Q2 2023 Consumer Portfolio Services Inc Earnings Call

Participants

Charles E. Bradley; CEO & Chairman; Consumer Portfolio Services, Inc.

Denesh Bharwani; CFO & Executive VP of Accounting; Consumer Portfolio Services, Inc.

Michael T. Lavin; President, COO & Chief Legal Officer; Consumer Portfolio Services, Inc.

Presentation

Operator

Good day, everyone, and welcome to the Consumer Portfolio Services 2023 Second Quarter Operating Results Conference Call. Today's call is being recorded.
Before we begin, management has asked me to inform you that this conference call may contain forward-looking statements. Any statements made during this call that are not statements of historical facts may be deemed forward-looking statements. Statements regarding current or historical valuations are receivables, because dependent on estimated of future events are also forward-looking statements. All such forward-looking statements are subject to risks that could cause actual results to differ materially from those projected.
I refer you to the company's annual report filed March 15 for further clarification. The company assumes no obligation to update publicly any forward-looking statements, whether as a result of new information, further events or otherwise. With us here today is Mr. Charles Bradley, Chief Executive Officer; Mr. Danny Bharwani, Chief Financial Officer; and Mr. Mike Lavin, President and Chief Operating Officer of Consumer Portfolio Services.
I will now turn the call over to Mr. Bradley.

Charles E. Bradley

Thank you, and welcome, everyone, to the second quarter earnings call. It was another good quarter for us. We continue to move forward with what we consider should be a very strong year. Sort of the highlights, I guess, you have to sort of look back at what was happening in the last couple of years during the pandemic. The pandemic was sort of a really rare event in the 30 years plus we've been doing this. With all the influx of government money, it really changed the dynamics of everything. Everything performed great. People got somewhat aggressive, but it was a whole windfall across the industry. So 2022 became the first year where we got back to what we'll call pre-pandemic sort of the normal kind of business we should be doing.
And as such, because some of the people in the industry got aggressive and probably because of a few of the things that came out as a result of the pandemic government funding, '22 turned out to be a tougher year for just about everyone. So having said that, our '22 paper is doing quite well. It's not as great as we might have hoped, but it also is probably much stronger than most in the industry. So we're really pleased with how that's performing. It continues to be an ongoing struggle, but we're really making some progress in having that paper perform very well. '23 should be even better. And then going forward, we sort of have the new normal based on what happened after the pandemic. So again, it's kind of nice that we've got our hands around the performance. We're looking forward to improving. And again, '23, the rest of the year should be very good.
Probably more important is the securitization market, it's kind of the lifeblood of how we run our business. And again, during the pandemic, during '20 and '21, we had some of the lowest cost of funds possible and certainly in a long, long time. And then, of course, they started going up very quickly. And we were able to go along with that and raising our prices. And so today, where we sit as even though the cost of funds is much more, we are also charging more. And so we've actually been able to absorb the entire cost of funds was really not a lot of problem in terms of our market share and our market performance. And now with the last securitization, we've now had 3 securitizations in a row that actually have leveled out at what we'll call a flat or normal what -- again, we'll call the new normal cost of funds.
And again, we're not as concerned with what the cost of funds is. We just don't need it to keep going up. And now with 3 securitizations in a row at basically the same cost, we can say we probably reach that flattening we've been looking for. And some more importantly, even though the rates have continued to go up, not in the rapid rate they were, but even again last week, the spreads have tightened enough so we've been able to keep that cost of funds flat. That is very, very important. The other part of that, that's even just as important is our last securitization was massively oversubscribed, up and down all tranches since securitization market is clearly working really well and fits perfectly with what we're doing.
Again, that's sort of the backbone of how things work for us. So having that, again, prove itself out in the last couple of quarters has been very, very important. Overall economy, hard to judge, you can be -- there's a recession around the corner. Are they going to have a soft landing for the first time ever. That's always up for debate. Generally, we think the economy looks okay. But what we really, really care about is unemployment, which again we say all the time. Unemployment looks very good these days, continues to remain strong. It's probably one of the problems the government most would like to see go the other way. We don't. We think unemployment is perfect. Even if it goes up a little bit, not a problem as long as it doesn't go up a lot.
So again, as much as '23 has started off and not the most exciting year for us, it's still a very good year, and it is most important to get us back to a normalized run rate where we can again start looking to the future to grow and that's exactly where we're going to do. I'll have a few more comments, but for now, I'm going to turn it over to Danny to go over the financials.

Denesh Bharwani

Thank you, Brad. Let's go over -- start with revenues. Revenues for the quarter, $84.9 million, that's up 4% from the $82 million in the prior year June quarter. For the year-to-date period, $168 million, is up 7% from the $156.4 million for 2022. The fair value portfolio is not really the key driver of that revenue yield. It's yielding 11.4% overall. The legacy portfolio, which is accounted for under CECL, not only has about $50 million left. So it's really not really contributing anything meaningful to interest income. The other thing of note with the revenue change is the prior year had a fair value markup of $4.7 million in the second quarter of '22 and $7.1 million total fair value markups for the 6-month period. If you remove those markups, the revenue increase is actually 10% for the quarter and 13% for the year-to-date period.
Moving on to expenses, $66.3 million in the June quarter, is up slightly from the $64.7 million in March, and up 39% from the $47.8 million in June of 2022. The year-to-date expenses are $131 million for the current year, up 41% from $92.8 million in June -- in the year-to-date period of 2022. The main reason for that increase, as Brad alluded to, is the increase in interest expense, mainly from the securitization debt. Part of the increase is due to the larger debt balance by itself, but the main contributor is really the rise in the cost of funds.
The expenses for the year also includes an adjustment to loss provision, and this relates to the reserves we had posted on our legacy portfolio. That is the portfolio that's not accounted for under fair value, rather it's accounted for under CECL. All periods reflect an adjustment to this loss reserve to the legacy portfolio, was $9.7 million in the June quarter versus $8 million in the June quarter of last year. For the year-to-date period, that loss provision adjustment is $18.7 million, which compares to $17.4 million for the year-to-date period last year. And that, again, that works as a reduction to expense driven by a reduction to the reserves in the legacy portfolio.
Pretax earnings for the quarter, $18.6 million, is down 46% from $34.2 million in the second quarter of last year. For the year-to-date period, $37 million pretax earnings compared to $63.5 million in the year-to-date period for 2022. Again, mainly driven by the increase in interest rates causing the rise in expenses. The same trends follow for net income, $14 million for the second quarter this year, $25.3 million last year. For the 6-month period, this year, $27.8 million of net income versus $46.4 million or a 40% reduction compared to the 2 quarters of 2022.
Diluted earnings per share is $0.55 for the second quarter compared to $0.91 in the second quarter last year, $1.09 for the year-to-date period compared to $1.66 in the year-to-date period for 2022. I won't go over all the necessarily all the components of the balance sheet, but I'll point out a couple of things of note. The fair value receivables line, which is $2.6 billion is up 20% for the current June quarter compared to last year. Comparing that to the 15% increase in our securitization debt is showing that we're not -- our leverage is down because of the structures of our securitizations. We're simply not leveraging as much as we used to in the past. And our growth in the fair value receivables are outpacing the growth of the debt, which makes our balance sheet stronger.
Another item of note in the balance sheet is the shareholders' equity. June of this year, we posted our highest-ever shareholders' equity balance of $255 million. That's up 29% from the $198 million in the same point a year ago. And that's driven by the 47 consecutive quarters of pretax profit that we've been able to generate. We are 1 year shy of having 12 full years of pretax profits -- positive pretax profits that's contributing to our -- the strength of our balance sheet and the rise in our shareholders' equity.
Looking at some other metrics. The net interest margin is $49.2 million in the current quarter. That's down 2% from $50.3 million in the March quarter, but it's down 22% from the $63.3 million last year. The compression in the net interest margin is partly driven by the rise in interest rates compared to the slower rise in the yield on our fair value portfolio. So the yield in the fair value portfolio will take a little bit longer to manifest and catch up to the rise in the interest rates. And that for the moment, that's causing compression in the net interest margins.
Our core operating expenses of $40.3 million in the quarter. That's down 1% from 40.9% in the March quarter, and it's up 9% from $37 million in the second quarter of last year. Measured against the managed portfolio, that core operating expense is now 5.5% compared to 5.7% in the prior quarter, and down from 6% last year. So we're beginning to see the growth in the portfolio and our diligence in keeping our expenses flat, we're starting to see some improvement in the operating leverage metric.
And finally, return on managed assets is 2.6%, the same as 2.6% in the March quarter, down from the 5.5% in the second quarter of last year. For the year-to-date period, the return on managed assets was also 2.6%, also down from 5.4% last year, primarily due to the NIM compression that we discussed earlier. I will turn the call over to Mike.

Michael T. Lavin

Thanks, Danny. In originations, the second quarter remained solid as we purchased $318 million of new contracts. That compares to $415 million in Q1 and a whopping $548 million during the second quarter of 2022. Now that reduction in volume was purposeful as we scaled back due to certain macroeconomic headwinds. We continue to operate with a tighter credit box, and we kept a keen eye on the affordability of our product for our consumers.
In terms of affordability, we continue to hold firm on our payment-to-income and debt-to-income ratios. The PTI trended down for the quarter, which is good, and the DTI remained flat, which considering inflation in the raising rates is good for our customers. One key metric we're tracking right now is the average monthly payment, which for Q2 was $530. That remained relatively flat over Q1. And that payment actually is well below the industry average in our space and is a good indicator that our credit box is maintaining affordability for our customers.
As I reported last quarter, the demand for our product remains strong. We are getting roughly 8,000 applications a day, which is slightly less than Q1, but that's expected due to seasonality, tax season in Q1, et cetera. Our approval rate ticked up a bit in Q2, which is good, moving from 59% to 62%. The average amount financed for the quarter was $20,800, which is down about $1,000 quarter-over-quarter and down $2,500 in Q2 of 2022. And of course, that is directly related to the cost of used cars.
Most important, we continue to hold a strong APR in Q2, where we registered an average APR of 21.46%, which is about 1 point higher quarter-over-quarter and significantly higher than the average APR in Q2 of 2022, which was 16.33%. So the important thing to know about our march towards a higher APR is that we did that despite tightening our credit box in early February of 2022 and continuing to tighten into 2023.
In terms of competition, we saw more banks, sort of smaller banks and regional competitors completely pull out of the space. And we've seen in the last quarter, some of our friendly competitors cutting back on their originations. That sort of correlates into our continued strong demand.
There remains a tremendous upside for us in the market to grow as we currently have 14,800 dealers that could send us an application. And of that, 8,385 dealers that do send us an application. And of that, roughly 4,400 dealers funded a contract with us on a circular basis in the second quarter of this year. To that end, we continue to look to deploy sales reps to territories with sufficient population and historically good portfolio performance.
Moving to portfolio performance. There's certainly is some macroeconomic issues that are weighing in on some of our more recent vintages as Brad acknowledged. Inflation and raising interest rates are headwinds that remain in the market that were there in the beginning of the year, in the last half of last year. But as also Brad mentioned, that's balanced out with a fantastic unemployment rate, which is definitely more of an important metric for us.
So in the quarter, our DQ, including repossession inventory ended up at 11.72% of the total portfolio as compared to 9.71% in the same quarter in 2022. Our annualized net charge-offs for the quarter were 6.29% of the portfolio as compared to 3.51% in the same quarter in 2022. Extensions and repossessions were up slightly in the quarter. Good news on the recovery front, which, of course, helps offset losses as recoveries climbed to 44.19% in the quarter, which continued the trend of rising recovery rates.
That, of course, is well below the COVID-related historical recovery rates, but they dipped from this -- in the 60 percentile down into the 30 percentile, and now they're, again, rising from about 41% where they were at the beginning of the year to now in the mid-40s. So that's a good trend. So in the quarter, we continue to employ several unique strategic changes to improve our performance. One good trend for us is we were successful in hiring a good amount of collectors in what otherwise is a tough labor market. That will allow us to lower our accounts per collector and when we do that, that tends to improve performance.
We also continue to leverage our nearshore collection program with great success. A couple of miscellaneous items is our nearly 5-year journey to sunset our legacy technology to employ best practices technology stack is nearly complete. The bonds of our system are set, but we continue to add more artificial intelligence-driven technologies, mostly from third-party vendors on the margins to make our business more efficient for our dealers and our customers. For example, in the quarter, we launched an AI-driven technology and originations that is designed to cut down on processing time, which we think will allow us to fund faster for the dealers, which is really what they care about. Some ancillary benefits of that is it will continue to help lower our operation expense in originations. In servicing, we are nearly complete with the pilot of an artificial intelligence-driven bot that streamlines the collectors' workflows that is allowing us to employ more efficient collection strategies like more calls per hour, more contacts per hour to be employed, which we think will improve performance. And like the originations AI product should help our operating expense percentage in servicing. So with that, I'll kick it back to Brad.

Charles E. Bradley

Thank you, Mike. So I think you can tell overall, as much as we like exciting years, '23 has been slightly kind of rebuilding year. So we set ourselves up for the future. Again, we had all the benefits of the pandemic in '20 and '21, '22 was sort of the let's figure out what the normal is going to be. And then '23 is make sure that you've got your hands around '22 and you move forward in '23. So at this point, we're halfway through the year, obviously, a little bit more than halfway through the year, and we think we're exactly where we want to be in that sense. And so now we're back to the mode, let's grow, let's get bigger. Let's do all things we can.
Again, important things in that is we know that the financial markets are healthy. We know that our cost of funds should be relatively flat and potentially down depending on which side of the recession soft landing you take. So again, knowing those things in terms of our performance, in terms of our cost of funds, in terms of the economy, those are the things we've been sort of waiting on. And at this point, we probably feel like we have arms around that, and we can move forward. So over the rest of this year and into next, let's get going again and see how much we can grow and build out our portfolio. With that, I think that's all we have for today, and we look forward to speaking to you in the next quarter. Thank you all for attending.

Operator

This concludes today's teleconference. A replay will be available beginning 2 hours from now for 12 months via the company's website at www.consumerportfolio.com. Please disconnect your lines at this time, and have a wonderful day.