Santander Consumer USA Holdings Inc.
Q3 2019 Earnings Call Transcript

Published: 30 Oct 2019

[Operator:]

Good morning, and welcome to the Santander Consumer USA Holdings Third Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, all parties have been placed in the listen-only mode. Following today's presentation, the floor will be opened for your questions. [Operator Instructions]. It is now my pleasure to introduce your host, Evan Black, Vice President of Investor Relations. Evan, the floor is yours.

[Evan Black:]

Thank you, Audra. 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 are maybe 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.

[Scott Powell:]

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 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 most recent our Head of Pricing and Analytics. So he knows the business inside and out. He is absolutely right person for the job. It’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 [funding] process.Our non-FCA core business came in at $2.6 billion which is up 11%. Chrysler loans were at $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 JD Power results, which were recently released, Chrysler Capital increased nearly 5 percentage points versus the previous survey, which is 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 dealer 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 three 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 a 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 were up 100 basis points, just because of what you would expect seasonally. This year, we're basically flat to the second quarter. So I think that reflects kind of the inherent credit 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 sign as our TDR balances are down 27% year-over-year.We do remain very disciplined on expenses here. This year our expense ratio is up 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, we remain super focused on that, keeping track of all the trends. Used car prices continue to exceed people's expectations at the [end] of the year. New car sales are 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 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 Karam:]

Thanks Scott. And good morning, everyone. Turning to Slide 4 for some key economic indicators that influenced 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 for consumers remains robust.On Slide 5 there are a few key factors that influenced 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 non-metal 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, non-prime industry securitization data points a 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 segments, which is driven by Chrysler Capital exclusive offers and our SBNA flow program.Our 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 non-prime 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 find mutually beneficial ways to increase our volume and drive sales for FCA.Turning to Slide 8, the serviced for others platform generated $21 million in servicing fee income this quarter. In addition to those servicing fees, $13 million SBNA origination fees are in our fees, commissions and other line item. During the quarter we added $2.1 billion in origination 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 discounts.Continuing to Slide 10, versus the prior year quarter early stage delinquency 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 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 totalled $3.1 billion, decreasing $5 million from last quarter, which represents an allowance ratio 10.5% at the end of this quarter. In regards to the reserve walk, the allowance increased a $188 million due to new originations in the quarter, higher inflows into TDR migration which increased the reserve by $8 million and $3 million increase due to unfavourable 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 lower TDR inflows given the strength of the consumer and lower modification levels. As we mentioned in the past, the 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 totalled 2.3%, up from 2.1%, the prior quarter driven by a one-time expense in our legal reserve, excluding this expense, 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 continues 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 continue to diversify our funding through private financings and lender commitments which totalled $18.3 billion. Subsequent to quarter end we also closed $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 and 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 four 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 were 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 pattern.We expect total other income to be $65 million to $75 million driven by normal seasonality of the Bluestem held for sale portfolio. Operating expenses were higher than anticipated this quarter due to some one-time 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 the metrics we previously guided to are relatively in line with our ranges we've 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, a mid 8% net charge-off ratio for the full year, a stable expense ratio around 2.1%. And regarding the 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?

[Scott Powell:]

Thanks, Fahmi. Well, I'd like to come back to four 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 progress we've made because I think this quarter shows how those changes have had a sustainable impact on our results.Number two, and Fahmi mentioned it, as did I my opening remarks, we remain very disciplined on expenses with the positive operating leverage. Number three, we spend 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 has been the Head of Operations here at Santander Consumer. She has also taken a broader role in running Santander U.S. operations. It goes to the depth of the management team that she has 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 for questions. Operator, over to you.

[Operator:]

Thank you. We will now open the call for questions. [Operator Instructions]. We'll go first to Moshe Orenbuch at Credit Suisse.

[James Ulan:]

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

[Fahmi Karam:]

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.

[James Ulan:]

And just a quick follow up that's related. You've got CECL phasing in first -- fourth -- 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?

[Scott Powell:]

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 will be a function of our portfolio credit mix and trends that we're 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 one 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 is 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 the loans are not changed. So it's more of a timing thing than anything.

[Operator:]

We will go next to Jack Micenko at SIG.

[Jack Micenko:]

Looking at the NIM and thinking about some of the inputs there, historically -- probably you guys are somewhat liability sensitive, obviously rates have come down but you're also remixing the portfolio a little higher quality. Just thinking through where rates have gone maybe we get something this week, does the NIM begin to inflect 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?

[Scott Powell:]

Part of the NIM story is as you mentioned the mix of the portfolio. As lease is continuing to grow, as they’re 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 non-prime assets. The cost of debt has ticked down throughout the year, I believe we are about 20 basis points better than we were in Q1. We will be able to see some of that impact further as we reprice our credit facilities and we continue to do new securitization. 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 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.

[Jack Micenko:]

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 modification of the TDRs, I think you’ve moved to doing less TDRs which I would assume give you better recovery rate at auction because of the time frame, as you're compressed when you're taking the car back. Curious if you could parse out that 600 basis points, how much is just street pricing and how much is changed methodology?

[Scott Powell:]

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 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.

[Operator:]

We will move next to Mark DeVries at Barclays.

[Mark DeVries:]

Yes, thanks. 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 serviced for others portfolio, I think you indicated in the press release it’s mixed. Could you give us a little more sense of why that is and what kind of impact maybe that declining fee is having on the overall profitability of that business?

[Fahmi Karam:]

Yes, I think the serviced 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. I just want to remind you that as part of the fees and commissions line items, 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.

[Mark DeVries:]

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

[Fahmi Karam:]

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 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 four or five 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.

[Scott Powell:]

Yes. And 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 originationss this year has been really good from -- Fahmi was saying from a credit perspective based on early delinquency reads. And we also feel good about 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 and people there that we feel pretty positive about next year.

[Operator:]

We’ll go next to John Hecht with Jefferies.

[John Hecht:]

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

[Fahmi Karam:]

We're not going to comment on the legal reserve, but I will point you to our disclosure coming up in the 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 one-time extent off, our ratio is consistent with our guidance and the prior quarter.

[John Hecht:]

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 end markets that's driving the change or is that more based on focus on return on capital and where the best margins lie?

[Scott Powell:]

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 executing 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 -- support our FCA partnership and it helps us to 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.

[John Hecht:]

Okay, and then last question. Just in used car volumes, sustaining modest growth this year. Scott, you commented on this in the past year relative value. Where do we -- where do you think we are in that cycle? Where do you think there's a persistence in this constant growth coming into next year?

[Scott Powell:]

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 changing there, especially given the strong consumer and strong demand and relative value to new cars. You got to admit we're hanging in there pretty well despite all the people out there calling a significant downturn. New car sales are down a little bit, but still a very healthy level and used cars -- value for used cars as you see in the recovery rate and you can see the demand for used cars. So I think it will continue. Again, barring some change in the macroeconomic situation, it will continue. I don't think there is any reason to see a big change there.

[Operator:]

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

[David Scharf:]

Hi, good morning. Thanks for taking my questions. I wanted to just return to the recovery rate and sort of expectations going forward, because -- and obviously given gross charge-off trends you 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 non-auction recoveries? Just trying to get a sense for whether there are more purchases out there? Whether this quarter's recovery represented maybe a bit of an anomaly in terms of how much efficiency paper and otherwise you may have sold?

[Scott Powell:]

I think the answer is no. I mean it's -- we're consistently doing those kind of things if any change in strategy with respect to deficiency balanced 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. The 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 of the 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…

[David Scharf:]

Got it. I understood. That's helpful. And then just as a follow-up, it's interesting, Scott, regarding your comments about the mix in the serviced 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 -- or kind of broader longer-term plans for growing that serviced for others portfolio. In a sense, is there a pipeline being developed of other lenders that may be coming onto that platform or should we be viewing this pretty much as a proxy for SBNA volume?

[Scott Powell:]

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 serviced for others business outside of the SBNA program. The SBNA program, as you said, has been a huge success for us for a whole bunch of reasons and a success for the 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'll be looking for other opportunities in that space because we're really good at it. We're efficient, and we think there will be opportunities in the future to do more of that.

[Operator:]

We'll go next to Arren Cyganovich at Citi.

[Arren Cyganovich:]

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

[Fahmi Karam:]

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

[Arren Cyganovich:]

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

[Fahmi Karam:]

Yes. I know we've seen that recent trend in September and 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 have 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. It's not enough data to call it a trend yet, but it's something that we're very mindful of and we'll continue to watch.

[Arren Cyganovich:]

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

[Fahmi Karam:]

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

[Operator:]

We'll go next to Rick Shane of JP Morgan.

[Rick Shane:]

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?

[Scott Powell:]

Yes, I mean, the quick answer is no, just because 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.

[Rick Shane:]

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

[Scott Powell:]

Yea, I mean 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 and close 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 -- and to make sure we're doing the right thing for the company. And so we're always tweaking it, but we can change because of the -- you're right, there is a potential opportunity in CECL but that's -- we wouldn't think about it that way.

[Operator:]

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

[Kevin Barker:]

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. I understand you're growing your portfolio -- buying growth, but could you give us a little bit more understanding of what's driving a lot of that OpEx growth beyond just normal growth in the company?

[Fahmi Karam:]

Yes, I will comment on background 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 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 on our 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 a $1 is up because of our asset balance is up.

[Kevin Barker:]

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 you're recovery rates match up against some of your peers, when you consider the mix of business that you're underwriting today?

[Fahmi Karam:]

Yes, so on the servicing practices, we've 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 there is 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.

[Operator:]

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

[Betsy Graseck:]

Hey, good morning. Couple of questions. There has been some chatter recently about the SDART securitization and some of the early defaults 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, I mean if you can give us some color on that?

[Fahmi Karam:]

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 an earlier recognition of losses based on those servicing practices.So performance of our securitizations are in line with our expectation. They are very consistent with our overall portfolio. There was one or two 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 two retail securitization platforms, 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 2018 DRIVE to a 2016 or 2017 SDART and 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, there are flashing five year best. And so we're really positive on what we're bringing in through the door currently. So we're not seeing some of the overall ...

[Scott Powell:]

Yes, and Betsy thank you for asking the question. I will add a few things to what Fahmi said because a number of people have already asked these questions. You guys, who are on this call kind of follows all these trends like we do because it's important to understand, is the environment changing, is asset quality changing. And to Fahmi's point, 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 published 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, vintage delinquency metrics for originations this year, those suggest that credit performance will be improved versus 2018.So yes, I mean 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 period. So again, we think the 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.

[Betsy Graseck:]

Because you buyout if there is a non-payment 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 in early buyback as well and maybe if you could touch on just how you're underwriting the client today versus maybe last year, if last year was not a great year -- if there is 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 if you could give us some color there.

[Fahmi Karam:]

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 is earlier recognition of losses. The 2018 vintage is reflective of those changes. So there’s 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 the 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 to anything material that's really changed.

[Operator:]

We'll go next to Vincent Caintic of Stephens.

[Vincent Caintic:]

Two part question on going back to credit. So very good delinquency trends this quarter. Sort of wondering if you could describe -- if you can 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 of this delinquency improvements or is it really the consumer being strong? And then back to another question on 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 September weakness. Would you be able to share the recent recovery rates that you've been getting? Thanks.

[Scott Powell:]

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

[Fahmi Karam:]

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 deficiencies it has and market conditions on sale. 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. And 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.

[Scott Powell:]

And to answer the first part of your question or your first question about the improvements 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 see that and 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 will make sure I give them a shout out, because they are always looking for ways to make the place better and they've made progress over the last year or so in doing that too.

[Vincent Caintic:]

Okay, great, very helpful. And actually relatedly so on your prepared remarks, you also mentioned kind of how you think about capital usage, whether you're looking at buybacks or investments. And 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 some things that might be interesting that are a little bit larger?

[Fahmi Karam:]

Yes, I think we're always looking for 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 which we are going to be very thoughtful and opportunistic in our approach as we evaluate how to deploy our capital.

[Scott Powell:]

Yes. 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. That will have a meaningful impact on our results. And I mentioned earlier in the call, investing in the serviced for others business, we're doing that, because we think there are opportunities there. As Fahmi said, we're investing to support infrastructure to make it run better and make it more effective when dealing with consumers or dealers. So we have made investing in originations process. We talk a lot about funding which is really important dealers and we continue to make those kind of investments, as well as investments and how we serve our consumer customers too.

[Fahmi Karam:]

And I'll just add on to that because of our capital base and one of that, we have the ability to kind of give 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 execute.

[Operator:]

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

[Chris Donat:]

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 to question. So here we are.

[Scott Powell:]

Well, thank you for the question. Yes. Leasing is down year-over-year. 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 in leasing. So we're comparing to a high base. But yes, I mean there is -- more of Chrysler leasing went to our competitors in the third quarter and in prior periods. We're always adjusting what we're doing and looking at what that means for Chrysler and for ourselves. So yes, it was down in the quarter, but again, I tend to look at how are we 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. Penetration rate was up which is good. Our satisfaction with dealers as measured by JD Power was up which is good. So I think we're making good progress there.

[Fahmi Karam:]

And if I didn't add on. I think most people know that 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 two 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.

[Chris Donat:]

Okay, got it, thanks on that. 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, I think you might be able to answer. Is there anything in your amended agreement with FCA that anticipate some sort of change in control in Fiat Chrysler and what that would mean for Chrysler Capital or should we expect no change for the agreement through the 2024 expiration?

[Scott Powell:]

Yes, I think that's like -- I think that's a no comment from us. But look I mean this has been often in 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 just take care of what we can take care of and the world changes, then we'll deal with that.

[Operator:]

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

[Rob Wildhack:]

Touch on 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?

[Scott Powell:]

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 go 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.

[Operator:]

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

[Scott Powell:]

Great, 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.

[Operator:]

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