Santander Consumer USA Holdings Inc.
Q1 2017 Earnings Call Transcript

Published: 26 Apr 2017

[Operator:]

Good morning and welcome to the Santander Consumer USA Holdings’ First Quarter 2017 Earnings Conference Call. [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:]

Good morning and thank you for joining the call. On the call today we have Jason Kulas, President and Chief Executive Officer, and Izzy Dawood, Chief Financial Officer. Before we begin, and as you’re aware, certain statements made today, such as projections for SC’s future performance, are forward-looking statements. Actual results could be materially different from those projected. SC has no obligation to update the information presented on the call. For further information concerning factors that could cause these results to differ, please refer to our public SEC filings. Also on today’s call, our speakers may reference certain non-GAAP financial measures that we believe will provide useful information for investors. A reconciliation of those measures to U.S. GAAP is included in the earnings release issued today April 26, 2017. For those of you listening to the webcast, there are a few user controlled slides to review, as well as a full investor presentation on the website. Now I’ll turn the call over to Jason Kulas. Jason?

[Jason Kulas:]

Thank you, and good morning, everyone. Today I’ll discuss our first quarter highlights and provide an update on our key strategic priorities. I’ll then turn the discussion over to Izzy for a detailed review of the quarter’s results, and then open the call for questions. Turning to Slide 3 to share some of the key highlights from the first quarter of 2017. We are pleased to report solid results for the first quarter of 2017. Our assets are producing solid risk adjusted cash flows. Our capital base is solid and our focus on keeping our business simple, personal and fair, is positioning us for continued success. During the quarter SC earns net income of $143 million, or $0.40 per diluted common share. Net income was impacted by a few unique items this quarter, including accrued interest related to TDR allowance, write-downs on loans and bankruptcy and expenses. Izzy will discuss these items during his more detailed commentary on Q1 performance. Return on average assets for the quarter was 1.5%. Auto originations, including loan and lease, totaled $5.4 billion this quarter, down from the prior year quarter, due to our disciplined underwriting standards and a competitive market. During the first quarter, we executed an agreement to flow prime retail loans to Banco Santander. We expect this strategy to further strengthen our relationship with FCA and positively influence Chrysler Capital by providing a stable framework for originations. Our track record of rating agency upgrades continued, demonstrating the strength of our ABS platforms. In total, 49 ABS tranches were upgraded this quarter, positively impacting more than $4 billion in securities. Turning to Page 4, here are some key economic indicators that influence our originations and credit performance. U.S. auto sales remained elevated that are ticking down versus recent highs, and consumer confidence remains high. U.S. GDP growth is in line with the recent historical range, and employment levels continue to be very low. These metrics are strong indicators of the health of the economy and the U.S. consumer. On Page 5, there are a few key factors that can influence our loss severity and credit performance. As expected our auction-only recovery rates are trending down and in line with the NADA trends. However, auction-plus recovery rates which include insurance proceeds and bankruptcy and deficiency sales, are only slightly down versus the first quarter of 2016. We continue to model lower recovery assumptions than current experience, and believe we are adequately reserves. Additionally, nonprime industry securitization data, including delinquency and loss, show these trends are relatively stable to moderately higher. In either case, SC, auto ABS remain structurally sound. Turning to Page 7. In March, we executed an inaugural transaction for approximately $700 million prime retail loans with Banco Santander. We expect this strategy to support Chrysler Capital by providing a more stable framework for Chrysler Capital originations. This will in turn also be supportive to our serviced for other strategies through more prime asset sales. The two-year agreement will also provide SC with $750 million in additional capacity to fund originations between transactions. This warehouse agreement closed in April, bringing our related party funding commitment to approximately $7.7 billion up from $7 billion as of March 31, 2017. Turning to Page 8. Auto originations during the quarter totaled $5.4 billion, down 21% from the prior year quarter. Originations with FICO scores below 640 in our core and Chrysler Capital channels, decreased 60% and 33% respectively, versus the prior year quarter. Core originations increased 9% quarter-over-quarter and Chrysler Capital loans above 640 decreased 42%, and leases were flat versus the prior year quarter. Regarding to our direct-to-consumer platform, volume through our RoadLoans channel totaled $53 million this quarter, up slightly versus the prior year quarter. This online portal has been added to application volume and we expect RoadLoans to be incremental to our originations as the market evolves. We are committed to booking loans with attractive risk adjusted returns that will perform through cycles and create shareholder value. And our efforts to find pockets of value, we saw a moderate increase in nonprime originations in both our core and Chrysler channels quarter-over-quarter, which just continued into April. Turning to Slide 9 and further drilling down into our originations mix. In the first quarter the mix of our originations was relatively constant on a percentage basis. Loans with FICO scores below 640 decreased approximately $840 million to $2.7 billion from $3.5 billion during the prior year quarter. In addition, the average loan balance has decreased due to a larger percentage of used vehicles and lower to loan to values reflecting credit discipline. Now moving to Slide 10. The Chrysler Capital penetration rate as of March 31 was 19%, up from 17% in December. We remain the largest finance provider for FCA. Chrysler Capital is a focal point of our strategy, and we continuously seek out ways to enhance and grow our relationship with FCA. We remain focused on three key strategies, including first, we’ve increased the number of Chrysler Capital dealers in our VIP program and we’re still on track to roll this program out to all FCA dealers in 2017, and this improves our ability to book standard rate transactions. Second, our dealer floor plan strategy with Santander Bank NA continues to grow. We have increased our dealer receivables originations by 44% compared to the prior year quarter after a year of strong originations growth in 2016. And finally, the Bank of Santander flow agreement as I mentioned previously. It’s also important that our Chrysler Capital volume and penetration rate are influenced by strategies implemented by FCA including product mix and incentives. Turning to Slide 11. While still a differentiator for our business, our serviced for others balance continues to decrease due to lower prime originations and lower asset sales. Servicing fee income totaled $32 million this year, as we continue to deliver value through this capital efficient platform. Moving forward we expect to drive the serviced for others platform by increasing our Chrysler Capital penetration through the execution of the flow agreement with Santander. I’d like to turn now to Izzy for a review of our financial results. Izzy?

[Izzy Dawood:]

Thank you, Jason, and good morning, everyone. As Jason mentioned, there are some specific items that I will discuss in more detail, which I also mentioned in our call last quarter. As we continue to remediate our material weaknesses in our best qualitative findings in CCAR and federal agreement, we are also aligning several practices to reflect FFIEC guidelines and performance of certain vintages. One of these changes related to bankruptcy accounts, increased our next credit loss by $24 million which was offset by $9 million lower allowance for credit loss and decreased our pre-tax income this quarter by approximately $16 million. This impact is timing related, by which I mean it would have been incurred in future periods but was accelerated into this quarter. Separately, we are taking a more conservative approach to the accrual of interest for certain TDR loans. This change does not impact the bottom line, but reduce net interest income by $26 million and was completely offset by lower TDR impairment and is reflected in allowance with credit loss. I will cover these points again with respective slides. Let’s turn to Slide 12 to review this quarter’s results. Net income for the first quarter was $143 million, or $0.40 per diluted common share. Net leased vehicle income increased 18%, as we continue to see growth in our leasing portfolio with FCA. Total other income this quarter was $55 million, which is net of approximately $65 million of lower of cost or market adjustments related to personal lending and $12 million in other losses that I will detail on a subsequent slide. Moving onto Slide 13, which highlights our performance, excluding the impact of personal lending; further details can also be found in the appendix of the presentation. Interest on finance receivables and loans decreased 6% year-over-year due to a mix shift in the portfolio towards higher credit quality assets with lower APRs, and lower interest income accruals was specific categories of TDR loans. During the first quarter, we shifted to a more conservative approach related to the accrual of interest of certain TDR loans, and the approximate impact of the top line was $26 million. As I mentioned previously, this is completely offset in our allowance for credit loss. As it reduces the carrying value of the loans and therefore acquires lower impairment. This is also reflected in a lower TDR allowance ratio this quarter. Interest expense increased 25% versus the prior year quarter, driven by the increase in benchmark rates. One-month LIBOR increased more than 50 basis points from March 2016 to March 2017. Cost of funds and third-party advertisers and warehouses increased approximately 60 basis points versus the first quarter 2016. Cost of funds in newly issued term ABS improved approximately 30 basis points due to spread tightening, partially offset by benchmark rate increases. Similar to last quarter, these increases were partially offset by interest rates derivatives. Servicing fee income decreased 29% year-over-year due to lower balances and a change in the credit mix of the service for others portfolio. Average growth retail installment contracts balances were flat year-over-year. Lease assets were up 20% year-over-year and are expected to remain flat for the foreseeable future and our new originations are in line with lease terminations. Turning now to Slide 14, we will further drill down into total other income. Reported total other income was $55 million in the first quarter 2017. The impact of lower of cost or market adjustments for personal lending of $65 million include $111 million in customer defaults, offset by a net reduction of market discounts of $47 million, as balances decreased versus the prior quarter in line with seasonal patterns. Normalized investment losses for the quarter were $12 million, primarily driven by losses on assets sales and customer defaults associated with auto assets held for sale. After including servicing fee income and fees, commissions and other, normalized total other income was approximately $120 million. Turing our attention to provisions and reserves on Page15. At the end of the first quarter 2017 the allowance figure totaled $3.5 billion, up $31 million from the end of the prior period. Drivers of the increase include $171 million associated with new originations, $128 million due to troubled debt restructuring, or TDR migration, meaning the additional allowance coverage required for loans that now qualify for TDR treatment, per our definition, which are not classified as TDRs during the prior period, and $10 million due to performance adjustments. These are partially offset by $278 million in liquidations, which includes pay-downs and charge-offs. As we discussed in our Investor Day, TDRs are an accounting classification for assets that meet certain loan modification or extension criteria. Our loan servicing team uses loan modifications and extensions on a case-by-case basis to offer assistance to some customers experiencing temporary financial hardship. Under GAAP, the allowance requirement on an asset classified as a TDR takes into consideration lifetime losses. And even if the loan performs, it will continue to be classified as a TDR for the remainder of its life. The allowance to loans ratio was 12.7% as of the end of this quarter, up from 12.6% at the end of the prior period. The primary drivers were increases in TDR balances and the denominator effect of slower portfolio growth. As I mentioned earlier, the allowance for credit loss includes the reduction of approximately $26 million related to TDR interest accrual and $9 million related to accelerated charge-offs. Continuing to Slide 16. Delinquency rates, including the 31 to 60 and 61-plus buckets, increased 40 and 80 basis points respectively from the prior year quarter. Retail installment gross charge-offs increased 180 basis points, and net charge-offs increased 120 basis points. The net charge-off ratio increased to 8.8% this quarter, up from 7.6% during the same period last year. The increases in both of these ratios were driven by the aging of the more nonprime 2015 vintage and overall portfolio aging. As an example, in the current quarter the 2015 vintage was approximately 30% of our loans outstanding, but contributed 35% of our losses. Additionally portfolio aging driven by lower originations decreases the denominator of this ratio and decreases the balances of loans in the numerator that are newer, and have not yet experienced delinquency or charge-offs. Losses were also impacted this quarter due to write-down of loans and bankruptcy, which I’ll cover further on the following slide. Recovery rates as expected increased from the prior quarter but decreased year-over-year. We continue to see bifurcation in performance between sedans and larger vehicles such as SUVs and trucks, which have performed better but still continue to face declines in value. Turning to Page 17 to review the loss figure in dollars. Net charge-offs in our auto loan portfolio for individually acquired retail installment contracts increased $59 million to $599 million. This quarter we accelerated approximately $24 million in losses, attributable to assets, which were written down upon receipt of a bankruptcy notice. The majority of these losses would have otherwise occurred later in the year and do not alter our overall view of losses for the year, but rather represents a timing impact for Q1. Another $19 million of the overall increase is due to portfolio growth, aging and mix shift. The primary driver was portfolio aging at the average unpaid principle balance was relatively flat versus prior year quarter. Recoveries were also lower this quarter by approximately $19 million and bankruptcy deficiency sales increased versus the prior year quarter by approximately $15 million. Turning to Slide 18. Operating expenses this quarter totaled $305 million, an increase of 5% versus same period last year. This increase was driven by continued investment in compliance and control functions and severance expense related to efficiency efforts. The expense ratio for the quarter totaled 2.4%, up from 2.2% in the prior year quarter. Turning to Slide 19. Total committed liquidity increased 5% to $41.4 billion at the end of the quarter versus prior quarter end. During the quarter we executed two DRIVE and one SDART securitization, totaling approximately $3.1 billion. As with our other DRIVE and SDART nonprime securitizations, these typically remain on our balance sheet and we retain the first last position. Also during the quarter, 49 ABS tranches were upgraded, positively impacting more than $4.2 billion in securities. Also this quarter we increased unused capacity in our revolving facilities by approximately $1.9 billion and remained confident in our overall liquidity position. Asset sales during the quarter totaled $931 million, driven by our new agreement with Banco Santander. Briefly turning to Page 20. Our CET1 ratio for this quarter is 13.8%, which was 170 basis points higher than first quarter 2016. During the same time our assets also increased demonstrating at feasibility to generate capital and support growth. Looking ahead to Q2, my comments will be relative to Q1 unless otherwise noted. So relative to Q1 2017 unless otherwise noted and will include the impact of personal lending, unlike prior quarters when we excluded personal lending. The personal lending assets remain on the balance sheet are still classified as held for sale. We will update our comments if necessary based on any developments in our sales process. We expect net interest income to be down 5% to 7% in the second quarter due to credit mix, lower interest accrual on TDR loans and a smaller balance sheet. Also lease assets are expected to be flat next quarter relative to first quarter 2017. We expect our allowance for credit losses to be down $20 million to $40 million. Net charge-offs are expected to be $130 million to $150 million lower as the second quarter is seasonally our best performing quarter. Therefore incorporating the outlook on net charge-offs and allowance for loan loss, overall provision expense is expected to be $180 million to $220 million lower than Q1 2017. Other income is expected to be $30 million to $40 million lower primarily due to customer defaults in Bluestem, held for sale assets, lower servicing fees driven by lower managed assets and changes in consumer practices. Operating expenses are expected to be down $5 million to $10 million. Before we begin Q&A, I would like to turn the call back over to Jason. Jason?

[Jason Kulas:]

Thanks Izzy. During the quarter we continue to make progress on strengthening our culture of compliance and enhancing our consumer practices with several notable changes which Izzy briefly referenced regarding fees. In order to be more simple, personal and fair with our customers, SC now provides more free ways to pay or methods for our customers to make payments without payment fees. In addition, beginning on April 1 in order to align with industry best practices, SC will no longer accept credit cards, which in the past carry higher fees. We’ve also reduced the fee to pay with debt cards. We are also focused on continuing to improve our customer experience with a pipeline of other consumer initiatives, including a look at our customer statements and more financial education for our customers so they can have more insight into the status of their loan and how late payments impact their status. We look forward to sharing updates on these topics in future discussions. Finally, during the quarter we launched a new compliance management strategy, which we expect to enhance our ability to identify and address root causes of compliance and put us in a position to better serve our customers. Finally, in response to several investor inquiries regarding dealer management and monitoring following the recent settlement with Massachusetts and Delaware, we’ve included two slides in the appendix of our presentation this quarter. These slides provide additional color on our dealer services team and the evolution and enhancements to our dealer performance management program over the past several years. These slides represent the timeline of our dealer oversight and monitoring efforts. As the industry continues to focus on this area, we are committed to being leaders in dealer management, moving beyond the traditional methods of monitoring credit performance. We believe there’s a direct connection between strong consumer practices, a culture of compliance, and the creation of shareholder value. Simply stated, the companies that embrace and execute on these concepts will be more successful than those who do not. In 2017, SC will drive value through enhancing compliance controls and consumer practices, continued credit discipline, diverse and stable sources of liquidity, industry leading efficiency and technology, a focus on recognizing upside in Chrysler Capital through dealer VIP floor plan and the Santander flow program; and finally, being simple, personal and fair with our customers, employees in all constituencies. And with that, I’d like to open the call for questions. Operator?

[Operator:]

Thank you. We will now open up the call for questions. Please limit yourself to one question and one follow-up question, thank you. Our first question comes from John Hecht from Jefferies. Please proceed with your question.

[John Hecht:]

Hey, guys, thanks very much.

[Jason Kulas:]

Good morning.

[John Hecht:]

Real quick question. Sorry guys, I thought I was on mute. Real quick question, there’s a lot of moving parts with respect to the trajectory of your allowance. You’ve got TDR migration with the 2015 vintage that should be ovulating over the year. You’ve got a tightening credit book with newer aging originations. How should we think about the trajectory level over the year given those factors?

[Izzy Dawood:]

Yes, sure. John, I’ll take that and then Jason will chime in. First of all, I think we’re seeing what we expected that the growth in TDR, even though it’s occurring it’s growing at a slower pace. We remain comfortable. I think TDRs will peak late 2017, early 2018 based on everything we’re seeing. That’s the first item. The second item, if the credit mix of our origination holds true and what we see; overall timing of provisions – by math and intuition, provision should come down. It’s just the timing of that decrease in provision can’t be exactly pinpointed. But I think as I said, if everything continues the way we’ve been seeing about what we’re experiencing, we should see that allowance level get lower.

[John Hecht:]

Okay. Is that sort of a linear down takeover if is there some seasonality we should think about there?

[Izzy Dawood:]

Yes. Like I said, John, from a quarterly basis, it’s tough to pinpoint. It’s really not seasonality, it’s more about the overall – the two things; one, the overall change in credit mix of our portfolio at 2015 more nonprime vintage runs offs, and second just over the last several quarters overall portfolio growth has slowed, that’s the other driver of the overall allowance level.

[John Hecht:]

Okay. That’s helpful, thanks you. And then, second question – yes, we’ve heard some banks talk about pulling back. You guys have already alluded to some improvements in certain components of the competitive market. I wonder if you could give us a little bit more deep dive there, what are you seeing, at what point do you think you’ll be able to both tightened and take that share, where we are in – where are we in the overall cycle? And thanks.

[Jason Kulas:]

Okay. So what we typically talk about is kind of the top 20 or so lenders versus the rest of this fragmented market that we operate in. And couple of observations there, if you look at the all-in retail market, what we’re seeing is the top 20 lenders are still incrementally losing share to everyone else. But if you drill down into prime versus nonprime, that story is still prove for prime, but the prime and near-prime parts of the business remain extremely competitive and the top lenders are continuing to incrementally loss share to everyone else. But it’s not true in nonprime, where we’ve seen – again these are incremental steps, but an incremental pick up in the top 20s overall share of nonprime versus everyone else. And I think you see that reflected in our originations where we’re factoring in what we see to what we originate, and we’re getting incrementally more of it relative to the past couple of quarters. Relative to this time last year we were still getting significantly less. So we’re still in a very competitive market, and that’s a reason we keep stressing this word incremental. But we are seeing that competition has declined maybe slightly in nonprime allowing some of the larger lenders to get a little bit more of that share on terms that a larger more sophisticated lender would think make sense. And so, I’d say again, these shifts are very minor shifts and what we see is what we’ve been seeing which is it is a very competitive market. Cost of fund is still very low, availability of liquidity is still very high. And we’re factoring in everything we see in origination and I think you see that reflected in the quality of what we’re putting on the books right now.

[John Hecht:]

Great, guys. I appreciate the color, thanks.

[Jason Kulas:]

Sure.

[Operator:]

Our next question is from Jack Micenko with SIG.

[Jack Micenko:]

Hi, good morning guys. First question follow-up on the first one. We’ve seen certainly the prime world and then maybe a few of the nonprime, some modest uptick in pricing over the last couple of quarters. I think it’s consistently what you’re saying, but I guess my question would be, are you seeing less competition through more rationale pricing of the loan or are you just seeing less providers out there?

[Jason Kulas:]

We haven’t seen rationalization in numbers of competitors and we do talk from time to time about how longer term we actually expect that to happen. This is more about how people are pricing and structuring loans, different ways to put in prices not just APR, you can advance more or less in those kinds of things. What we’ve – I can speak obviously the most about what we do and what we’re seeing is that we’re being more conservative on payments, income ratios, would be more conservative on loan to values. Our terms, our contractual terms are relatively flat and with that approach we’re getting volume that that we think makes sense, specifically down year-over-year, but a little bit more sequentially. In terms of pricing going up in the market, that’s not a big surprise given the fact that benchmark rates have migrated the way that they have. For us what you see is more than that, right. We’ve migrated our APRs more than what would be needed to make up for increases in cost of funds, because we’re still focused on this tradeoff between losses and risk adjusted yield. We’re not looking for lower losses, we’re just looking for the relationship between losses and risk adjusted yield to be at the right level, and we’re pretty pleased with what we’re seeing. We showed a slide in the Investor Day where we look at 2016 versus 2015 and talked about those concepts of yield versus loss. And what we’re looking at now is Q1 versus Q1 versus Q1, kind of looking at 2017, 2016 and 2015. And we really like that relationship between risk adjusted yield and loss and what we put on the book in 2017, even more than we did in 2016. So we feel good about where we are in this competitive environment. Yes, price is going up, people are doing at different degrees and not everyone is holding the line as much on PTI and LTV as maybe some others are.

[Jack Micenko:]

All right, that’s helpful. I know the expenses were up this quarter, you guided I think down 5 to 10 sequential, I think you talked about some investment in compliance offset with some severance. Is there an investment cycle that were in the perhaps falls offs or is that sort of down 10 from here sort of the new run rate?

[Izzy Dawood:]

Hey, terrific question. So the investment is basically in our run rate, I think we’re getting to a point where it’s pretty mature. The reason I got it down for a lower expense for next quarter is they’re just several non-recurring one-time items that at this quarter, not really a compensation. One of them was severance, obviously compensation, but we have some higher legal and professional services fees in this quarter that are offset by other efficiency and elsewhere. So you would think about our guidance next quarter is kind of a run rate and kind of where we feel comfortable and then we’ll update that going forward.

[Jack Micenko:]

All right.

[Jason Kulas:]

Just a bit of additional color on expense side, we are making – we’re continuing to make investments in our risk and control and financial areas and some of that headcount – some of it’s also just cost per person. We’ve made some really key additions to the company. And these are people who understand – the way we talk about it internally as they understand what good looks like in a highly regulated bank type environment and we think that that’s going to continue to serve us really well as we work on improving a lot of those control areas of the business. Even with those additions though, we’re proud of our relative efficiency. We’re always focused on it, the severance expenses was related to that. We had an opportunity to outsource some functions in a very specific area of the company. But we want to be efficient even while we’re making those weird key investments that we think will differentiate us going forward, if that make sense.

[Jack Micenko:]

Yes, it does. Thank you.

[Operator:]

Our next question is from Mark DeVries from Barclays.

[Mark DeVries:]

Yes, thanks. So, since you’ve got another written agreement from the fed, while it seems to address a lot of issues that you’re already mediating also it seems to reflect growing impatience on their part. We’re just interested Jason in getting your comments on what this may reflect in terms of their willingness to approve any kind of capital returns for the upcoming year.

[Jason Kulas:]

Okay. So Mark, thank you first of all for the acknowledgement. These are items that we’ve been working on for some time and talking about for some time and we’re very optimistic about our ability to meet regulatory expectations. We think that level of dialogue and the level of progress we’re making is very encouraging. At the same time, we do have this written agreement. And I think an important distinction we need to make is that, when we talk about distributions – in the past we talked about CCAR, but then we’ve also expanded that to include the written agreements that were in place from 2014 and 2015, the due restrict capital actions and cover a lot of the qualitative aspects that you also see in CCAR. We’re still very cautiously optimistic that we’re on the right path and all of those items. And obviously, we don’t want to get ahead of the process and say exactly when we’ll be able to resume distributions, but we’re focused on all of the actions that will get us there, and we don’t feel like this new written agreement in any way is a step back for us in that regard. Our ability to pay a dividend at some point in the future is not changed by the presence of this new written agreement and maybe I’ll come full circle back to your initial comment which is, as you said these are topics we’ve been discussing for some time. And we feel really good about our ability to get where we need to be.

[Mark DeVries:]

Okay, great. I appreciate that.

[Jason Kulas:]

Sure.

[Operator:]

Our next question is from Betsy Graseck with Morgan Stanley.

[Jeff Anderson:]

Hi, this is actually Jeff Anderson speaking for Betsy. Hi, I just wanted to follow-up on the guidance you gave for the next quarter, sounded like it was down 5% to 7%. Just wondering what the bigger driver was there. Is it more just of loan growth? Is it more of the credit mix or accrue on TDR as you mentioned?

[Jason Kulas:]

Yes. Actually it’s primarily the change in the credit mix that we see, which is the portfolio that we have generated last year of lower APR with higher credit quality. Even though this last quarter we do have higher APR, it will take a while for that to run through the income statement. So that that’s a partial driver, I won’t say it is primary but a big part of it and the other one is the non-interest accrual in the TDR loans.

[Jeff Anderson:]

Okay, thank you. And then just one more question. With regards to the new flow agreement with Banco Santander, you’ve obviously done the $700 million already. Just wondering if you could help us think about the benefit that you may have already had to origination like is that $700 million you wouldn’t have done otherwise and then maybe the second part of the question, how big could that flow agreement eventually get?

[Jason Kulas:]

Well, that’s a difficult question to answer because, as we mentioned before, we still think the upper parts of the credit spectrum are the most competitive parts of the market. So what we know for sure is that what we’re doing, what we’re originating for this flow agreement with Banco Santander is we’re better off with that agreement than without it. And so it will produce incrementally more volume in terms of how much of the $700 million would or would not have been originated without it, it’s again kind of difficult to say, but it’s even more difficult to say going forward how much we’ll get. What we do know is that we’ll be competitive and depending on what the rest of the market is doing and how they’re pricing and structuring loans, we’re going to try to get as many of them as we can. The reason is still encouraging for us is we want to focus on the things for Chrysler in that relationship that we can control and that’s the reason we continually mentioned those three items, because we can control those, right. We can control this relationship we have with our ultimate parent and in becoming more competitive in prime origination. We can control how much dealer full-prime we put in place to a certain extent, I obviously we’re active in that market and we’re seeing big increases year-over-year in our originations which is where we want to be. And we’re also actively rolling out this dealer VIP program with a goal – a continued goal and then we’re on progress on track for this of rolling it out to the entire Chrysler dealer network by the end of year. And all of those efforts will bring us incrementally in volume we think, all are sequel. But unfortunately for us, all are not equal and we don’t know what the migration of the competitive market will be. Perfect word for us is that we do those things and at the same time the market continues to get maybe incrementally more rationale, I mean we get a multiplier effect, but we can’t count on it.

[Jeff Anderson:]

Okay. Great, thank you.

[Jason Kulas:]

Sure.

[Operator:]

Our next question is from Steven Kwok from KBW.

[Steven Kwok:]

Hi, thanks for taking my questions. So I was just wondering if you could talk about the lease portfolio, and what are your assumptions around the used car prices and any sensitivities on changes to that?

[Izzy Dawood:]

Yes. Hey, Steven, it’s Izzy, let me address that. So, as you talked about Investor Day on an economic basis, we’re still seeing and we saw in Q1, our lease terminations came in slightly above our CRLIT or the residual life science we have in Texas, and we did see that in Q1. And we do expect obviously residual prices to adjust as expectations for prices come down. But at the same time, we do benefit from the residual risk agreement that we have at FCA. So if there is a significant drop in our residual prices, there’s a loss agreement that protects us. Furthermore, we are also – you’ll see though our depreciation now, we are also adjusting any meaningful changes in residual prices by through depreciating the lower value over the remaining life of the asset. But net-net, even though prices are coming down, residual values are coming down, we are not seeing a significant location in the marketplace that were potent to do anything really meaningful from an impact perspective.

[Steven Kwok:]

Got it. And then just around your practices of no longer accepting credit cards. Do you know how – what percentage of your customers were using credit cards and debit cards to pay?

[Izzy Dawood:]

We haven’t disclosed the percentages, but we feel like – we are doing this because we think it’s the right thing to do. As we sort of looked out in the market at the benchmark competitors and large banks who are actively competing up and down the credit spectrum in consumer finance, we tended to be a little bit of an outlier in that regard. And so what we’ve done with our customers as we’ve – as we mentioned given more ways to pay without a fee, which we think is a good practice, we also have a ramp on this where there’s a notice period. And anyone relying on making payments by credit cards, had time to pay with a different means. But in terms of disclosing the actual percentage we’ve not given that write-down.

[Jason Kulas:]

Hi, Steven, I will chime in. For me economics perspective, obviously we have introduced multiple options where it doesn’t cost the customer anything, in the past where they were paid a fee. And we believe we currently get about $3 million to $4 million a month in fees through those practices and that’s been incorporated into the other income guidance that provided that we assuming there’s a full pickup of that we would see a lower amount in our fees commission other line item.

[Steven Kwok:]

Got it. I was just wondering if there’s any thoughts around like the credit quality as a result of the daily customers that can’t no longer use their cards to pay?

[Jason Kulas:]

No, we don’t expect that. We don’t expect to see that.

[Steven Kwok:]

Great. Thanks for taking my questions.

[Jason Kulas:]

Sure.

[Operator:]

Our next question is from Eric Wasserstrom with Guggenheim Securities.

[Eric Wasserstrom:]

Thanks. I have a question, just one quick point of clarification, Izzy, on the other income guidance the sequential delta that’s relative to the 55.5 reported figure, is that right?

[Izzy Dawood:]

That is correct, exactly.

[Eric Wasserstrom:]

Okay, thanks. And then my question also goes back to the allowance. Does the – given all of the dynamics that are moving through currently, is there any significant change to the historical pattern of seasonality?

[Jason Kulas:]

To some degree, seasonality almost gone away from an allowance perspective, and the reason I say that is the allowance is now broken into basically two meaningful buckets, one is TDRs and the impairment on TDRs is complete depended on the cash flow expected from that asset. And so there’s no real seasonality there. And the non-TDR effective performing loans, there was a loss emergence period that we look at. And again that is just in 12 months or so of losses that we’ve put in on TDR. So we probably had seasonality in the past before we changed the allowance methodology, that’s really gone away.

[Eric Wasserstrom:]

Got it. So from that perspective, you’ve given guidance on the TDR trend and therefore anything the other effects will really be a function of credit experience in the non-TDR portfolio and growth trend.

[Jason Kulas:]

Exactly right. And that’s actually a good way to think about. And I think that change has made our allowance much more reflective of the portfolio we have or as opposed to any seasonal elements associated with it.

[Eric Wasserstrom:]

Okay. Thanks very much.

[Operator:]

Our next question is from David Ho with Deutsche Bank.

[David Ho:]

Good morning. I just want to talk about how aggressively – these returns on in terms of how aggressively you would pursue incremental opportunities if the market presented its up to you in the nonprime space? Just trying to gauge your confidence on in terms of how much you believe the mix is mostly stabilized from here given the competitive outlook?

[Jason Kulas:]

So Dave, thanks for the question. I think the first part of the answer to that question is that, right now we’re focused on the other elements that we’ve discussed making sure we’re fully realizing the upside potential of the Chrysler relationship, looking at the control areas of our business, compliance, consumer practices, those kinds of things to make sure we’re playing for 20 years from now as much as we are in the near-term financial performance of the company. Having said that, I think the reason you asked the question is that we’ve done more of these kinds of acquisitions than anyone else. So we’ve got a team who’s very experienced in acquiring and converting assets and taking them from other people systems and consolidating into our very scalable system. We would certainly hope that in the future we’d see more of those types of opportunities. We don’t see a lot of activity on that front, you’ll see something from time-to-time, and when it’s out there, it tends to get shown to us. But I think in order – that’s the order we will take it. We will focus on our business first and the upside opportunities we already have. And then over time as those things happen, they’re likely to happen in conjunction with a shift in the economy that sort of state of the economy. As those opportunities happen, we would certainly hope to be in the mix and get involved.

[David Ho:]

Thanks. And separately, in terms of the mix of originations, and kind of your incremental shifts a little bit towards sub-prime again, is that a function of what the competitive environment has given you and how do we have confidence that you won’t pursue have deeper sub-prime kind of what you saw in 2015, disadvantages in any meaningful way kind of what – depending on the competitive environment?

[Jason Kulas:]

That’s exactly what it is. It’s taking what the market gives us. We always want to maximize our capture with all applications that we get. The issue we always have is that a lot of many times in different parts of the credit spectrum in different times what we think is the right price and structure, the market may have a different view, so we get less. There are cash rate in nonprime even though they are up sequentially are still in the high single digits, which historically is the range we’ve been and that’s the range that has served us well through several cycles. So for us it’s – we don’t – we track competitive factors, we track market share, we look at volume, but what we really want is the right risk adjusted return for every single asset we bought. And that’s where we’re going to be focused, not on doing more or less of any certain part of the credit spectrum. I will say being specific about comparing 2015 to what we’ve originated so far in 2017, there are some very key differences. We feel like going back to the other comments about the trade-off and risk adjusted yield versus loss, we feel like there’s a much better trade-off in our early 2017 vintages on those two factors than what we had in 2015. There are certain pockets of what we originated in 2015 that we are no longer originating. So just by definition in terms of our approach to the market, it’d be different. And we saw that same thing by the way when we went through 2006 and 2007. When you go through those types of situations you learn from them, you leverage your data, you make decisions based on what you’re seeing. And some things you never do again, some things you just make for your price for and for us it’s a little bit of both. So that’s what we’re doing. We’re learning from what we see, we’re factoring in that to the new originations and we would expect that for example, if we were sitting here on our second quarter call talking about incremental growth in nonprime originations that we would be getting more than paid for those originations and we feel very good about them or we want them.

[David Ho:]

That’s helpful. Thank you.

[Jason Kulas:]

Sure.

[Operator:]

Our next question is from Moshe Orenbuch from Credit Suisse.

[Moshe Orenbuch:]

Great, thanks. At the risk of asking a version of originations question again. I mean, can you just talk a little bit to what you had alluded to Jason in the fact that there are some still some things that need to be done from a process standpoint and will that as those get done will that in fact improve your ability to originate loans and any way to kind of think about that?

[Jason Kulas:]

Well, let’s talk in general about credit trends. So, is that’s really what is the driver for what we’re getting relative to the market? We’re not in control of how competitors react to it, but obviously we can put this point place ourselves. So 2016, we always talk about 2016 vintages have performed better than 2015. We were expecting in terms of the overall migration of TDRs in the company that will peak as we’ve said sometime in 2017. As you look at the consumer, the consumer still strong and that’s a fairly consistent story where unemployment is low and gas prices are still relatively low. And one aspect of the consumer are watching is consumer debt, and we talked about this in the past, but that continues to sort of inch-up. So non-mortgage consumer debt is still increasing, that’s something we watch because over time that does contribute to higher delinquency and you got a factor that’s into your underwriting. But in general, the consumer is strong, the economy is strong. We’re pricing the trends that we’re seeing in delinquency in loss in the new originations. We feel good about that and that’s reflected as I mentioned earlier, what we’re seeing in some of the credit trends PTI, LTV to such a thing. As you look at recoveries in auction, we are seeing a gradual decline. If you look at all-in recovery rate it is gradual, so it’s 53% down to 51%% if you look at Q1 versus Q1. And we would expect that to continue, we don’t see the bottom falling out of recoveries, we expect it to continue to be gradual. But those – the reason I go through all of those items is those are the items that really influence our originations more than anything else, because we react to them and we see them at a cost of funds to it. But when we see those things happening, we react to them and we factor them in. And different companies do that as different rates and this kind of normal inflow, people taking share, giving share. For example, in Q1 domestic OEMs picked up some share based on some incentive strategies that were being put in place. But as you look at what happened post Q1 they’re getting some of that share back. So there’s a natural event flow and what we’re trying to do is maintain a consistent approach, factoring into what we see, what we originate and just making sure that what we get is good, no matter how much of it we get. In terms of the question about the other areas of the business we’re focused on, I think that’s more about long-term success. We know that whether you’re a highly regulated banking institution or you’re a non-bank finance company licensed in all 50 states, the regulatory environment – our operating expectation is that it’s not going to change. We actually believe that highly regulated environment benefits players like us who are making real investments in those areas. But we have to continue to focus on those areas, those areas are they lead themselves through, the written agreement we have with the fed, they’re very key front center items for us that. I think are more about long-term opportunity cost for the business than they are about short-term ability to originate assets.

[Moshe Orenbuch:]

All right. Just a follow-up, the $700 million that you did with your parents for Chrysler, that’s something that they will do that how often? I guess and maybe if you kind of just put that in context, if that agreement had been in place as of the beginning of the quarter, what would you think your penetration for Chrysler would have been versus that 19%?

[Izzy Dawood:]

Hey Moshe, its Izzy, let me answer that. So two questions, one, I mean we expect right now based on what we see is at least execute the transactions quarterly. It just isn’t a matter of how quickly we could “fill up the bucket”; but at least quarterly to get to a size that’s efficient and cost effective to execute on. Second we’ve been talking to parent obviously since the middle of last year. So we had incorporated many of these elements before we finalize agreement. So we’ve been working in the last couple months to fill up the bucket so that we can execute in Q1. So I don’t – the penetration I think where we have is what we can offer to the marketplace, keep our profitability, take advantage of strategies that FCA has in place. So, no meaningful difference in terms of the timing of when that agreement was executed.

[Moshe Orenbuch:]

Got it. Thanks.

[Operator:]

Next question is from Chris Donat from Sandler O’Neill.

[Chris Donat:]

Good morning and thanks for taking my questions. Jason, I wanted to revisit something that came up at the Investor Day in February, there’s the issue of the delay in federal tax refunds and you’ve said there have been timing issue with originations. I was just wondering if you could give us a sense of the pace of originations by month in the quarter, like it was January below normal, February above, March above and can you give us a sense on what’s going on in April or – I’m looking for what’s going on if that was just blip or something more lasting?

[Jason Kulas:]

Yes. What’s really interesting about tax returns is as more information comes out on that it appears that a lot of the delay was based on filings with earned income tax credits. Those earned income tax credits are more kind of lower income type returns which would be far more squarely and nonprime originations and trends. We’ve been tracking more closely than volume. I do think it impacted volume some what. We’ve been tracking more closely than volume is performance. So we actually think that as these returns have come in maybe a little bit later, April versus March in that timeframe, that we’ve seen maybe some incremental benefit or at least not an incremental detriment given the fact that those returns are coming in, with some of the billions of dollars of refunds that that were held up to fill in that earned income tax credit category. So I don’t know that we have a definitive answer to the question, it’s something we watch very closely to look for trends and performance and how that factors into the new originations. For us the origination story is really about our own credit at this point about what competitors are doing. And we have to be careful about how we talk about what it’s related to, right. So because, well, it’s certainly true that we’ve done more nonprime originations in the last couple of months than we did in a couple of quarters that procedure that. We also are doing substantially les than last year, so it’s – we’re constant looking for ways to do more up and down the credit spectrum. The impact of tax refund, the impact of gas prices, performance in different areas of the country, those kinds of things are one of – or I guess a few of many things we look at and trying to figure out that, that’s a very complicated answer.

[Chris Donat:]

Okay. Thanks, I appreciate that complexity of what you’re working on it. And then at the risk maybe taking a comment you made a few months ago out of context. On recoveries you said you expected to see a gradual decline, there’s been a lot of focus on used car prices and what’s going on there. Just any comment so far on April trends?

[Jason Kulas:]

We’re seeing more of what we’ve been seeing. We’re not seeing anything that’s concerning as we look at really performance year-to-date. It’s all very gradual and all we think still driven by supply demand factors. But I would say the sure answer to that question is we’re not seeing anything that really sticks out and causes any great concern.

[Izzy Dawood:]

And I’ll just add Chris is that, as we’ve mentioned we expect recovery rates come down, these core prices are coming down. We continue to see that again, but not away from the turf that we expected.

[Chris Donat:]

Okay. Thanks Izzy and thanks Jason.

[Jason Kulas:]

Thank you.

[Operator:]

Our last question comes from Charles Nabhan with Wells Fargo.

[Charles Nabhan:]

Good morning guys and thanks for taking my question. I understand a lot of factors go into the pricing and structure of loans. But could you talk about how your ability to pass on rate increases changes over time as the tightening cycle proceeds. For example, does it become incrementally more difficult to pass on a pricing increase when the fed funds goes from 150 to 175 for example versus 75 to 100 bps?

[Jason Kulas:]

So the answer that question is different for the different parts of the credit spectrum. The lower end of the credit spectrum it’s really about affordability. And so you have the ultimate ability to pass it on and just ultimately at some point your capture gets more impacted by affordability, and people just sort of falling out of the system and buying an older car at cheaper price point it’s really not our market, then it is about the competitor taking a loan from you. As you move up in the credit spectrum, there’s a lot more elasticity there, where the affordability is not as much of a factor and then it just comes down to what you’re doing versus what competitors are. I would say for us because we are looking at things from a markets perspective and looking at benchmark rates versus deposit basis. What we see is we all are in a situation where there’s a rising rate environment for prime originations will tend to react more quickly to that than the rest of the market, but over time those lines converge again. In over time in a rising rate environment deposit costs go up inevitably and that gets passed on when it goes up. But for us, we are sort of in a rising rate environment. As you move up the credit spectrum, you’ll see detriment before things catch up.

[Izzy Dawood:]

And Charles, I’ll add top of that, especially in the nonprime segment, where it’s back and back affordability, that’s a key item. We do pass on the rates pretty quick, but most of our competition there is also from marketplace funded lender, and we believe we truly have atmosphere where we will see earnings go up, by probably not as fast some of the others. So that would be kind of offset as well.

[Charles Nabhan:]

Got it, thank you. And as a follow-up, I was hoping to get your comments on the demand environment in the nonprime space. And specifically whether you’re seeing any softening in the used vehicle market, any drop off in application volumes that – there’s been some press about softening in demand in new vehicle sales. I was wondering what you’re seeing in the used vehicle market as well?

[Jason Kulas:]

Yes. We’ve definitely seen some of that. Not to any great degree overall, but we’ve seen some of that. The good news for us is we’re operating in both markets. So you’ve seen that in our trends, the mix of new versus used for us is shifted a little bit the other direction where we’re doing more used than new. And so you’ll see that reflected in the average amount of financed in those types of metrics. Another influencing factor also is the mix of the vehicles available. And so certain manufacturers are going to have line ups that are many more conducive than others, at price points that are more conducive to nonprime originations than others. And so that’s another factor to watch. But for us, we’ve definitely seen that – we’ve seen that some of the demand has shifted from new to used. And you’ve also seen in SAR, right. You’ve seen people in general maybe shifting slightly away, only slightly, but slightly away from new car purchases. And still at very high levels relatively where we’ve been historically, but down from the recent peaks. But even again for us, we operate in those markets. And I do think it’s very interesting if you look at, there was a sort of belief for some time that because the average age of cars on the road is at an all time high, at some point that would cause this windfall of demand. And I think generally at some point that that does maybe fall incrementally. What we’re really seeing is that cars last longer, they’re made better, they last longer. And so the idea of trading off new for used depending on where the prices are is not necessarily a negative thing for performance. That’s the reason why you’re seeing some extended term business being done. And if it’s structured the right way, it makes sense because the asset will be – will value and will run for a given period of time.

[Charles Nabhan:]

Got it. Thanks guys.

[Jason Kulas:]

Sure.

[Operator:]

Thank you. There are no further questions at this time. I would now turn the call back to Jason Kulas for his final comments.

[Jason Kulas:]

Thank you everyone for joining the call today and for your interest in SC. Our investor relations team will be available for follow-up questions. And we look forward to speaking with you again next quarter. Thank you.

[Operator:]

Thank you. This concludes today’s conference. You may disconnect your lines at this time.