Q3 2023 Consumer Portfolio Services Inc Earnings Call

Participants

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

Denesh Bharwani; CFO and Executive VP of Accounting & Finance; 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 Third 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 valuation of receivables because dependent on estimates of future events also are 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 on March 13 for further clarification. The company assumes no obligation to update publicly any forward-looking statements whether as a result of new information for the events or otherwise.
With us here 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 CPS third quarter conference call. In terms of opening comments, I think what we used to say a few quarters ago was, generally speaking, that our industry was returning to the pre-pandemic levels in terms of loss expectations and performance.
And since then, obviously, in the last few quarters, we've had a lot of things happen to make that return more bumpy. Things like has become a huge focus on the portfolio performance from the '21, '22 vintages. Also interest rates, obviously, much higher. Therefore, cost of funds is much higher. So -- and then just a consumer position in terms of inflation, lots of little things that all together make it a difficult time.
The good news is, even having said that, we turned in another strong quarter, and we're at a size now and we've been through all these problems before in numerous different iterations, and CPS is in a very good position to weather any potential storm. And it really looks like given our situation in the industry with other competitors that we're probably in a much better position today than lots of other people than we would have been in other previous scenarios.
The size of our portfolio, the size of the company, the experience we have and the credit controls we have in place, have put us in a good position today. And I would think, going forward, we can prove that even better. And I'll touch on that a little more after we go through the financials and the operations update.
And so with that, I'll turn it over to Danny.

Denesh Bharwani

Thanks, Brad. Going over the financials. We'll start with revenues. Revenue for the quarter, $92.1 million is 8% higher than the $84.9 million in our second quarter of this year and 2% higher than the $90.3 million in the third quarter of last year. For the 9-month period ending September 30, revenues were $260 million, which is 5% higher than the $246.7 million in the third -- the 3 quarters of 2022.
Of note here, our fair value portfolio is now $2.7 billion, continuing to grow. If you've been listening to these calls in the past, you will know that the yield on the fair value portfolio is risk-adjusted and it's after losses, and that portfolio is yielding 11.3% in the current period.
Also included in revenues for this quarter is a fair value mark. It's a markup in Q3 of $6 million. That compares to a markup of $8.1 million in Q3 of 2022. For the year-to-date period, that markup is $15.2 million in 2022 and $6 million in -- for the 3 quarters of 2023. The markup is a result of better-than-expected performance in our fair value portfolio, mainly the older vintages that have outperformed our initial expectation. And we recognize the benefits we received from our collections and losses from those portfolios, and that's resulting in the markup that you're seeing. That's included in revenues for all the 4 periods we're comparing.
Moving on to expenses. It's $77.9 million in the current quarter compared to $66.3 million in the second quarter of '23. That's a 17% increase in expenses. That is compared to $56 million in the third quarter of last year, which is a 39% increase. For the year-to-date period, expenses are $208.8 million for the 9 months ending 2023 compared to $148.8 million last year, which is a 40% increase.
Two things of note in terms of expenses, all -- again, all 4 periods that we're comparing here include an adjustment to our legacy portfolio, and that's the portfolio that's not accounted for under fair value. These are accounted for using CECL, and we posted a lifetime loss reserve on these loans. And over time, we've realized that the performance has come in better than expected, and we were able to reverse the loss provisions we took for this portfolio.
The reversing of loss provisions helped to reduce expenses by $2 million in the third quarter compared to $6 million in the third quarter of last year. For the 9 months, that reversal of loss provision is $20.7 million compared to $23.4 million in the 3 quarters of 2022.
The other driver of the additional expenses is interest expense, that interest expense is $37.9 million in the current quarter, $106 million for the year-to-date period, and that compares to $23.5 million in the third quarter of last year and 57 -- $58.7 million last year.
For the most part, that increase in interest expense is attributable to higher interest costs. The portfolio size is also greater. So that's partly contributing to increased costs. But the real driver of that is obviously the increase in rates that we've seen. In fact, to further quantify the increase in interest expense, it's up 61% quarter-over-quarter and 81% year-over-year.
Looking at pretax earnings. It's $14.2 million in the current quarter, $34.3 million in the quarter last year. For the 9-month period, $51.3 million this year versus $97.9 million last year. That's a 48% decrease. We're seeing the same trends in net income and earnings per share.
Net income was $10.4 million in the current quarter, $25.4 million last year. That's a 59% decrease. For the 9-month period, $38.2 million versus $71.8 million last year. So net income is down 47%, similar to the rate of decline in pretax earnings. And again, obviously, diluted earnings per share will reflect and manifest those same trends, $0.41 per diluted share this quarter compared to $0.95 last year, $1.51 for the 3 quarters ending September 30 this year versus $2.61 last year.
Moving on to the balance sheet. Our fair value portfolio grew by 2% over the June quarter and 14% year-over-year, driven by healthy origination levels throughout the year. Our securitization debt is up only 1% sequentially and 9% year-over-year. So this shows an area of strength on our balance sheet, where we're able to maintain our liquidity despite lower leverage on our loan portfolio.
Another area of strength is our shareholders' equity. The $265.9 million we posted at 9/30 this year, is an all-time high for the company. driven by 48 consecutive quarters of pretax profitability. So we've shown our durability that over the last 12 years, we've been able to post quarterly profits throughout the entire period.
Looking at some other metrics. Our net interest margin is $54.2 million in the current quarter versus $66.8 million in the third quarter last year. That's a decrease of 19%. For the year-to-date period, $153.7 million this year versus $188 million last year. That's a decrease of 18%.
Core operating expenses of $42 million in the current quarter, $38.5 million last year, $123.1 million for the 9-month period this year versus $113.6 million last year, that's an increase of 8%. And measured against the managed portfolio, core operating expenses are 5.7% this year, this quarter versus 5.8% in the third quarter of last year. 5.7% also for the year-to-date period this year versus 6.1% for the 9 months in 2022.
And lastly, our return on managed assets, 1.9% this quarter 5.2% last year, on an annualized basis, 2.4% in 2023 and 5.3% for the 9 months in 2022.
I will turn over the call to Mike to go over some of the operational aspects.

Michael T. Lavin

All right. Thanks, Danny. In originations, the third quarter remains solid as we purchased $322 million of new contracts. That compares to $318 million in new contracts in Q2 and that compares to $468 million of new contracts during the third quarter of 2022.
The slight uptick quarter-over-quarter in originations reflects the strong demand in our space. The reduction in volume year-over-year was certainly purposeful as we scaled back due to certain macroeconomic headwinds that Brad discussed, and we continue to operate with a tighter credit box and kept a keen eye on affordability of our product for our customers.
In terms of the ever important affordability factor in our space, we continue to hold firm on our payment to income and debt-to-income ratios. Equally important, our monthly payment remained relatively low for our space at $531. That compares to the upper 500s for a used car price that's irrespective of a subprime customer or a near prime customer. And that compares to a car payment in the upper 700s for a new car. So our payment target remains quite low for our space.
As I mentioned, demand remained strong in the third quarter. We are getting roughly 8,000 applications a day, which is roughly the same as we receive in 2022 when we originated a 31-year company record of $1.85 billion.
Our approval rate ticked down to 51%, which is significantly down from 2022 Q3 of 70%. Again, that's not a cause for concern as that drop was purposeful as we significantly tightened our credit box at the end of 2022 and really dug in at the beginning of 2023 on that credit tightening.
Specifically, we tightened our LTV, we cap payments in certain program segments. We've tightened job stability and residency requirements, and we definitely made less exceptions. Again, this has lowered our approval percentage, but most significantly and especially more importantly, it's lowered our LTVs, which is a leading indicator of losses.
Our average amount financed for the quarter was $20,100, which is down about $900 quarter-over-quarter and down a whopping $3,000 in Q3 of 2022. This drop is likely the result of a major pullback in back-end products that we offer, specifically warranty and GAAP. So we've allowed less of those back-end products to be financed, which has lowered the LTV caps, which has lowered the amount financed. And this has also contributed to our monthly payment remaining relatively low compared to our peers.
We continue to hold a strong APR in Q3, registering an average APR of 21%, which is about 0.5 point lower quarter-over-quarter and significantly higher than the average APR in Q3 of 2022 of 18%. Again, it's important to recognize that this APR was achieved despite materially tightening our credit box in late '22 and early 2023.
In terms of competition, we continue to see ways to credit unions come in and come out of the space with lower rates. And then they basically pull out of the space when they realize the losses don't meet their expectations. But like I said, demand remains strong. So there's more than enough business for the 5 or 6 market makers in the space, including us.
In terms of growth, there remains a tremendous opportunity as there are no new entrants into the market. Regional players are continuing to pull out and credit unions continually learn month-over-month that this is probably not their best target market. We are holding firm at $100 million a month until we see the fruits of our credit tightening and our portfolio performance. But nonetheless, we are planning to grow when the time requires it.
Moving on to portfolio performance. Certainly, there's macroeconomic headwinds that are weighing on some of our more recent vintages, particularly the 2022s and early 2023 vintages. Inflation and raising interest rates are the headwinds that make affordability and issue for our customers. That's -- but we must consider that that's balanced out with the fact that there's been no recession yet. Most talking heads believe that there's not going to be a recession. And if there is one, it's going to be very soft in short. And equally, if not more important, the unemployment rate still hovers in the mid-3s, which is well below the target 5s, which is one of the key economic metrics that we monitor for the success of our business. So we're looking good there.
For the quarter, DQ delinquencies, including repossession inventory, ended at 13.31% of the total portfolio as compared to 10.85% in the same quarter in 2022. Annualized net charge-offs for the quarter were 6.86% of the portfolio as compared to 4.93% in the same quarter of 2022. Extensions were up slightly, but still at average over the course of the last 5 years. and repossessions were actually down quarter-over-quarter.
On the recovery front, we -- which helps offset our losses, we're happy to report that recoveries are stabilizing in the low 40s, which is up from the low 30s, which we experienced earlier this year. That's something that we don't control that we're seeing is coming our way to help our performance going forward.
So -- well, our portfolio performance has picked up overall in Q3, we are taking so less and the fact that at least from what we've heard in the market from investors, from bankers that we are outperforming our competitors in the space.
In the quarter, we also continued to employ several unique strategic changes to improve performance, especially on collection tactics. We were successful in hiring 96 new collectors over the last 10 months to lower our accounts per collector by over 100. This allows more in-depth collection tactics such as skip tracing and talk offs, and we believe that this is improving our performance the last couple of months and going forward.
We also built out or built up our near shore collection program to focus on potential EQ accounts. reduce the roll rate and increase the use of our power dialers. So it's all hands on deck on servicing to collect the 2022 and early 2023 vintages.
One last thing. In the quarter, we launched our Gen 8 originations model. This model is a complete refresh of our Gen 7 model, been launched in 2021. We try to refresh these models every 18 to 24 months. So we hit our target on implementing the Gen 8 model. This model utilizes machine learning AI, our most recent originations to better score applicants. It's infused with updated alternative data and importantly, some new fraud scores to reduce fraud. But we believe that this is our best buy box yet. And we also believe that should improve performance going forward.
So with that, I'll kick it back to Brad.

Charles E. Bradley

Thanks, Mike. So that's a lot of information in terms of what the company has been doing. In terms of where we sit in the industry as both guys pointed out, it's been so much turbulent times. Everyone got quite aggressive after the -- during the pandemic with all the money flowing to the customers and people grew a lot and we're aggressive. We're now all as an industry, beginning to pay the price for that because the '22 performance has not been as good as anybody expected.
Again, as the guys pointed out, our performance has actually been way better than -- better than some and way better than most. So we're kind of happy with where we sit. It kind of means our control is really hung in there. However, what that does leave us sitting in, in a position where we're not really ready to go full bore again, where we would like to start growing again.
But we need to do 2 things. We need to let the '22 vintage get through the pipeline, which it's doing. We were -- initially, we're a little worried about the '21 vintage, but that's all the net fine. '22, we would expect to track the same way. It's going to be higher losses than we expected, but not nearly as bad as some. And again, certainly a lot better than a bunch of others. And so in terms of that, we're good.
The next thing we need is we need the '23 vintage, which is still quite young to show that the improvements and changes we made in late '22 and early '23, are, in fact, the proper moves and will hold. Now against all that, inflation is hurting our customers' performance, higher interest rates is cutting our margins. So there's a bunch of things recovery rates are returning to normal. There's a bunch of little items that again are making it, life somewhat difficult.
And given what we've done, I think we're in a very strong position to get through it. No problem. We've been doing this forever. This isn't easily the worst thing at all we've ever seen or had to get through. So we're confident where we go.
And again, I think just really getting to the next few months, the first half of '24 will be very strong. It's usually one of the strongest performance months. So that should hopefully take care of the problems in '22 and put that behind us and then we can look to grow again in '23.
It would also appear hopefully that interest rates will at least stay flat, potentially come down. Also that inflation will continue to ease. And so we're very optimistic about the future in terms of what we've done.
Again, us and everyone else has to sort of slug through the problems of '22 and get through '23. But '24 should be a very positive position for both the industry and our company in particular. So we'll see how that goes. Again, we're big enough. We've done it before. We're not particularly worried, and we're actually quite pleased with how well we've done and compared to lots of other folks, which is one of the first times, we can clearly identify that our program has worked very, very well.
With that, we'll just thank you all for being here, and we'll speak to you next quarter. Thanks for tuning in, and see you then.

Operator

Thank you. And 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.