Santander Consumer USA Holdings Inc.
Q4 2020 Earnings Call Transcript

Published: 3 Feb 2021

[Operator:]

Good morning, and welcome to the Santander Consumer USA Holdings Fourth Quarter and Full Year 2020 Earnings Conference Call. At this time, all parties have been placed in listen-only mode. Following today’s presentation, the floor will be open for your questions. Today’s conference is being recorded. It is now my pleasure to introduce your host, Evan Black, Head of Investor Relations. Evan, the floor is yours.

[Evan Black:]

Thanks, Tracy. Good morning, everyone, and thanks for joining the call today. On the call, we have our CEO, Mahesh Aditya; and our CFO, Fahmi Karam.

[Mahesh Aditya:]

Thank you, Evan, and good morning, everyone. Thank you for joining us to review our fourth quarter and 2020 results. 2020 was a year that will stick with so many of us given the devastation caused by the pandemic and the national awakening to social injustice and systemic racism. We begin 2021 full of hope and confident that we, as citizens and our institutions, will come together to pull us out of this very unique and severe crisis, and we will emerge stronger and united as a country. I'm proud of the way our company and our employees adjusted and responded, to help each other and our communities, to serve our dealers and our customers, demonstrating resilience and a determination to do the right thing in this very challenging time. Thank you to our team at SC for your dedication, feedback and contribution to our efforts to help our customers through this crisis. We also launched several new programs this year to address inequality in the workplace and to contribute to our communities in a meaningful way. I will cover these in my closing remarks. Turning to slide 3, I'd like to discuss some of the highlights. We earned $521 million in net income for the fourth quarter of 2020. The fourth quarter capped off a strong year of financial results, it did in part by fiscal stimulus, but also a product of our efforts over the past couple of years to improve credit quality, enhance our risk and compliance framework and refine our pricing decisions through advanced analytics. Net income for full year of $911 million was $2.87 per diluted common share, down $83 million versus last year, primarily from an increase in provision expenses. Despite the headwinds of the past year, we were able to improve the quality of our bookings, both in terms of borrow of credit and deal structure, while maintaining strong volumes. Total auto originations of $31 billion were down only 2% versus 2019, which is a record volume year for the company. $5.4 billion was originated for Santander Bank, mostly in the form of Chrysler prime loans. Our FCA penetration rate was down versus the fourth quarter of 2019, but stable for the full year of 2020 when compared to 2019. Overall, we are extremely pleased with our results, demonstrating an ability to grow responsibly while navigating through the crisis.

[Fahmi Karam:]

Thanks, Mahesh, and good morning, everyone. Turning to slide four for some key economic indicators that influence our performance. Although, most economic indicators have recently improved, the U.S. economy continues to face pressure due to the ongoing pandemic. Unemployment has improved from peak levels, but remains elevated versus prior years. The quarter-over-quarter change in GDP growth has come off the spike seen last quarter, and is beginning to normalize.

[Mahesh Aditya:]

Thanks Fahmi. As I mentioned at the beginning of the call, we've made several strides to build a foundation for growth in the organization. I'm pleased to announce our newly appointed Chief Diversity Officer, Dr. Virnitia Hendricks. Virnitia will serve as our first senior executive in this role, leading SC's cultural change with a focus on comprehensive and results-driven outcomes. In her new role, she will oversee SC's office of Diversity, Equity and Inclusion, helping it build sustainable DE&I capabilities and an inclusive culture through well-established and proven method. She will also provide counsel approaching to SC's leaders and employees as they work to build inclusive teams and processes throughout the organization. We are also pleased to have announced earlier this week, our partnership with Operation HOPE, to offer HOPE inside an award-winning financial wellness program as a benefit to all SC employees. HOPE insight provides financial workshops and one-on-one personal coaching designed to educate and transform thinking when it comes to making decisions about money, building wealth and working towards financial independence As we explore what it means – truly means to be an inclusive company, we know that when people aren't able to save or invest or don't understand the final points of financial drivers like credit lending and interest rates, they have a harder time translating into their wealth. Our goal is to make sure all SC employees have access to financial literacy and the knowledge and tools needed to build generational wealth and a successful future. We expect – with respect to our business strategy, we continue to focus on positioning the company for long-term and sustainable success. Our dealer experience and our dealer relationships remain a strategic priority for us. We are very pleased with our competitive position with dealers as we continue to grow market share. We are dedicated to providing our dealers superior service. Part of that commitment is enhancing our processes and our internal and external facing technology to make our people more efficient and make it easier for our dealers and customers to interact with us. Customer sales experience will continue to become more virtual in the future, increasing the reliance on digital solutions. Leveraging our position in the sector, we are investing in innovative solutions to seamlessly integrate with dealers and customer experience. We plan to invest significantly in this area in 2021 and solidify our leadership position for the long term. I will end our remarks – I will end our prepared remarks, again, by thanking all our employees for step stepping up in 2020 and delivering these great results. With that, I'll open the call for questions. Tracy?

[Operator:]

Hello, we will now open the call for questions. Our first question comes from Mark DeVries at Barclays.

[Mark DeVries:]

Yes. Thank you. Can you just discuss – assuming the Fed lifts some of these interim restrictions on capital returns, how we should think about the cadence of that going forward, balancing both the eventual phase-in of the CECL impact and also kind of your hopes and expectations for growing the balance sheet?

[Fahmi Karam:]

Sure. I'll start with the first part, I guess, of the question. Mark, thanks for the question. On capital. So capital has been a really good story for us, something that we're really focused on. A lot of efforts to have a more efficient balance sheet, and that journey started back in 2028 – 2018, as we worked really hard to distribute that excess capital. So we're still in an excess capital position. I feel like we've been very thoughtful and disciplined in our approach up to this point. We have decided to lower our internal target from 12.5% to 11.5%, and we plan to kind of work our way down to that level over time. Lowering the target to 11.5%, we feel still gives us a room to operate and execute our strategic plan. It gives us the opportunity to grow as well as absorb any stress in the portfolio, allow us to phase in CECL starting next year and the flexibility to distribute capital when the time is right, and we're allowed to do so. So we think we've been good stewards of capital, and we have a track record, as I mentioned, since 2018 of doing that. We’ve returned $1 billion of capital in 2020. And when the time arise we have approved it to DSO, we'll sit down with our Board and make the best decision for the company and all of our shareholders.

[Mark DeVries:]

Okay. Well, just a related follow-up then. I think the CECL impact is roughly 360 basis points of CET1. Is it right to think that if we assume little balance sheet growth that that would kind of enable you to maybe have about 100% payout ratio and get you on a glide path to that new target. Is that the right way to think about it?

[Fahmi Karam:]

Yes, I think so. Obviously, we're accreting capital every quarter, and we accreted a lot of capital this year with the big buyback. And so we feel like we're in a really good capital position to absorb it over the next 4 years from a CECL standpoint. As I mentioned, execute on our plan and appropriately distribute capital in the form of dividends and share buybacks, but also be able to do anything on the strategic front, whether it's organic or inorganic opportunities.

[Mark DeVries:]

Okay. Great. Thank you.

[Operator:]

We will now take our next question from Moshe Orenbuch at Credit Suisse.

[Moshe Orenbuch:]

Great. The main question I wanted to ask was here, you saw either strong originations this quarter, but kind of in different sorts of things, leasing came back so well. I mean, I think you mentioned that continued into 2021. But subprime's been weaker and some other subprime players have been talking about both supply and pricing. Can you talk about how you think that manifests itself during the next several quarters over 2021?

[Fahmi Karam:]

Yes. You pointed out most of, which is you have to look at our originations by channel. And you have to look at it and separated between core, Chrysler nonprime, Chrysler prime and then lease, and they all have different trends to them. On the core side in general, and that's obviously our nonprime used channel. We feel really good about where we stand from both a market share position, credit quality position and a share position. And you've really been able to see that if you look at Page 7 of our earnings deck. Really since the onset of the pandemic, we've been able to increase it slightly year-over-year, and we expect that to continue into 2021. On the Chrysler side, I mentioned in our prepared remarks that it's really driven around incentives that they put into the market on a monthly basis. Earlier on in the year, they were very heavy on the APR, so went through the incentives. And those are usually exclusive to Chrysler Capital. As we got later in the year, some of those APR incentives of those APR incentives return into employee pricing programs and things like that, which are less exclusive to Chrysler Capital. And so there, we have to just be consistent with our platform and therefore, our dealers, but it's going to ebb and flow based on FCA's incentives. Lease, we've talked about over the last couple of quarters, very competitive. There's only 2 other national players that that do Chrysler leases in the country. And so that one is something that we have to defend our share and grow it. And we've been able to do that over the last couple of months and hopefully do it in the first quarter of 2021 as well.

[Mahesh Aditya:]

And we are coming off a general sort of lower percentage of total sales for Chrysler in terms of lease over the last 3 years. So the fact that lease has -- overall industry lease vol, the Chrysler has been deemphasizing lease, our market share has been increasing successfully over the last four months.

[Moshe Orenbuch:]

Got it. Thanks. And I meant to thank you for all the new information that's in here on a monthly basis. But as just a quick follow-up on the previous question on capital return. Could you talk a little bit about the potential for what you, kind of, alluded to at the end of your answer, both organic and inorganic end of your answer, both organic and inorganic opportunities? Are there things that you see out there, or just talk about last portion and maybe if you would think about how much of your capital base, you would be kind of allocating in that direction?

[Fahmi Karam:]

Yeah, Moshe, we don't have a certain allocation per se of it. I think we've been opportunistic on the inorganic side. And right now, nothing to announce there, but we'll be opportunistic and buying portfolios as they become available. I think the pandemic slowed some of that discussion down as people were not sure exactly how the recovery would shake out and really couldn't reach an agreement on how the loss forecasting would be. So I think that part of it has slowed down, but we'll be opportunistic going forward. On the organic side, you've seen some of that strategy play out in our volume, and I mentioned in our core channel, as well as our Chrysler channel, we spent a lot of time with FCA and with partnership with the bank to put in programs through the pandemic that really helped our dealer network as well as our customers. So not a specific percentage of allocation, we're going to be opportunistic on the inorganic side. And then the organic side, you've seen the benefit of some of the initiatives we've started, and then we still have some room to go.

[Moshe Orenbuch:]

Thanks very much.

[Operator:]

Our next question comes from Rick Shane at JPMorgan.

[Rick Shane:]

Hey, guys, thanks and good morning. Thank you for taking my questions, and good morning. I'm looking at the loan deferral migration, one of the things that jumps out to me is that it looks like about 30-plus-percent of the greater than 30 days delinquent that expired last quarter rolled to charge this quarter. Is that a good way to look at it, that about one-third of those loans are going to migrate to charge-offs going forward?

[Fahmi Karam:]

No. one-third of the portfolio, I don't know if that's the right way to look at it, Rick. Just from a standpoint, it's very unique, depending on the accounts, the level of extensions that we're giving and case by case. So I don't know if that's necessarily a good way of doing it. But generally, thinking on loan deferrals, we do think it's positive for the consumers to give them a relief at this time. The trends that we're seeing, and we mentioned that the inactivity in December was probably a combination of stimulus checks ending as well as the normal seasonal dip that we see in the fourth quarter. For us, it really depends on the stimulus. And we've seen a big jump in January just from the new checks that were going out in December and January. And so it's something that we, obviously, monitor very heavily. We feel like we're reserved for the level of extensions that we have currently, but hard to say that's a trend to see quarter-over-quarter and try to extrapolate that going forward.

[Rick Shane:]

Got it. And I'm specifically talking that last quarter, there were 84,000 units that were greater than 30 days delinquent in and the forbearance bucket, and the number of charge -- the cumulative -- the change in the cumulative charge-offs was 26,000. So that's where I'm getting that number. That's what I'm wondering about the roll on?

[Fahmi Karam:]

Yeah, I'm with you Rick. I see that, too. But again, I think it's just a matter of quarter-over-quarter, it's going to be case-by-case on kind of the activity going forward.

[Mahesh Aditya:]

Also, Rick, the point here is that, the deferred portfolio does flow the charge-off faster than the normal portfolio that's not being deferred. So if you -- so the broad math, good work that about a-third of those that were delinquent and did not pay would flow to charge-off. But that's only specific to the portfolio that’s under deferral.

[Rick Shane:]

Got it. Okay. That's interesting. So the days to charging off are a little bit shorter for that portfolio, once they roll through the 30-day bucket?

[Mahesh Aditya:]

Right. Because either they've run out of deferrals, because they've come up against the maximum in our policy, in which case, there is no option, but to pay the loan. And if they can't pay the loan, then they go to charge-off. So the defining constraints of this are -- we don't add infinitum and keep giving deferrals. We have a cap on the number of deferrals that -- number of months that we'll defer a loan. So if you come up against that, then there's no alternative, but to charge-off, or pay.

[Rick Shane:]

Got it. Okay. Thank you very much, guys.

[Operator:]

Our next question comes from John Hecht at Jefferies.

[John Hecht:]

Thanks very much, guys. Most of my questions have been asked. I guess a couple. One is, the lease portfolio, obviously, lease margins were pretty strong. You're getting some residual gains in the back end. Where is your depreciation curve set now? And how do we think about the expectations for the lease margins given that and that and your outlook for used car pricing?

[Fahmi Karam:]

Good morning, John. Thanks for the question. So, yes, lease has been pretty volatile from a lease yield standpoint, all year. If you remember, go back to Q2, we saw very limited maturity and very limited sales at auction, which really basically drove down and eliminated all of our gain on sales. So we saw a very low trough in Q2 and then we've seen a big spike up since then. So in Q3, we saw a lot of dispositions and record used car prices. In Q4, we had less dispositions, still elevated prices, but the big benefit was depreciation. And the way I think about the depreciation expense is the residual forecasts have improved throughout the year, the depreciation expense that you're seeing in the fourth quarter kind of makes up for the heavy depreciation expense in Q2. So for the year, we ended lease at about 5% overall net yield. That's about 50 basis points below where we ended in 2018 and 2019. So, going forward, we still expect to have elevated used car prices. I think the depreciation expense will be lower than normal, but will not be at the level we saw in Q4. The 6.8% or 6.9% yield, net yield, is something that do not think is sustainable. But, overall, for the year, I do think we'll be above the 5% net yield for the year.

[John Hecht:]

Okay. And separate question. I mean, can you just remind us the unsecured loan portfolio, I believe, has been -- whether it's formally or informally on the market for a few years, and then there's also a contract. I can't remember. I think it's maybe coming up is it this year or next year. Can you just give us the update on that, maybe talk about your strategic plans around that and what you might do if you do you decide to keep it, or do you decide to sell it with the capital?

[Fahmi Karam:]

So nothing to update here, John, as far as our activity on selling the portfolio. We're still -- its part of our plan to exit that business. And hopefully, we're able to do that. The contract does expire in April of 2022, and it does have a 12-month tail on it. That portfolio has been performing extremely well as you can see by the profit sharing increases we saw in both the fourth quarter and for the year. So, nothing to announce at this point, but we'll let the market know as soon as we do. And just residual question on that. Can you tell us how much capital you've got put in that portfolio, or any way to think about what kind of capital would be unlocked when you do are able to move on from that?

[Fahmi Karam:]

So, in the detail in the appendix in the presentation, I'll let you look through the details there and figure out. But it's about a $1.4 billion portfolio at the end of the year, and we haven't marked to fair value.

[John Hecht:]

Great. Appreciate that. Thank you very much.

[Operator:]

Our next question comes from Betsy Graseck at Morgan Stanley.

[Betsy Graseck:]

Hey, how are you? Good morning. It's Betsy Graseck.

[Mahesh Aditya:]

Hey Betsy.

[Betsy Graseck:]

Hi. I just wanted to dig in a little bit to how to think about NIM going forward. I know you highlighted the mix shift that's expected this year between the non-prime and the prime normalizing, but then I'm also wondering about how you're thinking about the cost of funds, in particular, is there room to bring I just wanted to dig in a little bit to how to think cost of funds, in particular, is there room to bring that down further from here? So, maybe you can give us some color on that.

[Fahmi Karam:]

Sure. So, NIM, from a dollar standpoint was obviously up year-over-year and quarter-over-quarter because of the balances are up -- the most high were up about 10%. And on the lease side, we're up about 6%. But I'm going to separate it again between loan and lease. So, on the loan side, given all of the prime that we retained on the balance sheet in 2020, we've talked a lot about the incentives in the market, exclusive to us, and we've seen in our prime volume. Now, look at the balance sheet, we had about $3 billion of prime loans on the balance sheet at year-end. And then typically, you run somewhere around $1 billion. So, we definitely had extra prime loans, and that's going to bring down our loan yield. Strategy there, Betsy, is to do what we did in January and try to optimize that balance sheet and periodically execute off-balance sheet securitization or do whole loan trades to sell off those prime assets. And if we're successful in doing that, then you'll see an uptick in our loan yields towards the end of the year. On the lease side, I just went through what think at least, I think it's obviously very sensitive to residual forecasting and used car prices. I feel good about both on the lease side. And then as far as cost of debt, we were 60 basis points better for the year, 80 basis points better for the quarter, and about 10 basis points better from the third quarter. And I do think that trend will continue as we re-price our securitization, and we re-priced our private deals. The low rate environment there is definitely a tailwind for us.

[Betsy Graseck:]

Okay. So, we should see some nice uptick in NIM from here, even if auto used car prices pulls back a little bit. I mean, I realize that's a bit -- that's the flex and it's hard to forecast, but ex-used car should definitely be higher?

[Fahmi Karam:]

Yes. That's the flex and as well as our ability to do off-balance sheet some of the time that we've retained over 2020. I think that's the big driver.

[Betsy Graseck:]

Okay. And now on deferrals because we're getting some questions in on that. I get that the request increased in December, you had the benefit of that stimulus in August running out, so that took basically like four months. At this stage, we have the checks hitting people's pockets for the recent slug of stimulus that was put out there. So can you give us a little more color on what you're seeing with regard to the payment rate, since the recent checks have hit people's pockets? And then give us a sense as to what you think the benefit will be from this $1.9 trillion that the government looks like, it's going to be passing in the next few weeks?

[Fahmi Karam:]

Yes. So, Betsy, I'll start and maybe Mahesh, you can add in. But definitely saw a change in the payment rates in January compared to December. December, obviously, it was a little bit better than in November. So I think part of it was the first round of stimulus ending kind of in late summer. We definitely saw people start asking for extensions again or deferrals again, but in January, it has slowed down, and the payment rates are back to where they were, call it, the August, September time frame. So it is very sensitive in our portfolio, and our consumer base is very sensitive to that stimulus, given the level of unemployment in the market. So we're still going to be there for our customers. We're talking to them and making the right decision for them and right decision for us, but we do expect to have elevated deferral levels, at least for the next couple of months or so. And if that $1.9 trillion does pass as proposed, that's obviously going to be a big influx of cash for them, it should just continue the improvement we've seen in payment rates.

[Mahesh Aditya:]

So we're seeing – as Fahmi said, there's almost instantaneous reaction between the passing of a stimulus package and the way our payment rates reacted. And with that comes a slowdown in requests for extension. So the extension request in January have perceptively slowed down. We've also seen, as Fahmi said, a spike in payment rates. But what we're going to increasingly see if this whole reallocation, the sort of payment hierarchy of both payment rates and payoff rates are going to continue to increase as the new stimulus package, if it's passed, if it goes through, then both payments, the sort of secular increase in payment rates and payoff rates will continue to increase into 2021, which could result in a couple of things. One is lower delinquencies and therefore, lower charge-offs, and we've also seen some stickiness in the way balances are holding across vintages. So vintage – given vintage – let’s say 2020 vintage at the end of the year has a higher balance as a percentage of what was originally originated versus what happened in 2019, because of what's happening over here in terms of the sort of reallocation – the availability of all liquidity. But the important thing here is going to be if this stimulus package gets passed. Then it's a sort of race against race to a sort of, call it, a finish line, which is what happens when normalcy returns. And it's going to be enough to take the economy through to a point where jobs start coming back and people start being able to pay at their own. The other important thing, countervailing force for us as sort of cross wind or headwind is once the moratoria expire on rents and mortgages, what’s going to happen with the payment hierarchy at that point? Does it allocate back towards paying down rents and mortgages that are due? So those are all the factors that we built in when we think about our payment

[Betsy Graseck:]

Do you have any visibility on that topic in your portfolio? For example, when people are calling in and asking for a delay, do you – are you able to collect the information at that point as to whether or not they're paying rent or mortgage?

[Fahmi Karam:]

So that's a great question. We've, so far, been very light touch as far as handling those calls are concerned because we understand there's a national sort of disaster, and we don't want to cross examine the customer too much, but there is some analysis that we've done at the back on how our portfolio distributes across industry categories. And about 1/3 of our portfolio is in what we call high-risk industries, which have had a significant job change or sort of shift in employment rate deterioration and employment pre-pandemic versus post. So we do understand that there's about 1/3 of our customers who are going through a job event sort of crisis, so to speak, and they are probably the ones who are – the biggest beneficiary with stimulus and eventually demonstrating this kind of payment behavior.

[Betsy Graseck:]

Okay. Thank you.

[Operator:]

Our last question comes from Steven Kwok at KBW.

[Steven Kwok:]

Hi good morning. Thanks for taking my question. I just had just one quick follow-up around the exemptions to the Feds structure or capital to plan. Was the assumption around just dividends, or did they include buybacks as well?

[Fahmi Karam:]

Steven, we're not going to comment on what was asked on the exceptional request. But as we said, we will announce it whenever we hear back, but hopefully, we get some good news, consistent with what we did in the third quarter of last year.

[Steven Kwok:]

Thanks. Got it. Thanks for taking the question.

[Operator:]

There are no further questions at this time. I will now turn the call over to Mahesh Aditya for final comments.

[Mahesh Aditya:]

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

[Operator:]

This concludes today's call. Thank you for your participation. You may now disconnect.