Santander Consumer USA Holdings Inc.
Q1 2018 Earnings Call Transcript

Published: 24 Apr 2018

[Operator:]

Good morning, and welcome to the Santander Consumer USA Holdings First Quarter 2018 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 thanks for joining the call today. On the call, we have Scott Powell, President and Chief Executive Officer; and JC, Chief Financial Officer. Before we begin today, as you’re aware, certain statements made 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 info 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 to investors. A reconciliation of these measures to U.S. GAAP is included in the earnings release issued today April 24, 2018. For those of you listening on the webcast, there are a few user-controlled slides to review as well as a full investor presentation on the Investor Relations website. Now I’ll turn the call over to Scott Powell. Scott?

[Scott Powell:]

Great. Thanks, Evan. Good morning everybody. Thanks for joining the call. I’ll start out by reviewing our first quarter highlights before I turn it over to Juan Carlos for a more detailed review of the first quarter. So let’s start on Slide 3, in the presentation. You’ll see that the first quarter was a really strong quarter for Santander Consumer. Our results demonstrate our continued success in strengthening our management team, operations and risk management. Our net income totaled $242 million, which was $0.67 per share. Our return on average assets was 2.4% compared to 1.5% in the first quarter of 2017. And we’re also declaring a dividend of $0.05 per share to be paid in May. So looking at originations, we had a really strong quarter in originations in total and across all of our channels compared to the first quarter of 2017. Total originations were $6.3 billion, which is up 18%. Our core originations were $2.3 billion up 4%, and Chrysler loans came in at $1.9 billion up 24%, leases $2.1 billion up 31%. And importantly, our Chrysler penetration rate improved to 28% versus 23% in the first quarter of 2017. Our originations do reflect some seasonality, but they also reflect the initiatives that we’ve talked about in the last call. We’ve been focused on optimizing our pricing and credit risk management and improving our dealer and customer service. We’ve done this by streamlining the underwriting process and reducing funding time, which make it easier to do – which make it easier for dealers to do business with us. So all in all, we feel really good about the quality of originations that we’ve booked in the first quarter, there has been no change in our target ROA and there has been no significant change in our credit buybacks. Turning to the credit metrics, you’ll see that delinquency ratios remain flat to the first quarter of last quarter. Let’s take a look at the dollars that are delinquent, you’ll see that they are down 6% year-on-year. Now, our overall balances were also down 4% year-over-year but still that’s a pretty good story. Our auction-plus recovery rate improved 400 basis points to 55.1% versus the first quarter of last year. Our net charge-off ratio improved by 50 basis points to 8.3% verus the first quarter of last year and significantly our TDR balances were lower by $263 million versus the fourth quarter, which is more than we expected. So, Juan Carlos will cover that in a more detail, and then I’m sure we’ll have some questions during the Q&A portion of this call to talk about that. So all of these things in lower balances led some more reserve release than we had previously anticipated. And with respect to the used car prices, our outlook hasn’t changed, we still expect less than 5% decrease in prices in 2018. We feel really good about the U.S. economy and we feel really good about the strength of the U.S. consumer in both prime and non-prime. You’ll see that our results continue to reflect the benefit of the Banco Santander U.S. and Santander Group. The floor plan business at Santander Bank grew to $2.1 billion in the first quarter, which is up 9% from the fourth quarter. SBNA also launch the pilot in the first quarter to leverage Santander Consumer to originate and service prime loans. And we expect the full rollout of that – full rollout of that program in the third quarter of this year. We also did a flow transaction with the Group in the quarter for $1.5 billion. The four transactions we’ve done with the Group since 2017. And both of these things, both the pilot and the flow agreement with the Group are positive for our prime business and also our service for others business. In addition, after the first quarter ended, we completed a prime auto loan portfolio conversion for a new third-party for us, which will increase our service for others balance by $1 billion and it demonstrates our ability to do this the service for others business. And we’ll look for more opportunities to capitalize on our capability. Okay, just a brief update on our digital strategy before I turn the call over to Juan Carlos. In the first quarter, we reached an agreement with AutoGravity. This is an addition to the agreement we reached with AutoFi in January. And the goals of these two initiatives are very similar; we want to simplify the car buying process by aligning consumer preferences to our capabilities. And we want to make our finance officer – our finance offers digitally available to more customers nationwide. So with that, I’ll turn it over to Juan Carlos, for a more detailed walkthrough of the presentation.

[Juan Carlos:]

Thanks, Scott and good morning everyone. Turning to Slide 4 for some key economic indicators that influenced our originations and credit performance. The overall microcosmic environment remains stable and supportive of our business. Consumer confidence is high, GDP growth is in line with recent historical range. Unemployment levels continue to be very low and job creation is healthy. These metrics are strong indicators of the state of economy. Despite the gradual downward trend, total auto sales remained robust and are indicative of a stable and healthy market for new vehicles. On the Slide 5, there are a few key factors that can influence our loss severity and credit performance. And as Scott mentioned, we’ve had very good recovery performance, our auction-only and auction-plus recovery rates improved this quarter compared to Q1 last year. Our auction-only recovery rate ended the quarter at 46.8% up from 44.9% at the end of Q1 last year, driven by improved performance across almost all of our vehicle types including vans, trucks and SUVs. Our auction-plus recovery rates which include insurance, insurance proceeds, bankruptcy and efficiency sales were 55.1% in the quarter up from 51.1% the same quarter last year. We turn to Slide 6, our total core retail auto loan originations increased 4% in the quarter compared to the prior year quarter. Total Chrysler loan originations increased 24% during the same period including growth for both the greater and less than 640 FICO and leasing originations continue to be a strong increasing 31% compared to Q1 last year. Our strategy remains to increase non-prime volume by targeting the appropriate risk return profile leveraging the Santander programs for prime originations and maintaining a strong presence in lease. As Scott said, this was a strong quarter for originations and we’re encouraged by the results. We’ll continue to fine tune our pricing and credit risk management, streamline our underwriting process and work to improve our dealer and customer experience. Turning to Slide 7, we’re pleased to report that our average quarterly FCA penetration rates was 28% for the quarter up from 23% in the prior year quarter. We’re continuing to optimize our full expect from lending and servicing platform across loans, leases, floor plan and third-party service. Turning to Slide 8, our service for others balance increased in Q1 compared to the prior year quarter but an increase sequentially as we executed another flow transaction with Santander for $1.5 billion in Q1. Servicing fee income totaled $26 million this quarter moving forward we expect to drive this platform by continuing to increase prime origination. And also in next quarter you will see the additional assets from the third-party portfolio conversion that we completed in April. Let’s move to Slide 9 and review our finance performance for the quarter. We’ve had a encouraging start to the year with net income for the quarter of $242 million up from $143 million during Q1 of 2017. Interest on finance receivables and loans decreased 8% year-over-year primarily driven by lower average rate balances. Interest expense increased 6% versus the prior year quarter primarily due to higher market rates in the period, partially offset by favorable derivatives, which decreased interest expense $70 million compared to Q1 last year. Provision for credit losses decreased to $459 million in the quarter from $635 million in Q1 last year. This decrease in provision is driven by a combination of lower balances, stabilizing credit performance and higher recovery rates. Total other income was $25 million in the quarter and included $59 million of lower cost or market adjustments related to the held for sale personal lending portfolio. This comprised of $106 million in customer charge-offs, partially offset by a $47 million benefit in market discount, consistent with seasonal patterns. Turning to Slide 10. We’ll review vintage performance. This slide is placed gross and net losses for 2014 through 2016 vintages and consistent with our update from last quarter, our 2016 vintage continues to outperform the 2015 vintage on a gross as well as net loss basis. We still believe that 2017 vintage will likely fall somewhere between the 2015 and 2016 vintages in terms of gross and net losses. Continuing to Slide 11. The 31 to 60 and 60-plus delinquency rates in the quarter were flat compared to Q1 last year. Gross charge-off dollars decreased $25 million in the quarter compared to Q1 last year. However, the gross charge-off ratio of 18.5% in the quarter increased 40 basis points from Q1 last year, due to average rates, the denominator in the ratio decreasing by approximately $1.2 billion or 4% over the period. On a net basis, net charge-off dollars also decreased this quarter, down $61 million versus Q1 last year. Our rate net charge-off ratio of 8.3% is down 50 basis points from Q1 last year. As evidenced by our flat delinquency ratios and lower net charge-off ratio, we’re seeing continued stabilization in credit performance supported by improved recoveries. In addition, and as predicted, some of the hurricane related benefits we have experienced in Q3 and Q4 of last year have begun to reverse in Q1. Turning to Slide 12 to review the loss figures for the quarter in dollars. Net charge-offs for individually acquired RICs decreased $61 million in the quarter to $538 million which was primarily attributable to lower RIC balances. Stabilizing credit performance and improving recovery rates. Let me briefly address the components of the work. $24 million in higher losses due to a higher gross charge-off rates was more than offset by $42 million in lower losses due to better recovery rates for a net decrease of $80 million. The $27 million decrease in balance is the result of lower average RIC balances over the same period, and therefore, lower opportunity for losses. And then the $60 million decrease in the other category is primarily driven by fewer bankruptcy loans write downs compared to the prior year quarter. Now turning our attention to provisions and reserves on the Slide 13. At the end of Q1 2018, the allowance for credit loss totaled $3.2 billion decreasing $80 million from last quarter, which represents an allowance to total to loans ratio of 12.3% at the end of the quarter, down 30 basis points versus the same period. I’ll now go over the components of our reserve book. The allowance increased $140 million due to new originations in the quarter and $59 million due to TDR migration. These increases were more than offset in our allowance by a $70 million decrease due to favorable performance adjustments and $209 million decrease due to liquidations and others, which includes payoffs and charge-offs. Let’s now turn to Slide 14 to discuss TDRs in more detail. We provided the similar update during our Investor Day in February of last year. TDR balances decreased $263 million in Q1 2018 to $6 billion from $6.3 billion in the prior quarter. This is the second consecutive sequential decline. Now as you can see, there are considerable portion of older vintage TDRs that remain on our balance sheet, dating back to 2013. In prior vintages, demonstrating this modified lines continue to perform. In addition, while the contribution of the 2015 vintage of TDRs is decreasing, this still represents 35% of the TDR balance as of the end of Q1. As a reminder, once the loan becomes a TDR, it will remain a TDR unless it pays off or charges off. Turning to Slide 15. Operating expenses this quarter totaled $288 million a decrease of 6% versus the same period of last year. This decrease was primarily attributable to discipline expense management and severance and legal expenses in Q1 last year. Expense ratio for the quarter totaled 2.4% flat versus the prior year quarter. Turning to Slide 16, our funding and liquidity position remains strong with total committed funding of more than $42 million. As we continue to demonstrate consistent and deep access to the capital markets, we have been offered and sold $3.3 billion of new ABS transactions in the quarter, including SRIP and DRIVE transactions. Subsequent to quarter end, we also completed $1 million [indiscernible] transaction. And in Q1, we also completed our second SRT lease ABS securitization, which continues to optimize our finding and structure and to improve the cost of funds for Chrysler lease assets. Also of note, we renewed $1.8 billion of our non-prime revolving warehouse facilities in the quarter, expanding the maturities for our core business. Finally, turning to Slide 17. Our CET1 ratio for the quarter is 16.9%. As Scott mentioned, we are declaring a cash dividend of $0.05 per share for the second quarter. Earlier this month, SHUSA submitted it’s updated capital plan to the Federal Reserve, and we look forward to updating you once the results for the upcoming capital planning cycle are released. In terms of guidance, we’ll provide guidance for the second quarter. My comments will be relative to Q1 unless or otherwise noted and will include the impact of personal lending. Despite net finance and other interest income, we have 1% to 3%, primarily driven by higher loan on lease balances. The recent expense is expected to be down $20 million to $60 million, attributable to seasonally strong credit performance in the second quarter. We expect total income to be flat to $20 million lower, in line with seasonal patterns. Operating expenses are expected to be flat, around $20 million, attributable to seasonally lower reposition expense and disciplined expense management. Before we begin Q&A, I’d like to turn the call back to over to Scott.

[Scott Powell:]

Thanks, Juan Carlos. Yes, so to sum things up, we’re off to a good start in the year, with strong originations. I’d say, stable-to-improving credit trends, which is good to see as well as the initiatives that we’ve been focused on paying off in terms of strengthening our management team and optimizing around credit and pricing per risk in our business. And we’ve also seen improvements in our efforts to improve the dealer experience when they deal with us, so that all feels pretty good to us. I’d also like to announce that Santander Consumer is launching a new Corporate Social Responsibility program at the end of the second quarter. It’s going to include about $1 million of targeted charitable giving in our communities. We’re going to get our employees engaged through volunteer opportunities with non-profits that promote economic mobility and financial inclusion. And this is part of Santander’s broader corporate social responsibility commitment in the United States. So with that, we’d like to open it up to questions. Over to you, operator.

[Operator:]

[Operator Instructions] We’ll go first to John Hecht, Jefferies.

[John Hecht:]

Good morning, guys. Thanks very much. I guess, the first question is, maybe thinking of advising as much as anything, just our interpretation of the trust data during the quarter, that is to believe that charge-offs would be a little bit higher than they actually came out to be. I’m just wondering is there a different characteristic of loans that aren’t in any ABS structure right now, that are generally stronger than those in the ABS trust or is there any other way we should be thinking about that at this point in time?

[Juan Carlos:]

Yes. Thanks. I think, one of the key drivers of the discrepancy, if you will, is the fact that in the trust data, you have a growing percentage of DRIVE in there, which, as you know, is a deeper type of non-prime product. So that might be swaying the overall charge-off. So I think it’s just a matter of mix in the trust data versus what we actually have on the balance sheet.

[John Hecht:]

Okay, appreciate that. That’s helpful. And then second question, I guess, to JC as well, your TDR migration two sequential quarters with this coming down, we’ve seen the performance of 2015 versus 2016. Should we – at this point, is it fair to think that the TDR migration should be relatively down every quarter or is there some reason where this would be variable, depending on the quarter?

[Juan Carlos:]

No, we still expect the trends to be very gradually down. One thing to note, if we look at Q1 performance, we’ve had, overall, as we just discussed, a very good credit performance. Q1 that tends to see seasonal higher pay downs across the board and also on TDRs. And we also had some of the increase in TDR balances that came back in Q3. Some of those have reversed into Q1. So I would say that the delta during Q1 is reflective of the general direction but probably, the magnitude in Q1 was a little bit larger than it would have been otherwise, okay? But they were all trend with respect to gradually trend down.

[Scott Powell:]

Especially as 2015, becomes the smaller and smaller part of that portfolio. Now the offset to that, which is a year or so down the road is, if we have strong originations for the rest of the year. That is, all things being equal and unchanged, that will obviously, increase the influence of TDRs as well. But that’s down the road a fair piece.

[John Hecht:]

Great. I appreciate all that color. Thanks guys.

[Juan Carlos:]

Thank you.

[Operator:]

[Operator Instructions] We’ll go next to Vincent Caintic with Stephens.

[Vincent Caintic:]

Hey, Good morning. Thanks very much guys. First on the Chrysler penetration rates, so a improvement from last quarter and last year. I’m wondering if you could maybe describe some of the execution that you’ve done in order to improve that penetration rate and what should we expect that to continue to move higher and what sort of your target levels over time?

[Scott Powell:]

Yes. Thanks for the question. And it is what I’ve been describing, kind of as a general improvement in our optimizing pricing for risk across all our channels, and especially, with Chrysler. So we’re taking a much more granular approach to how our pricing for risk and finding those opportunities for improvement. We do work very closely with the Chrysler team around promotions they have and making sure we’re closely collaborating with them on how to drive business in the peak selling seasons. So there isn’t any real – there’s no magic to it. And as I said, we are not expanding our credit buybacks we’re not changing our ROA targets. So this is really been more focused on originating the right business at the right price. And then, being very focused on the Chrysler dealers skills, making it easier for them to do business, understanding issues that get in the way of them working with us, including improving our speed to funding. So it’s kind of a whole series of things, which are starting to pay off now – starting to pay off in the fourth quarter, and we’ll continue to move forward with those things. So I would – we’re going to look for ways to increase it. I can’t guide you to anything much different than where we are today, but we are hard at work on it and very focused on it.

[Vincent Caintic:]

Great. That’s helpful. And maybe relatively, have you maybe – have you seen more engagement from the Chrysler side, is that been pushing – I guess, I’m particularly interested with rising interest rate environment and how that plays out. Thank you.

[Scott Powell:]

Yes, we have – since I joined in September and Juan Carlos joined in September and then Rich Morrin moved into a different role, which really focuses on Chrysler. I would – yes, it’s fair to say there is a lot more engagement with the Chrysler team around like I said, their initiatives, things that are important for them, the models that are important to them, both on the lending and leasing side. And I think we’ve got ourselves into a pretty good rhythm with them. And you know, rising rates are, and it’s going to be a challenge. We also do a lot of used car financing so I don’t see that as a impediment on the production side.

[Vincent Caintic:]

Okay. Great. Thank you.

[Operator:]

Our next question comes from Rick Shane with JPMorgan.

[Rick Shane:]

Hey, guys. Thanks for taking my question. Given the auction-plus platform, as you guys have unique access to data about what’s going on in the used car market. I am very curious if you were seeing any changes over time related to Rideshare? Are there certain cars that are showing up with more miles that you’re more concerned about or anything that you’re altering your strategy, as we we’ve seen Rideshare sort of disrupt the way Americans use their cars.

[Juan Carlos:]

I can’t say that if related to Rideshare but remember that we do get the stable, high mileage on the vehicles that we take to auctions, those by the nature of our portfolio. But the improved performance has been pretty much across almost all of our vehicles, and we do have – also, we have seen lower balances at the time of reposition. So in time that investors – sorry, customers are sustaining those vehicles for a bit longer. But as a whole, it’s an improvement in terms recovery rates.

[Rick Shane:]

Got it. [indiscernible] with higher mileage?

[Juan Carlos:]

No, they trended to have them but again, also a lower balance, okay. So all in all, it’s an improved recovery rate. Also important to note that if we give some thought to your question on Rideshare, the bulk of our portfolio is focused on Texas and Florida, California, and Rideshare is probably more focused on metropolitan areas.

[Scott Powell:]

Yes, I think, we haven’t really gone through and taken a look at it that way. It might be kind of interesting for us to do that. You certainly can go pause the data and take a look at it that way. We haven’t seen a big driver, right? I mean, It is true that from 2016 to 2017, demand for used cars has clearly gone up, and I’d say more than offset the decline in our used cars. So it’s an interesting question. But we’ll go look at it. We’ll dig to the detailed data on that point. We haven’t really seen it so far though.

[Rick Shane:]

Okay. Great. Thank you guys.

[Scott Powell:]

Yes. Thank you.

[Operator:]

We’ll go next to Moshe Orenbuch with Crédit Suisse.

[Moshe Orenbuch:]

Great. Thanks. Maybe given that you guys have been able to increase your originations in the core sub-prime without expanding the credit box. Can you talk a little bit about the competitive environment? I mean, we’ve talked to some competitors who said things are pretty good and then some who are saying it’s really tough to make loans. So you maybe talk a little about what you’re seeing and how you’ve been so successful.

[Scott Powell:]

Well. Moshe, it’s a really fragmented marketplace. So it’s a little hard to read the ins and outs of the competitors. You know the guys that are in and out some of the big name brands are pulling back and – but it remains a very, very competitive space. And so, we do look at what other people do for pricing and compare prices across different cells. But it feels just as competitive as it’s always been to us. I mean, there aren’t any big movers in the market one way or the other but there are people are going in and out but because there’s so many players in the space that it’s hard to say who is going out or coming in on this one.

[Moshe Orenbuch:]

Okay. Thanks. But it does feel like given the level of originations and kind of the pay downs that you’re seeing that we’re likely to see the balance sheet growth for 2018. And so, maybe – I know you’ve given guidance for Q2, but could you kind of just talk through what the implications are from a standpoint on a slightly longer-term basis, net interest income and provisioning, any kind of additional color you can kind of give?

[Juan Carlos:]

Yes, you’re right, we’ve had a very good start to the year in terms of originations and credit performance. We feel good about where we are and started the second quarter. But in terms of balance sheet growth, remember that these are assets that pay down fairly quickly. So replacing the back book is not easy. We hope to continue to take advantage of the opportunities that the market will give us at the right risk adjusted returns. So that’s what I can tell you in terms of replacing. In terms of provisions, we guide for a quarter out, but again, we feel good about the – we feel good about what we’ve seen in Q1 at this point in time.

[Moshe Orenbuch:]

Thank you very much.

[Operator:]

We’ll go next to Betsy Graseck with Morgan Stanley.

[Betsy Graseck:]

Hi, good morning. A couple of questions, one is on – just questions around the submission you mentioned that SHUSA put the submission in. And I was just wondering was there anything left to do to satisfy regulatory requirements this year anything that you are still working to complete for the regulars from your end. I’m just wondering if there’s anything going on there.

[Scott Powell:]

Well, there are regulatory issues we are working on. There’s one public agreement out there related to compliance with the Federal Reserve. So that is certainly on the horizon for something to work on but – where you started your question, it doesn’t have any that – the exist use of that agreement doesn’t have anything directly to do with our capital plan initiatives. It’s not impediment, it’s out there, it’s a big regulatory issue that we’re working to address.

[Juan Carlos:]

And that’s what the…

[Betsy Graseck:]

Sorry, go ahead.

[Juan Carlos:]

I was going to add that in terms of the capital plan, SHUSA’s capital plan submission like we said last quarter all the different capital alternatives in capital actions were available to us, and we look forward to seeing those results come soon.

[Betsy Graseck:]

Okay. And the other question is, obviously there’s a rule change in Europe that is requiring Santander to not count some of the capital that they count for you. They’re holding in you already. And so, the question is, whether or not that matters to you or not. Just wondering how you read that ECB rule change for your parent’s parent.

[Juan Carlos:]

It doesn’t impact how we treat our capital ratios or anything of that kind, here locally or at the SHUSA level. So it hasn’t impacted our capital planning or capital transformation at the foreign level.

[Betsy Graseck:]

Okay. So then the other question just on recoveries, recoveries obviously really strong this quarter I know you had some conversation earlier on about the type of product that you’re underwriting. But is that the only reason for the recovery improvement or is there anything else going on there?

[Juan Carlos:]

No, we think, it’s been a pretty broad performance, pretty much across the entire spectrum of vehicles. Yes, I think, we’ve seen a general trend in Q1, both in metal and as well as non-metal.

[Betsy Graseck:]

Okay, thanks.

[Operator:]

We’ll go next to Geoffrey Elliott with Autonomous Research.

[Geoffrey Elliott:]

Good morning thanks for taking my question. Maybe first on the Santander capital change that you mentioned. Can you just explain to everybody exactly what has changed and then, does that, in any way, change the thinking about putting Santander Consumer minorities getting bought out? Kind of feels like it might change the discussion there a bit.

[Juan Carlos:]

No, I really can’t – look, Group had their earnings call earlier today. I believe they had some material related to this, so you should review those. And like I said, it hasn’t changed in any way, shape or form or capital planning process here locally and nor our operations at all.

[Geoffrey Elliott:]

Okay, thank you.

[Operator:]

We’ll go next to Eric Wasserstrom with UBS.

[Eric Wasserstrom:]

Great. Thank you for taking my question. Juan Carlos, just a follow-up on the TDR discussion for a moment. How do we think about, given the trend that you’ve signaled, which is obviously, very constructive. How do we think about the, like, incremental contribution to provision expense from TDRs going forward?

[Juan Carlos:]

Yes. TDRs carry a higher coverage ratio, as you would expect. So primarily, it’s been – we’ve had good performance but it will be primarily a function of the balance. As we discussed earlier today and in previous calls. So in terms of the key those balance trends that we discussed earlier, and we expect those for the rest of the year to gradually trend down, okay? There will be ebbs and flows, right. The Q1 move was relatively large – larger than we expected. And as I alluded to earlier, particularly the hurricane-related TDRs did pay down faster than we expected. But that aside, the trend should remain for the rest of the year.

[Eric Wasserstrom:]

Great, thank you for that. And if I just may follow-up on one piece of guidance, the expectation around net interest income. Can you help me understand to what extent that’s a function of changes in spread or changes in the size of the balance sheet. Or I guess, really the core of my question is, given the strong originations, how should we think about balance sheet growth from here.

[Juan Carlos:]

Yes, it’s – look, I’m glad you asked because I should have mentioned this to the earlier question. NIM, we are able to pass along the higher rates to customers, right, in our underwriting. It’s still, as Scott said, a competitive environment, but we have been able to do some of that with certain luck, if you will. But the higher rates continue to be a headwind for us, right. The cost of funds has increased year-on-year. With some hedging on our side, we’ve been able to moderate that impact. That continues to be a headwind on our spread. So as we go and look ahead, it will be primarily a function of balances. And given the strong start that we’ve had in originations, we should see that flow through to the top line in the coming quarters.

[Eric Wasserstrom:]

Great, thank you very much.

[Operator:]

Our next question comes from Chris Donat with Sandler O’Neill.

[Chris Donat:]

Hi, good morning. Thanks taking my question. Wanted to revisit one issue related to the securitizations, which is the rapid growth in the balances on the DRIVE securitization platform and the relative shrinkage in the SDART securitization. Is that reflective of a strategy on your part or the actual originations in the mix there or what investor demand is for securitizations. I’m just trying to understand the dynamics of why those two platforms are moving in opposite directions for balances?

[Juan Carlos:]

No, it’s reflective of – remember that we have, the DRIVE tends to be like I said in terms of credit. But we tend to remember that DRIVE hasn’t been active for quite some time. So there’s some catch up there. And now the sequence is a little more normalized so it just represents a bigger share of what it used to be. But it now represents of any particular intent or strategy of going deeper, more towards the DRIVE platform.

[Chris Donat:]

Okay. And then just from my follow up, just to be clear on – that 55.1% recovery rate for auction-plus, there’s nothing unusual or sort of one-time in there related to insurance proceeds or anything like that, right? It’s just a strong number?

[Juan Carlos:]

Okay.

[Chris Donat:]

Okay. Just checking.

[Operator:]

We’ll go next to Kevin Barker with Piper Jaffray.

[Kevin Barker:]

Thank you for taking my questions. In regards to the changes in your servicing practices that now count borrowers with at least 90% of payment versus 50%. Has this impacted your expectations for TDRs going forward, and has it impacted your expectation for recovery rates like we’ve seen this quarter?

[Juan Carlos:]

[indiscernible]

[Scott Powell:]

Kevin, are you talking about in order for a payment to be considered complete, it was changed on the SC side to 90% instead of 50%. In the past, it’s always been – Chrysler has always been 90%, so I think we’re just aligning the two platforms.

[Juan Carlos:]

They are both 90% now.

[Scott Powell:]

Correct.

[Juan Carlos:]

Yes. So the question was?

[Kevin Barker:]

Do has that had an impact on your expectations for TDRs and recovery rates?

[Juan Carlos:]

No. Not meaningfully, no. It’s just aligning the two.

[Kevin Barker:]

Okay. And then one of your competitors mentioned big changes to their accounting policy due to Cecil. Going forward, what are your expectations and how you’re going to address Cecil and the impact your reserving methodology?

[Juan Carlos:]

Yes, we saw that. Look, we’re not still some time away. It’s too early at this moment to give guidance in terms of the impact. What we saw was also the – we had a little bit more clarity in terms of what is intended. You might’ve seen the NPR, what is the intended treatment for excess reserves on capital. But it’s still too early to give you an estimate. And at this point in time, we are not considering any change in accounting, specifically, for Cecil or otherwise. Don’t forget, I think the company that did it is a smaller, stand-alone company. We align all type of accounting principles also to SHUSA and across Santander. So it’s not something that we are considering at this time.

[Kevin Barker:]

Thank you.

[Operator:]

We’ll go next to Jack Micenko with SIG.

[Jack Micenko:]

Hey, good morning guys. Wanted to ask a bit about the allowance. Here you on the TDR really been driven by the top line of those balance but if you think that TDR allowance ratio came down pretty significantly quarter-to-quarter. Obviously, the non-TDR was the originations something more pronounced on the TDR side about 100 basis points. I know you had the $70 million positive adjustment to just trying to reconcile all of that and what you’re thinking is and was the 26

[Juan Carlos:]

No, I think, in balance, it was overall credit performance and balance were the key factors. Now as we’ve mentioned before, there are many variables that impact our allowance. And frankly, as we look ahead, we have to think about strong originations in the quarter and expectations for continued strong originations in the future and all those other factors. So the key drivers is balances and credit performance in this quarter.

[Jack Micenko:]

Okay. So think about the TDR allowance ratio this quarter is more of an one-third.

[Juan Carlos:]

Yes.

[Jack Micenko:]

Okay. And then, Scott, 69 Tier 1, I think you said in the past, do you think 12 in the business the right way. Has that 69 come down over the next 12 or 18 months, is that – can you talk about sort of broad strokes on what your thoughts on there?

[Scott Powell:]

I didn’t quite follow that one.

[Evan Black:]

The Tier 1 capital, 69 and what our expectations for that?

[Juan Carlos:]

We talked about our capital targets being 12.5%. Originally, we are running with a significant amount of excess capital at this point. And that is the – that is what we incorporate into our analysis, as we submitted our capital plan.

[Scott Powell:]

Yes, and with – sorry, JC, and what we said last time was going into this capital stress testing cycle would be a different, we would take a different approach than we did in the previous one, right? Because that was the first time we expected to pass. And so, we did take a very conservative approach for the capital plan that got improved for these past four quarters. And I would just tell you, we have taken different approach for the capital plan when we submitted this time. Call it step in the right direction or more towards a normalized way to think about and manage capital distributions.

[Jack Micenko:]

I appreciate that color. That’s very helpful, thank you.

[Scott Powell:]

You bet.

[Jack Micenko:]

That’s helpful. Thank you.

[Operator:]

We’ll take our next question from David Scharf with JMP Securities.

[David Scharf:]

All right. Good morning. Most of my questions have been answered but maybe just a couple of follow-ups. First, regarding the spread between auction and auction-plus, I know somebody asked whether there were any one-timers and it sounds like the answer is no. But can you comment on whether or not looking ahead you are generally planning on selling more charge-offs. Are those becoming a more prominent part of recoveries?

[Juan Carlos:]

No, we don’t intend to our strategy there. We’ve – we do that on a regular basis so we haven’t set…

[Scott Powell:]

Opportunistic basis is the way I’d describe it but no change in our strategy.

[David Scharf:]

Okay, great. Because I know there are only a few buyers of those secured losses. So there are no flow deals or anything like that, got it. And then just a follow-up on credit. JC, are you able to share with us what the implied ending allowance rate that supports the provision guidance? I mean, is 12.3% the right ballpark we ought to be thinking about for the next few quarters?

[Juan Carlos:]

We don’t guide on the ratio. And I give you a range for the quarter because as you know well, there’s a number of factors that goes into our calculation. We are adequately served and intend to remain so. So it’s hard to give you more than that.

[David Scharf:]

Perfect. Thank you.

[Operator:]

We’ll go next to Mark DeVries with Barclays.

[Mark DeVries:]

Yes. Thanks. A few more questions on recoveries for you. Have you seen signs that both kind of the contraction and supply and increase in demand as a result of vehicle destruction under the hurricane had an impact on recoveries? And, kind of, what your expectations going forward for what recoveries are going to trend?

[Juan Carlos:]

We saw some and we talked about it last quarter. We wanted to make sure that the support and the recoveries was out of the way. We saw some of the normalization in Q4. So we think that for the most part, it’s paid through. And in terms of our outlook going forward, just used car prices. Last quarter, we talked about our expectation was more or less in line with the industry, and we’re looking for a overall drop of less than 5%. I think that deal generally remains, although, we’ve seen some moderation in terms of those expectations from industry players. But we’re still incorporating a overall drop in used car prices.

[Scott Powell:]

And certainly, it helped the demand for our used cars, especially, trucks, right? Because we’ve seen industrywide seen a pickup in demand for trucks and the sales for pickup trucks related to those vehicles. So I don’t know if that’s hurricane related but there’s certainly a lot more trucks being sold than previous periods.

[Juan Carlos:]

The length that we saw in Q3, we sort of saw normalizing in Q4, and we think it’s a breakthrough.

[Mark DeVries:]

Okay, that’s helpful. And then, is there any update that you can provide us on the sales process for the Bluestem portfolio?

[Juan Carlos:]

No, nothing new to report. We’re delighted and continue to work with our partners at Bluestem to optimize that relationship as well.

[Mark DeVries:]

Okay, got it. Thank you.

[Operator:]

We’ll go next to Steven Kwok with KBW.

[Steven Kwok:]

Great. Thanks for taking my questions. Just a follow up around Cecil, can you comment around what – how should we think about the weighted average life of the portfolio?

[Juan Carlos:]

So the weighted average life of our portfolio is a little bit over two more or less the rule of thumb that we go by for the entire portfolio.

[Steven Kwok:]

And what just on the retail installment auto loans?

[Juan Carlos:]

Roughly the same thing.

[Steven Kwok:]

That’s roughly, okay. And then, have you seen any impacts around tax reform on the consumer and how that’s been evolving?

[Juan Carlos:]

Yes, we were looking for signs but generally, still too early to tell. Definitely, a benefit. Folks have more dollars in their pockets but it’s still too early to say.

[Steven Kwok:]

Great. Thanks for taking my questions.

[Juan Carlos:]

But for us, the key things to – unless where we put it in the bank, the key macro points to look at continues to be the employment market, right, job creation. That is critical to us.

[Scott Powell:]

Yes, and we do believe that for folks there starting to see the impact of tax in their paychecks is that translated into demand for cars, it’s hard to see but certainly not going to hurt us, right. In addition, this season is a big for our core and non-prime business, tax season – tax refund season is a big part of that driver. So our volume tends to decline in core non-prime for the rest of the year. Not so much so for the Chrysler part of the business. We’re reading those TVs too so we think it’ll help us, it’s just hard to see.

[Steven Kwok:]

Got it. Thanks for taking my questions.

[Operator:]

We’ll take our next question from James Fotheringham with Bank of Montreal.

[James Fotheringham:]

Thank you. Two more question on capital, if I may. I’m wondering about the general scope of CCAR submission did it include a request to buy any SC minorities in addition to dividends and buyback? And secondly, I wanted to know if – did you know about the ECB’s derecognition of the SC majorities to Banco CET1 before or after you submitted your capital plan to the Fed? Thanks.

[Scott Powell:]

These are some good question. We’ve certainly had discussions, like I’m on the Executive Committee of Santander Group too. So there’s certainly conversations about how that change is going to impact the capital ratios of our Group if it is a pretty significant change but as it relates to the minority here first of all, we can’t tell you when we stuck in our capital plan that’s confidential information, and just like Jose Antonio Alvarez the Group CEO said this morning, there’s nothing happening. Have be on our guard all the time.

[Juan Carlos:]

And it’s called rate that’s an impact on capital planning here.

[Scott Powell:]

Not at all, exactly.

[James Fotheringham:]

Thanks, guys. Thank you.

[Operator:]

Our next question comes from Michael Tarkan with Compass Point.

[Michael Tarkan:]

Thanks. Most of my questions have been asked but I do have one follow-up. On DEFAST this year any impact from proper treatment of sub-prime auto that we should expect?

[Juan Carlos:]

We talked about that. I think, one call – one question on that during the last earnings call. You might remember from looking at last year we sold all the stress assumptions having higher than the Fed’s own stress assumptions, and we think we have – we are looking at the right way. We are always higher than them. So it will be interesting to see how they’ve updated their results. We never know exactly what is under the hood. Those continue to be on the run. We don’t see a lot of detail on it. So like we said last time, it hasn’t impacted how we have gone about or analysis, which we think is adequate and conservative.

[Michael Tarkan:]

Thank you. That’s all I got.

[Operator:]

We’ll take our final question from Arren Cyganovich with Citi.

[Arren Cyganovich:]

Thanks, I’ve got another question on capital. Can you remind me what the process is relative to SHUSA and how that impacts your requests for capital just kind of hit the dynamics there and if there’s any limitations whatsoever for you to get your capital plan approved through them? Thanks.

[Juan Carlos:]

Yes, I think we have commented on this before. The capital plan submission to the Federal Reserve is SHUSA consolidated capital plan just like every other bank holding company of that size. Our capital plan is analyzed here locally and then is submitted to SHUSA for then SHUSA to make that consolidated submission to the Federal Reserve. So our capital analysis, like we said, 12.5% is a reflection of what we view here at the company at SC. And then any capital actions have to make sense for us at SC but also on the consolidated view on the consolidated SHUSA capital plan.

[Arren Cyganovich:]

Great. Thank you.

[Operator:]

And with no further questions in queue, I’ll now turn the call over to Scott Powell for final comments.

[Scott Powell:]

Great, thanks. Thanks, everyone, for joining the call today. Appreciate the questions. We appreciate your interest in our company. As always, the Investor Relations team will be around for follow-up questions. So feel free to reach out to that team. Thank you, guys, see you soon.

[Juan Carlos:]

Thank you.

[Operator:]

Ladies and gentlemen, this does conclude today’s conference. We thank you for your participation. You may now disconnect.