Santander Consumer USA Holdings Inc.
Q3 2017 Earnings Call Transcript

Published: 27 Oct 2017

[Operator:]

Good morning, and welcome to the Santander Consumer USA Holdings Third 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, everyone, and thank you for joining the call. On the call today, we have Scott Powell, President and Chief Executive Officer; and Juan Carlos Alvarez, JC, Chief Financial Officer. Before we begin, as you are 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 this 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 today, issued October 27, 2017. For those of you listening on the webcast, there are few user-controlled slides to review as well as a full investor presentation on our IR website. Now I'll turn the call over to Scott Powell. Scott?

[Scott Powell:]

Great, thanks Evan. Good morning, everyone. What I’ll do is, I’ll cover some of the highlights of our third quarter results and then I will turn it over to Juan Carlos who will cover our results in more detail. So if you want to look at Slide 3, we will start there. Our third quarter results, really demonstrates continued strength in our business. You will see that we earned $199 million or $0.55 a share. You will notice that that includes the sale of an RV/Marine portfolio, which has a pretax gain of $36 million, or $0.07 a share. But overall, our results were driven by really strong credit performance in the quarter. You will see that our growth in net loss rates are 40 and 20 basis points lower respectively in the third quarter of 2016. And also, very encouraging are our recovery rate at about 49%, it is flat compared to the third quarter of 2016. Also, in the third quarter we had some important regulatory progress to report and I would say in general, 2017 is very much a pivotal year for us. So what happened in the third quarter is that, the federal reserve terminated the 2014 Written Agreement on capital distributions. And that comes on the back of the Federal Reserve not objecting to our capital plan in the second quarter of this year. So that’s very exciting news and so today we are declaring for Santander Consumer shareholders a dividend of $0.03 a share. It’s the first dividend Santander Consumer has declared since 2014 and kind of more importantly and putting that on context, we are very excited to be included now in the normal capital cycle for financial institutions starting in 2018. With that said, we still have more work to do on some legacy regulatory issues that we have outstanding and we are very focused on closing those things out. And I would highlight, some of the previously announced management changes that we made a couple of weeks ago. One of those was announcing our new CFO Juan Carlos Alvarez who is across the table for me here. Juan Carlos brings a lot of experience in the treasury function and the financial functions and was instrumental in helping Santander U.S. get over the hump on capital planning in CCAR. So it is great to have Juan Carlos, he is part of the team here. We also hired Sandy Broderick from USA. Before U.S. Bank, Sandy Broderick was at JPMorgan Chase and Sandy brings really decades of operational management expertise and we are excited to have Sandy on the team. Rich Morrin, is promoted into a new role, President of Chrysler Capital. And that will allow us to have Rich focused on Chrysler Capital in away which we're hoping will help us make improvement with Chrysler Capital. On a related note, we did our third transaction for 1.3 billion with Grupo Santander in the quarter. Again, and that is critical to the future success with Chrysler, especially in the prime segment. And again, it's a demonstration of our whole company support and commitment to our important partnership with Chrysler. So with that, I'll stop there and turn it over to Juan Carlos.

[Juan Carlos Alvarez:]

Thanks Scott. Good morning everyone. Turning to Slide 4 for some key economic indicators that influence our originations and credit performance. The overall macroeconomic environment is stable and supportive for our business. Consumer confidence remains high. GDP growth is in line with the recent historical range and unemployment levels continue to be very low. These metrics are strong indicators of the health of the economy. Despite the gradual downward trend, auto sales also remained robust. We believe that the uptick that we witnessed in September partially reflects hurricane-related replacement demand. On Slide 5, there are a few key factors that can influence our loss severity and credit performance. We're pleased to see that recovery rates stayed relatively flat this quarter compared to Q3 last year. Our auction recovery rate was 45.3% this quarter, up from 45.1% in Q3 last year. Our auction-plus recovery rate includes insurance proceeds, bankruptcy and deficiency sales were 49.3% in the quarter, which is relatively flat compared to Q3 last year. Turning to Slide 7. Our total core retail originations, loan originations, decreased 21% in the quarter compared to the prior year quarter, primarily due to the competition and our continued disciplined underwriting as we remain focused in earning the appropriate risk-adjusted returns. Chrysler originations with FICO score below 640 decreased 1% over the same period. Chrysler loans with FICO score above 640 decreased 10% in the quarter compared to Q3 last year, but increased 9% sequentially supported by our Santander flow agreement. These originations continued to be strong, increasing 28% compared to Q3 last year and 17% sequentially. Looking ahead, our goal is to increase non-prime volume, while ensuring the appropriate risk return profile and to increase prime volume through the Santander flow agreement. Moving to Slide 9. The Chrysler Capital penetration rate as of the end of Q3 was 19%, which is down from 20% at the end of last quarter. Now the quarterly penetration rate for Q3 2017 was 21%, up from 20% last quarter. In the past, we only provided appointing time penetration rate at the end of the quarter, but the quarterly penetration rate is more representative of our performance with FCA. We're pleased with the progress we're making on our many initiatives with FCA. Last quarter, we completed the national rollout of our Dealer VIP program with more than 2,500 Fiat Chrysler dealers enrolled, which, combined with the Santander flow agreement and Dealer Program, should support improved penetration rates in the future. Over time, we expect these strategies to further advance our relationship with FCA. A reminder, Chrysler Capital volume and penetration rates are also influenced by the strategies implemented by FCA, including product mix and incentives. In addition, we're excited about Rich’s new role as President of Chrysler Capital and Auto Relationships, which will allow him to devote more attention towards strengthening the relationship with FCA. Turning to Slide 10. Servicing fee income totaled 29 million this quarter. A unique part of our strategy of serviced for others balance has decreased due to lower prime originations compared to last year. Moving forward, we expect to drive the service for other platform by increasing our Chrysler Capital penetration supported by the strategies I mentioned previously. Moving on to Slide 12, which highlights our performance, excluding the impact of personal lending. Interest on finance receivables and loans decreased 6% year-over-year primarily driven by lower average rate balances. We continue to see growth in our leasing portfolio with leased vehicle income up 18% this quarter compared to the same quarter, last year. We saw an increase in leased vehicle expense, primarily driven by revised ALG residual value forecasts, leading to a decrease in net leased vehicle income of 13%. Interest expense increased 21% versus the prior year quarter, primarily driven by the increase in benchmark rates over the period. Provision for credit losses decreased to $536 million in Q3 2017 from $610 million in Q3 2016. This decrease in provision is driven by a combination of improving credit performance, stabilizing recovery rates, partially offset by an additional reserve for $53 million for customers affected by Hurricane Harvey and Irma. Turning to Slide 13. We will further drill down into total other income. We reported total other income of $59 million in the quarter. The impact of lower of cost or market adjustments for personal lending was $84 million, including $108 million in customer default, offset by a net reduction, market discount of $24 million. Normalized investment gains for the quarter were $30 million, primarily driven by the RV marine portfolio sales, resulting in a pretax gain of $36 million this quarter. After including servicing fee income and fees, commissions and other, normalized total other income was approximately $142 million in Q3. Turning to Slide 14 to review vintage performance. This slide displays gross and net losses for 2014, 2015 and 2016 retained vintages for up to 21 months of performance. Consistent with our update from last quarter, our 2016 vintages continues to outperform the 2015 vintage on a gross as well as net loss basis. Continuing to Slide 15, the 31 to 60 delinquency rates of 9.2% in the quarter is flat compared to Q3 last year. The 61-plus delinquency buckets increased 50 basis points during the same period. Our rate gross and net charge-off ratios decreased to 18% and 9.1% this quarter respectively, from 18.4% and 9.3% in Q3 last year, despite lower portfolio growth in Q3 2016. The decrease in net charge-off ratio is primarily attributable to improving credit performance, while recovery rates remain relatively flat compared to the prior year quarter. We do expect some additional delinquencies and losses over time associated with the relief that we provided this quarter as a result of the hurricanes. Turning to Slide 16 to review the loss figures in dollars. Net charge-offs for individually acquired rates decreased $20 million in the quarter to $611 million compared to Q3 last year, which was primarily attributable to improved credit performance and stabilizing recovery rates. Let me address the components of the net charge-off walk. $18 million is due to lower recovery dollars compared to Q3 last year. The $20 million decrease related to portfolio aging and mix-shift is related to the overall improvement in the portfolio's credit performance and debt sales were also higher by $16 million this quarter. Turning our attention to provisions and reserves on Slide 17. At the end of Q3 2017, the allowance totaled $3.4 billion compared to $3.5 billion last quarter. There was $138 million increase associated with new originations, a $130 million increase due to TDR migration and a $41 million decrease due to performance adjustments. Liquidations and other, which includes payoffs and charge-offs, totaled $304 million. The allowance to loans ratio was 12.8% as of the end of this quarter, up 20 basis points from the end of the prior period. Turning to Slide 18. Operating expenses this quarter totaled $298 million, an increase of 5% versus the same period last year. This increase was primarily driven by losses recorded for certain contingencies and severance expenses related to management changes. Expense ratio for the quarter totaled 2.4%, up from 2.2% in the prior year quarter. Turning to Slide 19. During the quarter, we executed DRIVE and SDART securitization, totaling approximately $1.8 billion. Asset sales this quarter totaled $1.5 billion, primarily driven by our third Santander flow transaction of $1.3 billion. Also to note this quarter, we renewed our $3.9 billion syndicated warehouse facility for Chrysler Capital loans and leases for an additional two years. Subsequent to quarter-end, we executed an additional DRIVE securitization, totaling approximately $1 billion our third publicly registered DRIVE transaction. Finally, turning to Page 20. Our CET1 ratio for this quarter is 15%, 190 basis points higher than Q3 last year. Our capital levels remained well above our internal capital targets. As Scott mentioned, we're very excited to have declared our first dividends since 2014 and look forward to further optimizing our capital in the future. We're pleased with the operational and financial performance we saw in the quarter and are encouraged by what lies ahead for our business. Looking ahead to Q4, my comments will be relative to Q3 unless otherwise noted and will include the impact of personal lending. Despite the net finance and other interest income to be down 5% to 7% in the fourth quarter, primarily driven by TDR interest accruals, lower balances and seasonality. Provision expense is expected to be flat to $40 million lower, primarily driven by improving credit performance, partially offset by higher seasonal losses. Total other income is expected to be $70 million to $90 million lower after adjusting for the gain on the sales of the RV/Marine portfolio. This is in line with the variation we experienced at the same time last year as we expect an increase in Bluestem balances, given the holiday season. Operating expenses are expected to be slightly better. Before we begin Q&A, I'd like to turn it back to Scott.

[Scott Powell:]

Thanks, Juan Carlos. I do want to say a couple more words about the hurricanes. The hurricanes have struck the U.S. and Puerto Rico. Juan Carlos mentioned that we did add $53 million to the reserve at Santander Consumer to cover both cars that were destroyed without insurance as well as future losses, primarily driven by our annual relief efforts. And those relief efforts here at Santander Consumer were pretty significant. And we helped 81,000 customers as they were recovering from the hurricanes and we feel really good about that. Santander across the U.S. has donated $2 million – donating more than $2 million for relief efforts both here in the United States and in Puerto Rico. I think folks on the phone know that we have a servicing center for Santander Consumer in Puerto Rico. That servicing center is fully operational and has been fully operational for a week or so which is great to report. Folks probably also know that we have a bank in Puerto Rico, Banco Santander Puerto Rico, which is a full-service bank in Puerto Rico. I mentioned that because we are working with our colleagues as they resume operations more broadly in Puerto Rico. And we're happy to report that all of our employees in Puerto Rico are safe and sound, and we continue to work to support our colleagues there as the island continues to recover. And so we will remain helpful to our colleagues there in Puerto Rico. In terms of concluding remarks, I would just say again that we feel really good about our third quarter results because it is driven by underlying strong credit performance. We're very encouraged about the future. The economy remains strong, and the outlook for used car prices and new car sales isn't as negative as it was earlier in this year. So that feels pretty good to us. We feel really good about the new management team we have in place here at Santander Consumer, and we will continue to execute well on operations across this organization. So our priorities going forward really aren’t changed. We're going to continue to strengthen our financial performance and our operational performance by focusing on pricing for risks every day. And we're going to deliver shareholder returns and continue to focus on our core customers. And I mean especially Chrysler who remains a very important strategic partner for us. Our third quarter results demonstrate progress financially and more broadly on some regulatory issues. So in a lot of ways, it is a pivotal year for us here at Santander Consumer and we feel really good about that. Having said that, maybe we should turn to Q&A.

[Evan Black:]

Perfect. Operator, can you take us to Q&A, please?

[Operator:]

Hello, we will now open up the call for questions. [Operator Instructions] Our first question comes from Mr. John Hecht with Jefferies.

[John Hecht:]

Good morning, guys. Thanks very much for taking my questions. Just you guys that – JC, you talked about targeting more subprime. So I’m wondering just looking at volumes and the effects on revenues and so forth in the current period and how do you think about next year, your ability to capture more share in subprime and start to grow the loan balances, given the competitive market and the overall end market size? And what do you see right now is like the target pretax ROA of that type of asset class?

[Scott Powell:]

Hey, John, it's Scott. And maybe I'll take the first part of the question and then let Juan Carlos give you the numbers on the pre-tax ROA. I mean, we do feel – in our core nonprime market, we do feel like we have an opportunity to grow there just by optimizing our credit underwriting and pricing models. So we feel like there's opportunity there for us. It's been very competitive. It continues to be competitive, but we think we have the ability to grow and we're confident we have the ability to grow in that space and we're looking forward to that.

[Juan Carlos Alvarez:]

In terms of pre-tax ROA, we aim for range of 3% plus for that particular segment of our business.

[John Hecht:]

And then just turning quickly, it's a broad question to the TDR migration. Where are we with that 2015 cohort in terms of managing TDRs? And when should we see that influence start to receive based on the difference between the 2015 and 2016 performance?

[Juan Carlos Alvarez:]

So the 2015 – 2015 vintage is, in terms of losses, it's already contributing less net losses, contributing net losses than the 2016 vintage. So that has already crossed. The TDR volume, we do expect to start to plateau in early 2018. In terms of TDR migration to ALLL, there will always be migration to ALLL, but it's more important to talk about the volume, as I just referenced, leveling off in Q1.

[Scott Powell:]

And John, just to add to what Juan Carlos said, that's assuming the portfolio remains relatively flat. We would hope and do expect to be growing more in core nonprime, which will contribute additional TDRs. So we do expect it to level off at the beginning of next year, but that assumes we're not growing significantly.

[John Hecht:]

Very good, guys. Thanks very much for the color.

[Juan Carlos Alvarez:]

Thank you.

[Operator:]

Thank you. Our next question comes from Moshe Orenbuch with Credit Suisse.

[Moshe Orenbuch:]

Great. Thanks, and thanks for the comments on the TDR. Just to kind of follow-up on that, actually, I think it's interesting that now we're sort of moving a little bit to focus on the revenue impacts. And could you just talk a little bit about the revenue impacts as you alluded to that being a driver in Q4? Is it a one quarter lag or anything like that? And how should we think about when those revenue impacts would start to moderate from the TDR?

[Juan Carlos Alvarez:]

So at the top line, that impact on TDR growth has started in Q1 when the policy was put in place, but that hasn't changed throughout the year.

[Moshe Orenbuch:]

So it's current. So it's – the impact would moderate as the balance has plateaued, as you're saying, in early 2018?

[Juan Carlos Alvarez:]

Yes, perfect. It's an overall component, relative overall component, yes, that the policy would remain in place.

[Moshe Orenbuch:]

Understood. And as just as a housekeeping item. When you talked about the reserve change in Q4, is that before or after the $53 million that you put in for the hurricane this quarter?

[Juan Carlos Alvarez:]

All the variances I referred to include the $53 million reserve.

[Moshe Orenbuch:]

Thank you. I’ll sit back in the queue.

[Scott Powell:]

Thank you.

[Operator:]

Thank you. Our next question comes from Vincent Caintic of Stephens.

[Vincent Caintic:]

Hey. Thanks. Good morning, guys. Hey. Good morning. I wanted to focus on Chrysler. I think you've highlighted the importance of this relationship on this call and also the Banco Santander Investor Day as well. Just wondering – so your penetration rate is at 20% right now, I think typical cap has run to 60% to 80% range. And you've highlighted one program or one importance just to trying to get your – you to have deposit like funding. I'm wondering if there's any programs to maybe help that. And then if there are anything else that needs to – that you're hoping to be done between your and Chrysler support to get the penetration rates higher?

[Scott Powell:]

Yes, it's a great question. And you're right, it is an extremely important relationship to us and so we're working on this one across a number of fronts. We have a dealer commercial services business, which is growing in Chrysler space. So that's one leg of the strategy. We have put in place a dealer rewards program called our VIP program to build deeper relationships with individual Chrysler dealers to drive more volume. We are making progress on our lease portfolio with Chrysler that continues to be extremely important part of the relationship, given how important financing is in the auto space today. And then leveraging Grupo Santander and then possible other bank partnerships to leverage their funding structure allows us to be more competitive in the prime space. And that is a very big deal because when you get down into near-prime and subprime, with our funding structure here at Santander Consumer, we can compete. We compete effectively on price. And so the challenge is to get deeper on overall penetration rate with Chrysler is really improving our commercial services to dealers, but more importantly, delivering more loans in the prime space, which means leveraging the Grupo Santander relationship and then, as you say, possibly bringing other bank partners to bear on this relationship. And so that is essentially our strategy, and it's a chip away kind of strategy that we're working all the time. And those are the things we discuss with our Chrysler partners when we review with them.

[Vincent Caintic:]

Got it. Thanks. And just, when you talk about more of the, I guess, tightness between you and Grupo Santander as well as maybe some other bank partners, is that more flow agreements or is there other maybe creative ideas to that?

[Scott Powell:]

I would say, maybe slight variations on that on the flow agreement-type structure, but nothing too far afield from that.

[Vincent Caintic:]

Okay. Great. Thank you. And just one more question on the expense side. So guidance were slightly lower expenses quarter-on-quarter in the fourth quarter. But as you think about going forward, you've had some great success with other regulatory front. Do we need the level of expenses that you've been running going forward or is there some operational efficiencies that we could see?

[Scott Powell:]

Well, I would – yes, it’s kind of a yes and a no. So we have other regulatory – sort of two other written agreements outstanding with the Federal Reserve that we need to close out over the next couple of years. And if you've read them, one is a very comprehensive written agreement from 2015, kind of is crossed – primarily around risk management, which kind of cuts across the whole thing. And then we will see the written agreement in 2017 focused on compliance here at Santander Consumer and also at the holding company level. That one is really a couple of years in works, and so we have made great progress, addressing issues in both of those written agreements. So kind of along answer to your question, but from a – can you expect lower regulatory committed expenses? I think the answer is no for now. Those will have to be maintained to address those issues. But on the operational efficiency question, we do expect – and this is one of our new leader, Sandy Broderick, we do expect to be looking for areas where we can operate more efficiently. We are very efficient today, especially when you compare us to competitors. But bringing in some new technologies, some new ideas, we do expect to be achieving, yes, more expenses through operational efficiency initiatives.

[Vincent Caintic:]

Got it. Very helpful. Thanks very much, Scott.

[Operator:]

Thank you. We will take our next question from Chris Donat with Sandler O’Neill.

[Chris Donat:]

Good morning. Thanks for taking my question. Just one more question on the TDRs. Was there anything in there related to hurricane or was that or hurricanes or did not have any impact on the TDRs?

[Juan Carlos Alvarez:]

No, it does have an impact. As we provided relief to our affected customers, the TDR balance would have been increased, but it's not a significant relative component of the TDR volume.

[Chris Donat:]

Okay.

[Scott Powell:]

Maybe – sorry, just to add a little on what Juan Carlos said. Some of the customers that we provided that we leased for through the extension would have moved then to TDR and some would not have. So it didn't have a big impact for that reason.

[Chris Donat:]

Okay. Got it. And then just kind of curious with the disruption the hurricanes have had to the used car pricing market, can you give us what your expectations are for used vehicle prices, say, for 2017 and 2018? We had sort of prior management comments. Just want to know what you’ve started building into your models.

[Scott Powell:]

Yes, I would say, we're more optimistic, right, than the projections we started with for this year on new car sales and used car prices. I think the hurricanes, I don't know if it's 500,000 or 1 million cars that were destroyed. That certainly has, I don’t know, a few months impact on these car prices. The manufacturers have been reducing their production. U.S. economy is still pretty strong. So I would say we have – we're using a less negative factor on both new car sales and used car prices as we think about next year.

[Chris Donat:]

Some of these are stable, right?

[Scott Powell:]

Stabilize – I mean, both will still be down. But instead of used car prices moving down 6% or 7%, maybe 3% is how we'll take that in.

[Chris Donat:]

Okay. Awesome. Thank you.

[Scott Powell:]

Yes.

[Operator:]

Thank you. We will take our next question from Rick Shane with JPMorgan.

[Rick Shane:]

Thanks guys for taking my questions this morning. Really just two things. One, you talked about sort of the ROA target by vintage going forward, and you historically provided some context for the 2014, 2015 and 2016 vintages. Can you provide us with sort of a thought on what the 2017 vintage is going to look like from an ROA perspective?

[Juan Carlos Alvarez:]

So I think last quarter we talked about the 2017 vintage being potentially – especially the early parts of the year being less profitable than the 2016 vintage. I think that remains the case. Going forward, it's very late in the year, so I wouldn't expect that to change very much. That guidance that was given previously could change very much.

[Rick Shane:]

So no change there on that guidance?

[Juan Carlos Alvarez:]

Correct.

[Rick Shane:]

Excellent. And then just want to make sure, there's a comment here on Slide 13 that the strategy on flow agreement is to sell near par. I'm assuming that there's been no change in the capitalization of the servicing rights, but I just want to make sure that there haven't been any little tweaks there we need to be aware of.

[Juan Carlos Alvarez:]

No, it’s ended.

[Rick Shane:]

Okay. Great. That’s it from me. Thanks, guys.

[Scott Powell:]

Thank you.

[Operator:]

Thank you. We will take our next question from Mark DeVries with Barclays.

[Scott Powell:]

Hey, Mark.

[Mark DeVries:]

Yes. Thanks. Scott, in your prepared comments, you alluded to a return to a more normal capital cycle in 2018. I was hoping you could elaborate on that. So should we expect a much more meaningful payout with a healthy contribution from share buybacks next year?

[Scott Powell:]

Yes. I can't really comment on that. Well, I can't comment on that except to say we're going to do what you would expect us to do as we start that capital planning cycle. We look at a number of different options and, again, having just passed, having just got a non-objection to our capital plan this year, there are a number of dimensions we'll have to be thoughtful about as we wear options on what we can do for our shareholders after the next Fed cycle. Yes.

[Mark DeVries:]

Okay. Fair enough. Yes, that's helpful. I certainly understand your constraints on what you can say here. So next question, your charge-offs obviously improved year-over-year, but your 60-plus day delinquencies now increased. I understand part of those was due to lower balances and receivables, but can you just parse out the impact so we can get a sense of the trajectory of charge-offs, not just in the next quarter or two, but as we look at it a year or so?

[Juan Carlos Alvarez:]

So the – let's say, you talked about charge-offs and delinquency?

[Mark DeVries:]

Yes, kind of moving in opposite directions right now.

[Juan Carlos Alvarez:]

Right. So we do have, in terms of the charge-offs, the extension is provided, right? These have an impact on the ratios. So for example, the charge-off ratio on the quarter would have been slightly higher than otherwise because of the hurricane, but very much the underlying trend that we've been talking about would remain in place, okay? So they would have been relatively flat compared to same quarter last year. In terms of delinquencies, the majority of the extensions were given in the earlier stage buckets, okay? So you'll see the 31 to 60 being flat year-on-year and the 61-plus being slightly higher, which is also what we would expect this time of year.

[Mark DeVries:]

Okay. Got it. Thank you.

[Operator:]

Thank you. We will take our next question from Steven Kwok with KBW.

[Steven Kwok:]

All right. Thanks for taking my questions. Two questions I have. First is just on going back to the charge-off rate. Around the debt sales of $16 million, how sustainable is that? How should we think about that going forward?

[Scott Powell:]

I think they're pretty regular. I should think that they'll be occurring now on a pretty regular basis. It's tales of our deficiency balances that we have all the time. So yes, I mean, it might be a little choppy because we're not, right now, not in the market every month. But as the pool builds and we'll be in the market to sell those. It's a regular part of the process.

[Steven Kwok:]

Got it. Okay. And then just on your tax rate, how should we think about it in the fourth quarter and going forward? Is it 28% rate good to use going forward?

[Juan Carlos Alvarez:]

I think we gave guidance on this last quarter, also related to SCI, the tax benefit in SCI. That guidance hasn't changed.

[Steven Kwok:]

Okay. Thanks for taking my questions.

[Juan Carlos Alvarez:]

Thank you.

[Operator:]

Thank you. Our next question comes from David Scharf with JMP Securities.

[David Scharf:]

Good morning, and thanks for taking my question. Most have been asked, so maybe just a couple of quick update questions. The first, I know last quarter, prior management had commented that more pieces seem to have been put in place regarding the potential acquirers of the Bluestem portfolio. Are there any updates you can provide on that front?

[Juan Carlos Alvarez:]

We continue to work on that and consider all our options. The portfolio remains on held-for-sale, and that's it we can give you on that.

[David Scharf:]

Okay got it. And then lastly, regarding Puerto Rico, I know it's been a while since the Company has discussed it. But not too long ago, there was talk of tax strategies being pursued around the servicing center there. And just given the developments on the island, can you speak to whether or not that's something that's still potentially viable going forward?

[Scott Powell:]

Yeah, so I think what we have said previously is the new service center in Puerto Rico is important for our management of the other servicing collection sites we have around Caribbean. And so it's an important part of our operations infrastructure and collections strategy, and then it also provides us some tax benefits as well.

[David Scharf:]

Okay thank you.

[Scott Powell:]

You bet.

[Operator:]

We’ll take our next question from Jack Micenko of SIG.

[Jack Micenko:]

Hi, good morning. Looking at your loan portfolio and the loan yields, noticing that you new money yields are coming in about 50 basis points higher than the portfolio. So I guess two-part question on that. Did the loan sale impact affects the reported yields for the portfolio this quarter? And then second, should we expect – is it reasonable to expect some sort of accretion to overall yields over time, given the high turnover of an auto portfolio in general if you're putting on higher coupon business today?

[Juan Carlos Alvarez:]

May you have to break that a little. The loan sales that I've been referring to, through the Santander flow agreement, those are prime.

[Jack Micenko:]

I was referring to the RV/Marine sale.

[Juan Carlos Alvarez:]

It is 135 million, so it is not very meaningful in that regard to the overall loan yields.

[David Scharf:]

And is it fair to assume that the new money yields coming in higher should help overall book yields overtime?

[Juan Carlos Alvarez:]

Yes. Remember, that's part of our strategy, as Scott discussed. We’re still focused on core and prime, and that's what we'll look to retain, the prime product goes through the flow agreement. So on that sense, the all-in yield should be boosted by that dynamic.

[Jack Micenko:]

Okay. And then I noticed that the repo expense was down about 12% year-over-year and I think you've guided to better expenses next quarter. Are you contemplating a higher rebounds in repo expenses in the 4Q, given you probably have some payment moratoriums this quarter, given the storms?

[Juan Carlos Alvarez:]

Our guidance bakes in repo and what I said is that we expect it to be slightly better. That already considers the underlying trends in repo activity including the hurricane.

[Jack Micenko:]

Okay thank you.

[Operator:]

Thank you. We'll move next to Arren Cyganovich with Citi.

[Arren Cyganovich:]

Thanks. The lease volume was outperforming your retail in summer contracts. What's your thought about adding a lease? Do you have much of a preference between the growth there versus growth in your loan book? And what are your thoughts on the upfront underwriting associated with that, given the trend of lower used car values?

[Scott Powell:]

Yeah, may be I’ll take a shot at that one and Juan Carlos can back me up. So yes, I mean, having a lease product and growing that product is important to the relationship with Chrysler. And so – but having said that, we're very analytical and thoughtful about the residual values in the lease portfolio. And so to the extent we get a new forecast with someone like ALG or run our own internal forecast related to residual values. That changes the underlying expectation at the time it's off lease. It changes our depreciation curves to account for that. So the leases are very important to us. We think we're managing the risk associated with residuals on a conservative basis, and so we feel good about the portfolio we have and how we're growing that portfolio as part of the overall relationship with Chrysler. Does that make sense?

[Arren Cyganovich:]

Yeah, thank you. Appreciate that. And then just a model question. Where there's difference, Scott? Did you specifically say how much cost related to severance in your comp this quarter? Can you give like onetime type of that?

[Juan Carlos Alvarez:]

Yes. That severance that we've discussed is public. It was discussed in the public releases, so that's why it was incorporated in that line.

[Arren Cyganovich:]

Okay thank you.

[Operator:]

Thank you. We'll take our next question from Geoffrey Elliott of Autonomous Research.

[Geoffrey Elliott:]

Good morning thank you for taking the question. On the net interest and financing income, can you help talk through when you think that can inflect clearly the negative impacts coming in 4Q? But how should we think about that going forward when it starts to move up again?

[Juan Carlos Alvarez:]

Yeah, so in terms of margin, for the quarter, the key drivers for interest expense is going up, given higher base rates, benchmark rates. Spreads remain relatively flat. The benchmark rates did increase. And the other big driver is the adjusted depreciation on leases, that's a key driver in the quarter. So going forward, right, if that were to moderate, remember that when we adjust depreciation on leases, we're pretty much looking with the one quarter lag. So we're looking at a Q2 metric. So that's the speed of the depreciation could moderate somewhat going forward. And then in terms of the top line, we've talked about how the mix of loans should also give a bit of a boost to the top line.

[Geoffrey Elliott:]

Great and then on Chrysler, I guess you talked a lot about that being a focus. What should we look at to judge whether you're succeeding there? Is it as simple as penetration rates or are there other things that we should be looking at to see whether that relationship is going in the direction you want?

[Scott Powell:]

Yeah I would say it’s some of those areas I touched on before. Are we making progress on dealer commercial services for Chrysler? Are we growing in the Chrysler nonprime? How are we doing with flow partners for the prime segment of the portfolio? And then leases is the other big component there.

[Juan Carlos Alvarez:]

Also, I think the stability that we provide in core nonprime is.

[Scott Powell:]

Yes. I mean, the key value we provide with Chrysler, thanks, Juan Carlos, is the consistency of our volume in the nonprime segments. So we believe it is a good partnership because both parties benefit from this relationship.

[Geoffrey Elliott:]

Great, thank you very much.

[Scott Powell:]

You bet.

[Operator:]

Thank you. We'll take our next question from Michael Tarkan of Compass Point.

[Michael Tarkan:]

Thank you. Just a follow-up on the capital question. I know you can't comment on plans for the CCAR, but you've talked about wanting to optimize excess capital. I'm just kind of wondering what your view is of what the right capital level for this company should be at over time?

[Scott Powell:]

So I think last quarter, prior quarters, we talked about our internal capital targets. That hasn't changed. It's 12.5 on CET1 and our internal capital targets get updated as part of that capital cycle, as Scott talked about, and is driven by our internal adequacy analysis. So the capital actions are related to that as well, and they follow the same cycle that Scott touched on.

[Juan Carlos Alvarez:]

Yes and there is – you probably noticed, but there is a connectedness to our improving ability to deal with some of these legacy – regulatory issues and deal with the overall management of the company. And so those elements do get factored in to the capital adequacy analysis that we go through every year.

[Michael Tarkan:]

Okay. So I mean, is it fair to say that over time, now that you're back on the regular cycle that will start to see, I think, broader, hopefully broader capital returns moving forward, maybe migrating you closer to that 12.5% level over time?

[Juan Carlos Alvarez:]

We've laid out what the capital actions are until the next cycle. So that – remember that we choose our capital plan. That includes stepping up $0.03 to $0.05 as proposed capital action, and that's as much as we have in front of us right now. As to that, it will be part of that adequacy analysis.

[Michael Tarkan:]

Understood. Thank you. And then as you're thinking about reserve levels here, bigger picture, you think about 2018 or even a little bit beyond that. Just kind of wondering what you guys view as sort of the right level of reserves for this company to be operating on at a steady state, assuming that credit that TDRs do peak in that first quarter 2018 or early 2018 and then improve thereafter?

[Juan Carlos Alvarez:]

So our level of reserves is a reflection of what we are – what we've experienced, what our outlook is and we believe that we are perfectly, adequately reserved for our portfolio. The update that I look that level of reserves with the information that we will receive, as we go along.

[Scott Powell:]

Yes, and just to add to that, I mean, we've laid out kind of the strategy and there won't be dramatic shift in the inherent credit quality mix in the portfolio as we move forward. So yes, I think it's – to build on Juan Carlos comment, I think it's fair to say it's kind of steady state unless something changes either in the environment or in inherent mix of the portfolio.

[Michael Tarkan:]

Okay, but just I guess – just on clear. If TDRs do peak in that first quarter and then presumably your reserve levels on new loans on an overall basis would be lower moving forward, is that fair to assume?

[Scott Powell:]

Yes. I mean – yes. So it kind of gets normalized right there, if that's your point. I agree with that. But we would like to grow our nonprime segments. And the way we reserve as we grow is, I think you know this, the allowance gets front-loaded for loans as we book. So for growing our portfolio, we're putting up reserves upfront for those loans. So that certainly has an impact on the overall portfolio.

[Michael Tarkan:]

Understood, thank you.

[Operator:]

Thank you. We'll take our next question from James Fotheringham with Bank of Montreal.

[James Fotheringham:]

Thanks, Scott, at the recent Santander Group strategy update, you said when, hypothetically, about SHUSA buying in the SC minorities and related potential funding synergies, you said it's something you think about all the time. So assuming that you've continued to think about it, could you give us your latest thoughts, especially with respect to required regulatory approvals and related potential timing? Thanks.

[Scott Powell:]

Yes, you try to get me in trouble, right? Well, look, I mean, we consider our options as a corporation all the time and think about what makes sense. So yes, that's what my comment meant on that context. But there's nothing to talk about with respect to that, so you just have to leave it at that.

[James Fotheringham:]

Thank you.

[Scott Powell:]

You bet.

[Operator:]

Thank you. We'll take our next question from Kevin Barker of Piper Jaffray.

[Kevin Barker:]

Thanks. Could you give us a little more detail on the puts and takes around yields and charge-offs? You stated that the 2017 vintage will be less profitable than the 2016 vintage?

[Scott Powell:]

Kevin, we missed the beginning part of the question. We couldn't really hear you.

[Kevin Barker:]

In regards to the 2016 versus 2017 vintages, you stated 2017 could be less profitable than the 2016. Could you explain – can you help us understand the puts and takes around charge-offs and yields between those portfolio?

[Scott Powell:]

Yes. I think the way we talked about it last quarter hasn't really changed. I think we talked about that happened within the context of recovery rates for the earlier part being lower than 2016. Remember that we also talked about operational issues that we had in the earlier part of the year impacting the profitability of the 2017 vintage. As I think we also talked about last quarter, those issues have been fixed and we should expect better performance going forward.

[Kevin Barker:]

Okay. Thank you.

[Operator:]

Thank you. There are no further questions at this time. I will now turn the call over to Scott Powell for final comments.

[Scott Powell:]

All right. Great, well, thank you all for joining the call. We appreciate all of the questions. And we appreciate your interest in Santander Consumer. Have a good weekend. Bye-bye.

[Operator:]

Thank you for your participation. That does conclude today's conference. You may now disconnect.