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [35]

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Yes. No, no, real update. We're still exploring alternatives there to find a clean exit for the portfolio on our personal lending business. In the meantime, I will point that it is very profitable for us. In the third quarter, we're going to -- we had $38 million kind of pretax on the portfolio. As move forward, if we have an update, we'll make sure we give you that feedback.

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Operator [36]

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We'll go next to Rick Shane at JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [37]

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As we move into a CECL environment, the accounting distortion associated with TDRs actually starts to narrow. I am curious if strategically you will see an increase in TDR usage as that distortion starts to dissipate?

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

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No. Yes, I mean the quick answer is no just because those are -- those modifications are specific to consumers' particular payment challenges that they're having. And it's an important way of helping consumers that deserve the help to get back on track. And so we wouldn't view that kind of activity in the context of accounting optimization, if you will. Unless, there's just no questions.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [39]

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No. One of the reasons -- the reason, we asked question is obviously, historically, it was so punitive from your perspective to put accounts into restructuring. And I'm just -- what I'm trying to determine is if historically you were optimizing that and it gives you greater flexibility going forward?

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

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I mean yes, the answer is -- I get your question now, and the answer is still, look, we want to make sure we give every consumer the opportunity to restructure their loan that deserves it. And we have talked about in prior calls how we've changed what we're doing to make it better and more precise, and we're happy with how we're doing that for the consumer and also to make sure we're doing the right thing for the company. And so we're always tweaking it, but we can change it because of -- you're right. There is potential opportunity to do CECL, but that's -- we wouldn't think about it that way.

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Operator [41]

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We'll go next to Kevin Barker at Piper Jaffray.

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Kevin James Barker, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [42]

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So your guidance for the fourth quarter implies that operating expenses, after normalizing for the legal recovery last year, are going to grow at over 10% on a year-over-year basis. And I understand you're growing your portfolio (technical difficulty) volume growth. But could you help to give us a little bit more understanding of what's driving a lot of that OpEx growth beyond just normal growth in the company?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [43]

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Yes. And I will comment back on Q4 operating expenses for 2018 as well before I get to your specific question. If you're comparing fourth quarter to fourth quarter, remember last fourth quarter we did have a benefit to our legal reserve as we closed out some of the matters that were more beneficial than we had actually reserved for. So if you normalize for that, we are up year-over-year, really in line with our asset balance and our growth that we've seen in the portfolio. As Scott mentioned, we are very vigilant of expense management, expense control. If you looked at it on a unit basis, our unit cost to originate and service is down year-over-year. Just the dollar is up because of our asset balance is up.

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Kevin James Barker, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [44]

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Okay. And then to follow up on some of the comments around the recovery rates. You mentioned in previous calls that you're adjusting some of your servicing practices as well. Could you detail some of those changes that you may have implemented? And then how your recovery rates match up against some of your peers when you consider the mix of business that you're underwriting today?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [45]

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Yes, on the servicing practices, we talked about it over time around just the lower level of modifications. As we continue to determine whether the customer really has the ability and willingness to pay off the loan, we're making a decision whether to modify the loan or not. I wouldn't necessarily draw the connection to recovery rates necessarily because I think that's a kind of an industry trend that we're seeing with used car prices and demand that consumers have for used cars. So I think they're a little bit disconnected. There is some tied to whether we have new -- heavier new mix versus used mix and how fast we do charge-off the loans, but what you're seeing in our recovery rate is more driven by the used car market than it is our servicing practices.

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Operator [46]

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We'll go next to Betsy Graseck at Morgan Stanley.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [47]

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A couple of questions. There's been some chatter recently about the SDART securitization and some of the early default loans increasing. They're small still, but still up a little bit. And just wanted to get a sense as to what's going on there? And is the underwriting changing a bit? Or is it different from how you're underwriting for your own portfolio? Maybe give us some color on that.

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [48]

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Yes. Thanks, Betsy, for the question. So no, we're not changing our underwriting practices and we haven't for quite some time. So I would say despite what you have read, we do repurchase loans from our ABS platforms. The repurchases have been consistent over time and consistent with our transaction documents. It all goes back to what we've talked about with lower modifications, we do expect because of the lower modifications and earlier recognition of losses based on those servicing practices. So performance of our securitizations are in line with our expectation. They're very consistent with our overall portfolio. There was 1 or 2 transactions in 2018 that did experience some elevated repurchases. However, the more recent securitizations are really back in line with our historical averages and our repurchase rates.

I would also add, when you look at our securitizations that you have to keep in mind that we have 2 retail securitization platforms, a SDART and a DRIVE. DRIVE being our more deeper credit platform. So when you're comparing some of those repurchase rates, you can't really compare a 2018 DRIVE to a 2016 or 2017 SDART to make a conclusion on the underlying performance of our portfolio or the state of the consumer.

So as I said, the 2019 securitizations are performing on average just like we expect compared to historical averages. And as I mentioned earlier in the call, when we look at the 2019 monthly vintages and we look at some of those early performance indicators, as I said, they're flashing 5-year best. And so we're really thought-positive on what we're bringing in through the door currently. So we're not seeing some of the overall performance that you've read.

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

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Yes. And Betsy, thank you for asking the questions. Maybe I'll just add a few things to what Fahmi said because a number of people have already asked these questions. And you guys, everyone on this call kind of follows all these trends like we do because it's important to understand is the environment changing, is the asset quality changing. And to Fahmi's points, if you look broadly at the auto finance industry, we talked a lot about recoveries, we talked a lot about new car sales, used car prices.

I look at the Fed data. They publish data on industry delinquency rates, and they showed over a long period of time. We're nowhere near, if you look at the percentage of loans which are delinquent. We're nowhere near where we were at the peak of the last recession. The industry as a whole is performing well. We talked a lot about our own delinquency metrics year-over-year. We're seeing significant improvement quarter-on-quarter. We didn't get the seasonal increase that we expected.

We mentioned earlier that when we look at our vintage, early vintage delinquency metrics for originations this year, those suggest that credit performance would be improved versus 2018. So yes, and we feel pretty -- and then in addition to that, which we haven't talked about, we are always looking for ways to do a better job, identifying fraud at the point of originations. And we're doing a better job of that than we have in previous years and previous time periods.

So again, we think that trends are all positive in the right direction, stable performance. And yes, there were a couple of securitizations last year that if you focus just on those securitizations, you might come to a different conclusion. But we all do -- you got to look at kind of all the metrics and kind of what's happening with the industry. So hopefully that answers the question, but thank you for asking. It's a good question.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [50]

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Yes. Okay. Yes. Because you buy out if there's a nonpayment in the first or second, I think. And I guess I was just wondering your comment on fraud, does that -- is there anything that you're seeing in fraud that's driving maybe an early buyback as well? And maybe you could touch on just how you're underwriting the client today versus maybe last year? If last year was not a great -- if there was a couple of securitizations last year that wasn't great. Is there anything that you can point to that you tightened up? And just wondering how you're thinking about things like income verification and that kind of thing? Maybe you could give us some color there.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [51]

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Yes.

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [52]

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Yes. I was just going to say, part of it is the modification levels that we've discussed on the call previously. Some of that earlier recognition of losses. The 2018 vintage is reflective of those changes. So let's see, nothing material that I would point to as far as changes in our underwriting practices. They've been pretty consistent, if anything, we've probably tightened up over the last couple of years definitely compared to 2019. The repurchase rates are a handful of things that we would repurchase loans from securitizations. I think you touched on probably the most impactful version. If you look at SDART, we've consistently been around 3% or 4% and drive somewhere in the 5.5% to 6%. I can't point anything material that's really changed.

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Operator [53]

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We'll go next to Vincent Caintic at Stephens.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst [54]

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Two-part question on going back to credit. So very good delinquency trends this quarter. Sort of wondering if you could describe -- if you could maybe break down the components to what you're seeing there? Are you seeing -- is it your collections practices maybe that's driving a lot those delinquency improvements? Or is it really the consumer being strong? And then back to another question, the vehicle recoveries. When we think about going forward, is 55% a good run rate? And then when you -- you also mentioned, I think there was a some September weakness. Would you be able to share the recent recovery rates that you've been getting?

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [55]

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Fahmi, maybe you want to take the recovery one -- recovery rate one, and I'll do...

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [56]

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Yes. Sure. So I think the recovery rate, when you factor in kind of the deficiency sales does get a little lumpy quarter-to-quarter, depends on when we do those. We try to do one quarter, but it just kind of depends on kind of the amount of efficiencies that we have and market conditions on sales. So I wouldn't stick to the 55% as a good run rate. As far as the trend over September, as I mentioned, it is one data point. I also want to make sure that we say it is up year-over-year even in the month of September. And overall, it is at a historical high level. So we did see a little bit of softness. It is entering into the fourth quarter, which we do have some seasonal pressures on. But again it's just one data point, and I wouldn't call it a trend just yet.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [57]

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And to answer the first part of your question or your first question about improvement in delinquency and what's driving that? We are always looking for ways to make our collections more effective and efficient. We've got a whole series of initiatives that we're always working on to do that and we feel good about the progress we're making there. But I would say the improvement in credit quality you're seeing is a reflection of what we're doing with pricing and credit at the point of origination. That's a more significant -- that has more significant impact on the results you're seeing. But I don't want to leave out our collections team, I'll make sure I give them a shout out because they're always looking for ways to make the place better, and they've made progress over the last year or so in doing that too.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst [58]

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Okay. Great. Very helpful. And actually, relatedly, so on your prepared remarks, you also mentioned kind of how you think about the capital usage, whether you're looking at buybacks or investments. And I'm sort of interested to hear about what sort of investments you're thinking about, whether it's technology or collections or something else? And maybe if you could help us kind of size what you're thinking about investments? Is it just a couple of million here? Or are there something that might be interesting that are a little bit larger?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [59]

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Yes. I think we're always looking for opportunistic opportunities to deploy capital, whether it's -- we mentioned the SFO conversion that we had last year, whether it's upgrading some of our infrastructure or whether it's deploying capital to our shareholders. So nothing to announce or kind of give you guidance on, we're just going to be very thoughtful and opportunistic in our approach as we evaluate how to deploy our capital.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [60]

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And I would just add. I mean in terms of investing in the business, we're doing that today and we'll continue to do that if that will have a meaningful impact on our results. And mentioned earlier in the call, investing in the service for others business, we're doing that because we think there are opportunities there. Regarding, as Fahmi said, we're investing in our core infrastructure to make it run better and make it more effective when dealing with those type of consumers or dealers. So we have made investments in our originations process. We talked a lot about (inaudible) of funding, which is really for dealers. And we will continue to make those kind of investments as well as investments in how we serve our consumer customers, too.

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [61]

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And I'd just add on to that because of our capital base and where it's at, we have the ability to kind of evolve all of the above if you will. So we've talked about being opportunistic as portfolio acquisitions come to market. Haven't seen any to announce. But as those come up, we'll definitely take a look. And if we can make the right return, we'll look to execute.

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Operator [62]

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And next, we'll move to Chris Donat at Sandler O'Neill.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [63]

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Scott, I wanted to ask on the leases and on the origination side that did decrease year-on-year and quarter-on-quarter. And you mentioned at the beginning of the call that you wanted a question, so here we are.

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [64]

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Well, thank you for the question. Yes, leasing is down year-over-year. So leasing with Chrysler is down year-over-year. Our total originations in the third quarter with Chrysler are actually up. So there is -- we had a really strong third quarter last year on leasing. So we're comparing to a high base. But yes, I mean there's more of Chrysler leasing went to our competitors in the third quarter than in prior periods. We're always adjusting what we're doing and looking at how -- what that means for Chrysler and for ourselves. So yes, it was down in the quarter. But again, I tend to look at how we're doing with the overall relationship with FCA. And again, our total originations between loans and leases were up almost 10% year-over-year, which is good. The penetration rate was up, which is good. Our satisfaction with dealers, as measured by J.D. Power, was up, which is good. So that we're making good progress there.

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [65]

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And if I can add on. I think most people know that we -- our competition in lease is very limited compared to retail. So if one party becomes more aggressive, it actually impacts our share pretty greatly. In the quarter, we also saw, not just from the 2 national players, but we did see some credit unions become a little bit more aggressive in certain high-lease volume regions of the country and that also impacted the quarterly number.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [66]

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Okay. Got it. And then taking a bigger-picture view of the Chrysler relationship. So this morning, Fiat Chrysler confirmed they are in talks with Peugeot. I guess the question, I think you might be able to answer, is there anything in your amended agreement with FCA that anticipates some sort of change in control in Fiat price and what that would mean for Chrysler Capital? Or should we expect no change for the agreement through the 2024 expiration?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [67]

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Yes, I think that's like...

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Scott E. Powell, Santander Consumer USA Holdings Inc. - President, CEO & Director [68]

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I think that's a no comment from us. But look, this has been off and on prior periods. And we have a great relationship with them, and we worry about what we can control. And that's all the things we've been talking about with respect to improving our partnership and doing a better job with them and helping them sell more cars. So that's where we're focused. We'll just take care of what we can take care of. And if the world changes, then we'll deal with that.

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Operator [69]

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We'll move next to Rob Wildhack at Autonomous Research.

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Robert Henry Wildhack, Autonomous Research LLP - Analyst of Payments and Financial Technology [70]

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Touched on it a little, but I wanted to ask more conceptually about CECL and the ongoing impact. What impact do you think CECL is going to have on the way you're thinking about growth, given the higher level of upfront reserving?

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Fahmi Karam, Santander Consumer USA Holdings Inc. - CFO & Head of Pricing & Analytics [71]

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Yes. From -- the accounting treatment is not going to drive our strategy as far as our origination plans. I mentioned, I think, earlier in the call, that it doesn't change the underlying risk of the loans that we're booking. So we'll continue to be very thoughtful on how we feel about booking loans with the right risk-adjusted returns for our balance sheet. So I don't think CECL is going to impact how we underwrite or price our loans or impact our growth.

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Operator [72]

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And that does conclude the question-and-answer session. I will now turn the call over to Scott Powell for final comments.

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

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Great. Well, thank you all for joining the call. Thanks for your really good questions today. We appreciate that. As always, our Investor Relations team is here if you have follow-up questions, and we'll look forward to speaking to you again soon, probably after the fourth quarter is finalized. Thanks, everybody.

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Operator [74]

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And that does conclude today's conference. Again, thank you for your participation.