Santander Consumer USA Holdings Inc.
Q2 2018 Earnings Call Transcript

Published: 25 Jul 2018

[Operator:]

Good morning, and welcome to the Santander Consumer USA Holdings Second Quarter 2018 Earnings Conference Call. At this time, all parties have been placed into listen-only mode. Following today’s presentation, the floor will be open for your questions. [Operator Instructions] It is now my pleasure to introduce your host, Evan Black, Vice President of Investor Relations. Evan, the floor is yours.

[Evan Black:]

Thank you. Good morning, everyone, and thanks for joining the call today. On the call, we have Scott Powell, President and Chief Executive Officer; and JC, CFO. 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 the 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, July 25, 2018. For those of you listening to the webcast, there are a few user-controlled slides to review as well as the full investor presentation on the IR website. With that, I'll turn the call over to Scott Powell. Scott?

[Scott Powell:]

Great. Thanks, Evan. Good morning, everybody. First off, we would like to start by sending our condolences to the friends and family of Sergio Marchionne and really send our best of the management team at FCA segue through this challenging time. So I'll start by hitting some of the highlights of the second quarter and then turn it over to Juan Carlos. But let's go to Page 3 of the presentation. So the big headline, of course, is we had a really good, solid quarter and really that's a result of us following through on the initiatives that we've been discussing on prior calls. We really feel like our strategy is working and producing results. And the second quarter results demonstrate that and the strength of our business. And so you can see that net income totaled $335 million, which is up 26% compared to the same quarter last year. Importantly, our return on average assets was 3.3%, which is up from 2.7% in the same quarter last year. And then on the regulatory front, we received a non-objection from the Federal Reserve to our capital plan for the second consecutive year, which we're very proud of. And again, this marks another significant regulatory step for us at Santander Consumer and Santander U.S. As a result, we're declaring a $0.20 dividend for the third quarter, which is up from $0.05. And we're announcing the board authorized the $200 million inaugural share repurchase program that will be executing over the next 12 months. Looking at originations, again a really good second quarter for originations. You'll see that originations are up across all of our channels. Total originations were $7.9 billion, up 45% from the second quarter of last year. Core was up 15%; Chrysler was up 51%, up $2.7 billion; and importantly, our penetration rate with Chrysler was up from 20% in the second quarter of last year to 32% in this quarter. Overall, as I said, our results really demonstrate that we're following through on the initiatives that we discussed on the prior calls. We continue to optimize our pricing and credit risk management. And we have increased our volume without taking on additional risk. So we're neither expanding our credit buybacks nor we're moving upmarket, okay. We kind of in our sweet spot with respect to the trade-off between net charge-offs and ROA. So we feel pretty good about where we're at right now. We are improving our dealer and consumer experience. We're streamlining our underwriting process. We're making easier for dealers to do business with us. And importantly, we continued to be very disciplined on expenses. Our expense ratio this quarter is 2.2%, which is exactly the same as it was in the second quarter of last year. In addition, we continued to be focused on important initiatives in the prime space. We are expanding our presence in the prime space through our serviced for others program. And then, very importantly, and this is an important strategic initiative for us, we've launched a flow program at our bank in Boston, SBNA, which launched on July 2nd. And our plans are to grow that program and run. Turning to credit. We see very stable credit performance. And quite candidly, we were a little bit surprised by how strong the credit performance was in the quarter. So you can see that our delinquency, if you're looking at the accounts, which are 60 days and worse, decreased by $138 million or 11%. Gross charge-offs in the quarter decreased by $100 million, 9% year-on-year, and our gross charge-off rate decreased by 120 basis points. And net charge-offs decreased by $140 million or 22%. Our charge-off rate was down 150 basis points. And a really positive sign is that our auction-only recovery rate improved from 44% last year to 47% this year. I'm sure we'll talk more about our TDRs. Our TDR balances did come down by $40 million from the first quarter to the second quarter. And we'll talk down about our expectation for the rest of the year, but we would expect that to – those balances to decline slightly over the rest of the year. And so our provision expense was down $168 million compared to the second quarter of last year. I guess the last thing I’d like to touch on, again, is the benefit of Santander Consumer being part of group of Santander and Santander U.S. From the group's perspective, we completed $1.2 billion flow transaction, which is our fifth transaction since we started that program with the group, and we expect one more transaction with the group. From the Santander U.S. perspective, I already mentioned the rollout of the program with SBNA. And that program really benefits both Santander Consumer and SBNA. So being part of the group and being part of the Santander U.S. really helps us drive our competitiveness in the prime space by leveraging our serviced for others platform And then, maybe I should have started the call with this, but lastly, I'm sure you have a lot of questions about our discussions with Chrysler, and we're happy to try to answer them. But I guess, the two key points here are, we continue to operate in BAU mode with respect to Chrysler. I think our results reflect that. And we don't have any new developments to report in our discussions with Chrysler on their desire to have their own captive finance company, but the discussions continue. So with that, let me turn it over to Juan Carlos.

[Juan Carlos:]

Thanks, Scott and good morning, everyone. Turning to Slide 4 for some key economic indicators that influence our originations and credit performance. The overall macroeconomic environment remains stable and supportive of our business. Consumer confidence remains high. GDP growth is in line with the recent historical range. Unemployment levels continued to be very low and job creation is solid. These metrics are strong indicators of the state of economy. And despite being off their peak, total auto sales remain robust and are indicative of a stable and healthy market for new vehicles. On the Slide 5, there are a few key factors that influence our loss severity and credit performance. As Scott mentioned, we had very good recovery performance in our auction-only. In auction-plus recovery rates improved this quarter compared to Q2 last year. Our auction-only recovery rate ended the quarter at 46.5%, up from 44.1% at the end of Q2 last year, driven by improved performance across most vehicle types, better overall used vehicle pricing trends and higher average payments made at the time of repossession, which leads to lower outstanding balances at auction. Auction-plus recovery rates, which include insurance proceeds, bankruptcy and deficiency sales and dealer recoveries, were 60.6% in the quarter, up from 53.9% the same quarter last year. Some of the industry forecast now expect used car prices to stabilize or increases slightly during the year, which will speak to the performance that we're seeing at auction. We'll remain constructive for the remainder of the year keeping in mind difficult seasonal patterns. We turn to Slide 6 for origination trends. We see that this is the second consecutive quarter with year-over-year increases across all our auto channels. Our total core retail auto loan originations increased 15% in the quarter compared to the prior year quarter. Total Chrysler Capital loan originations increased 51% versus the prior year quarter, including growth for both the greater and less than 640 FICO channels. Lease originations continued to be strong, increasing 84% compared to Q2 last year. As a reminder, the second quarter is a seasonally strong quarter for originations due to tax season, but we are very encouraged by this quarter’s results following our continued efforts to optimize our pricing, credit risk management, as well as the enhancements for dealer and customer experience that we discussed with you over the last several calls. Our strategy remains to increase nonprime volume by targeting the appropriate risk return profile, leveraging the Santander Bank origination program that Scott mentioned for prime and maintaining a strong presence in lease. Turning to Slide 7, in line with our positive origination trends, our average quarterly FCA penetration rate for the quarter was 32%, up from 20% in the prior year quarter. We continued to optimize our full-spectrum lending and servicing platform across loans, leases, floor plan and third-party services. As Scott mentioned, we don't have a further update on our exploratory discussions regarding FCA's strategy to establish a captive finance company in the U.S. We'll remain focused on serving our Chrysler dealers and customers and building on the progress that we made during the first half of the year. Turning to Slide 8, our serviced for others balance increased quarter-over-quarter, driven by two items. First, as we mentioned on the last earnings call, we completed the $1 billion portfolio conversion to service assets for a third-party. And secondly, we executed that additional flow transaction with Santander Group for $1.2 billion. The serviced for others platforms and this transactions drove servicing fee income of $28 million this quarter. Earlier this year, we discussed our pilot program with Santander Bank, whereby we facilitate the origination of mostly prime loans directly onto SBNA's balance sheets for a fee and we'll retain servicing. And as Scott mentioned, we're pleased to announce that we fully rolled out the program earlier this month. Moving forward, we expect our partnership and collaboration with SBNA to become a more meaningful source of funding, replacing the flow program with Santander Group. Let's move to Slide 9 and review our financial results for the quarter. Net income for the quarter of $335 million is up from $265 million during Q2 of 2017. Interest on finance receivables and loans decreased 6% year-over-year due to lower average RIC balances and non-accruals on certain TDRs, partially offset by higher loan APRs. Net leased vehicle income increased 36% due to continued growth in lease balances and good off-lease performance. Interest expense increased 17% versus the prior year quarter, due to higher market rates over the period, partially offset by favorable derivatives, which decreased interest expense $14 million compared to Q2 last year. Provision for credit losses decreased to $353 million in the quarter from $521 million in Q2 last year. This decrease in provision is driven by combination of lower average balances, better credit performance and increased recovery rates. Total other income was $22 million in the quarter and included $76 million of held-for-sale adjustments related to the personal lending portfolio, which comprised of $90 million in customer charge-offs, partially offset by $40 million benefit in market discount. Turning to Slide 10 to review vintage performance, 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. This quarter, we added data for the 2017 vintage, which as you can see, is performing in line, so slightly better than the 2015 vintage. Continuing to Slide 11, you may notice that we updated delinquency data to show 30 to 59 and 59 plus instead of 31 to 60 and 60 plus. Beginning in Q1 2017, we began to show both sets of ratios. Going forward, we're going to use the 30 to 59 and 59 plus only in order to be consistent throughout the various disclosures. Versus the prior year quarter, each of those delinquency ratios have decreased to 9.2 and 4.2, respectively. But since this is a transition quarter and for those of you that are interested, if we had shown delinquency figures using the prior method, the 31 to 60 and 60 plus figures would have been 8.7 and 3.8, respectively. Moving to the bottom portion of the slide. The RIC and gross charge-off ratio of 15.2% in the quarter decreased 120 basis points from Q2 last year. The RIC net charge-off ratio of 6% is down 150 basis points from Q2 last year. So as evidenced by the results, we continued to see a more stable performance, supported by improved recovery. And remember that, Q2 is also a seasonally strong quarter for credit. Turning to Slide 12 to review the loss figures for the quarters in dollars; net charge-offs for RIC decreased $114 million in the quarter to $399 million, which was primarily attributable to lower RIC balances, better credit performance and improving recovery rates. So let me address the components of the net charge-off walk. $87 million in lower losses due to better recovery rates, $46 million in lower losses due to a lower gross charge-off rates, and the $10 million decrease in balance is a result of a lower average RIC balances over the same period, and therefore, a lower opportunity for losses. The $29 million increase in the other category is primarily driven by an inventory adjustment due to lower reposses units to waiting auction versus last year. Turning our attention to provisions and reserves on Slide 13. At the end of Q2 2018, the allowance for credit loss totaled $3.1 billion, decreasing $47 million from last quarter, which represents an allowance to loans ratio of 11.5% at the end of this quarter. I'll go over the components of the reserve walk. The allowance increased $283 million due to new originations in the quarter and $58 million due to TDR migration. These increases were more than offset by $69 million decrease due to favorable performance adjustments and a $319 million decrease due to liquidations and other, which includes payoffs and charge-offs. Let’s turn to Slide 14 and discuss TDRs in more detail. TDR balances decreased $40 million in Q2 2018 to $5.96 billion from $6 billion in the prior quarter. Therefore, this is the third consecutive sequential decline. And as we discussed in our prior call, this quarter shows a lower variance than the prior quarter decrease of approximately $260 million. As you still see, there is a considerable portion of all the vintage TDRs that remain on our balance sheet, dating back to 2013 and prior vintages, demonstrating that this modified loans continued to perform. In addition, all the 2015 vintage of TDRs as we speak, still represents 33% of the TDR balance till the end of Q2. 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 $277 million, a decrease of 2% versus the same period of last year. This decrease was primarily attributable to disciplined expense management and severance and legal expenses that occurred during Q1 2017. The expense ratio for the quarter totaled 2.2% flat versus the prior year quarter. Turning to Slide 16, our funding and liquidity position remains strong with total committed funding of more than $43.3 billion. SC continued to demonstrate consistent and deep access to the capital markets, having issued $3.5 billion of new ABS transactions in the quarter, including two SDART transactions and one DRIVE. We also continued to diversify our funding through private financings and lender commitments, which totaled $15.7 billion. Subsequent to quarter end, we also completed an additional $1.3 billion DRIVE transaction. And finally, turning to Slide 17, our CET1 ratio for the quarter is 16.7%. As Scott mentioned, we're declaring a cash dividend of $0.20 per share for the third quarter as well as authorization for an inaugural share repurchase program of $200 million stock through June 30, 2019. Following continued regulatory progress, we are excited about the significant milestone as we continued to optimize our balance sheet, while increasing shareholder returns. I'll now turn to our guidance for the third quarter. My comments will be relative to Q2 unless otherwise noted and will include the impact of personal lending. We expect net finance and other interest income to be flat to up 2% in the third quarter, primarily driven by higher loan and lease balances. Provision expense is expected to increase $185 million to $135 million in line with seasonal patterns. We expect total other income to be flat to $10 million lower also in line with seasonal patterns. And operating expenses are expected to be flat to down $10 million attributable to discipline expense management. Before we begin Q&A, I will turn it back to you, Scott.

[Scott Powell:]

Great. Thanks, Juan Carlos. Yes, just sort of sum up things one more time. It was a solid quarter for us Good performance on the origination side including Chrysler. Obviously very good credit performance in the portfolio. And we can talk more about vintage performance on the Q&A., but we feel really good about the credit expectations for our portfolio. And again, this all aligns with what we’ve been talking about on prior calls bringing our focus – continued focus to improving our service to dealers and consumers, continuing to optimize our pricing and credit risk, and pricing for that credit risk in our business every day is extremely important, and then obviously making progress on the regulatory front, that continues as well as our focus on running Santander Consumer at financial institution standards. So things are on track. And we feel really good about the quarter and our performance. So with that, we'll open it up for questions. Over to you, operator.

[Operator:]

Thank you. We will now open up the call for questions. [Operator Instructions] Our first question will come from Chris Donat from Sandler O'Neill.

[Chris Donat:]

Good morning, thanks for taking my question. Scott, with everything going so well, I wanted to ask sort of a potential risk question. 60% of your originations this quarter were for new vehicles. And with the talk of potential tariffs on new vehicles, I just wondered if you got any thought on – is there exposure given your – I assume your mix is mostly domestic, but just wonder if – what your thoughts on how that might affect either new vehicle originations or used vehicle originations or is it too speculative at this point?

[Scott Powell:]

Yes, I mean, it’s a great question. Our mix of new cars really went up because we did more Chrysler prime loans and newer prime loans, so that tends to lean towards new cars. But, yes, I mean, you're right, I mean, it's too early to tell if the impact of tariffs and trade restrictions are going to leap, it’s certainly something we're very focused on and keeping the radar switched on. But it's a little bit too early to tell how that's going to impact us. Certainly, the price of new cars going up, will lessen demand, but that means good news on the used car side. So – but it's – I think it's little too early for us to tell exactly how that's going to impact the business.

[Chris Donat:]

Okay. And then just to follow up on the strength in the Chrysler originations and the penetration rate. Is this – is any particular factor you attributed to? Is it finally the consequence of higher interest rates affecting some of the other incentives, and how those are structured, or anything that you would call out there?

[Scott Powell:]

I would say we have just continued to bring extra focus to the relationship, working very closely with the team at Chrysler on optimizing and supporting their sales. So, we did put a little more bonus cash to work in the quarter, which drove some incremental production. But for the most part, it's just what we said on the prior calls is working together, providing better dealer service, being more responsive, kind of working on those same initiatives, which is producing results.

[Chris Donat:]

Got it. Okay. Thanks very much.

[Scott Powell:]

You’re welcome.

[Operator:]

We'll hear next from Moshe Orenbuch from Credit Suisse.

[Moshe Orenbuch:]

Great. Thanks. Scott, you did give us the invitation to talk about the vintage performance. And it is good to see – to hear you talk about the 2017 vintage coming in better than 2015. I mean, the lines that we see on the chart are close to on top of one another. Could you talk a little bit of what gives you that confidence? Is it the improved kind of auction results? Like what is it that gives you more confidence in the 2017 vintage and maybe if you can kind of address how that whole kind of flow into the TDRs over the next year or so?

[Scott Powell:]

Yes. I’ll kick it off, Moshe, and then let Juan Carlos back me up on this answer. First half, I mean, the 2017 vintage is a smaller vintage than our prior vintages, which is I guess, both the good news and the bad news. We did a number of things in the fourth quarter of 2017, which will drive, so that's the full year vintage and you're looking at on that chart. So we're confident that, that vintage will continue to perform and actually may even improve a little bit versus the 2015 vintage as it ages out because we're just showing the first six months on that chart. But we look at a lot more granular data on vintages like really understand at a detailed level how they're tracking. So if we have to adjust our underwriting and pricing strategies we would. So when we look at the fourth quarter of 2017; that looks good. And then as we take really early reads on our 2018 vintage, we feel pretty good about the expected credit performance there. So you want to add something to that, Juan Carlos?

[Juan Carlos:]

Yes, that’s right. The full year vintage rolls in that the overall year will should perform better, we expected it to perform better. And we don't expect any different impact on the comments that we have made regarding future TDR balances for the rest of the year. The roll rates of that vintage is similar to other vintages into TDRs. So it will be – mostly the impact on TDR it will be mostly from the smaller size.

[Moshe Orenbuch:]

Smaller size. Thanks.

[Scott Powell:]

Yes, I was just going to add, Moshe; which is why we say TDR balances should be declined through the end of the year. But then our expectation would be start increasing because of the larger vintage coming through from 2018. So that will drive the increase there.

[Moshe Orenbuch:]

Thanks. And just as a quick follow-up. Could you maybe expand a little bit on the new relationship with Santander Bank? And what it can accomplish for you in terms of the prime originations and perhaps the Chrysler penetration also?

[Scott Powell:]

Yes. So they've obviously got a very different funding structure with the deposits they have. So they – the way this one is setup is different than what we do in group. So group, we originate the loans, put them on our books for a short period of time and then sell the loans to Santander Group. The bank program, it is essentially – they're originating the loans directly. So we are getting an origination fee and the servicing fee for doing that for them. So they can use their funding costs, which is obviously significantly lower than what we have here at Santander Consumer to be more competitive in that space. So is that as you know prime tends to be very competitive space for banks. So we piloted the program for three or four months before launching it on July 2nd. And so just like the other programs we run here, we will be optimizing that program and looking for opportunities to grow volume in that space. And so it's a good thing for the bank because they get well-performing assets on their balance sheet. And then it's a good thing obviously for Santander Consumer because we could pay the origination and servicing fees, and it's a good thing for Chrysler because it allows us to ultimately do more incremental originations.

[Moshe Orenbuch:]

Thanks very much.

[Juan Carlos:]

Moshe, this year operationally for us as well as we will have the loss on sale or the added lower impact of lower yields as we carry those prime on our books much simpler set.

[Scott Powell:]

Yes, thanks for the question, Moshe.

[Operator:]

We will hear next from John Hecht from Jefferies.

[John Hecht:]

Morning, guys. Thanks for taking my questions. First, Scott, you mentioned that you're not increasing the credit buckets for getting more flow across all the channels. I'm wondering, number one, can you tell us what that means is that a state of competition? And number two, are you able to push through price increases to offset rising rates at this point?

[Scott Powell:]

Yes, so I didn't mean to imply that the space is any less competitive. It's just as competitive as it's always been. And so the battle continues on that front. We've brought a lot of focus to like, as I've said on all calls, to the – really understanding the risk on a deal-by-deal basis. So would be – getting into the secret sauce a little bit here, but it would be things like bringing in alternative data sources, building better models, using the models that are doing at a more granular level and doing a better job, adjusting quickly for changes after we book loans to adjust when we're high or low. So we're just bringing a lot more analytical effort to that space. And so not only as our originations up, but our applications are up and then our pull-through rate is up as well. So dealers are gaining more confidence in us and our ability to deliver. So that all feels good and again, reflects progress we're making on serving dealers better. And Juan Carlos, you want to take on the pricing side?

[Juan Carlos:]

Yes, regarding the ability to pass on the higher rates to clients. If you look at our trending and retained APR, you will see that it is higher. So we have been able to price adequately for higher rate environment and for the risk that we are on board everything.

[John Hecht:]

Okay, thanks for that. And follow-up question – a non-related follow-up question. You guys have any detailed update on the sales process with the unsecured loan book, anything that would be helpful to us?

[Juan Carlos:]

Still working on it, and the minute we have a something to update, we will convey that, nothing new to report there.

[John Hecht:]

All right, thank you guys.

[Juan Carlos:]

Thank you.

[Scott Powell:]

You’re welcome.

[Operator:]

We'll hear next from Jack Micenko from SIG.

[Jack Micenko:]

Hi, good morning. Hey, Scott, you – in the prepared remarks sounded like the SBNA agreement would – I don't want to put words in your mouth, would replace the group agreement. Is that a fair characterization or are both programs on the flow side going to be in existence two, three quarters from now?

[Scott Powell:]

That's exactly the intention, Jack, as for the SBNA flow program to replace the sale program to the group. But again, kind of net-net of those two things should be more volume in prime because the cost of funds that we're using to originate loans in that space is going to be better. So replaces it, but it's not an apple for an apple, I guess, we had to describe it. We should have the ability to generate more prime loans because we got a different funding structure.

[Jack Micenko:]

Okay. And then, looks like a lot of the uptick and penetration came from lease. Are you doing anything different on the lease origination sort of frame work in process? Or is that you got a new angle or you got some new model in your products come out?

[Juan Carlos:]

Yes, it's more the latter. In the trends, we only do lease with our Chrysler partners. Chrysler has seen a higher percentage of lease relative to the whole. And that's where we are benefiting. We feel very good about the leases that we're onboarding and also seeing pretty good off-lease performance as well. So that's really the key there.

[Jack Micenko:]

Okay. Just a real quick clarification, you said $135 million to $185 million on the provision guidance for next quarter?

[Juan Carlos:]

On provisions I said is expected to increase $185 million to $235 million.

[Jack Micenko:]

Okay, $185 million to $235 million, thank you.

[Juan Carlos:]

Jack, since you asked me, I'm not going to take a minute and go over the guidance again. Because I think I flipped on total other income. So I'm going to take the opportunity, okay. So on net finance and other interest income, we expect to be flat to up 2% in the quarter. Provision expenses, you just asked me about, is expected to increase $185 million to $235 million. In total other income expected to be flat to $10 million better. And then in operating expenses, we expected to be flat to down $10 million. Okay, just to make sure. Thank you.

[Operator:]

We will move next to Eric Wasserstrom from UBS.

[Eric Wasserstrom:]

Thanks very much. How should we think about the allowance coverage going forward given some of the strong – both credit performance and recovery trends?

[Juan Carlos:]

Yes. The allowance ratios you have noticed is down compared to previous levels. Mostly, that's a function of a number of factors, but clearly, the improved credit performance as well as the fact that our TDR balances have been coming down impacting our allowance as well. I think as we go forward, as we've talked about this in the past, we're originating – originations have increased. And I think also as our TDR balances, as Scott mentioned earlier, start to stabilize. They are reaching out the same, you expect allowance ratio to also stabilize.

[Eric Wasserstrom:]

Great, thank you. And if I could just follow-up on the net finance margin for a moment, it seems that over the past several quarters, it sort of settled out in this range in the low 10% level. Is that a good run rate to think about even as funding costs probably continues to take higher with higher base rates?

[Juan Carlos:]

Yes, we've been able to increase NIM sequentially, very slightly, but it's been up for a couple of quarters now. Like I've said in previous calls, the higher rate environment continues to be a headwind for us, is through increased hedging that we have been able to maneuver. So for the time being, I think we're still going to see headwind in that particular metric.

[Eric Wasserstrom:]

And by headwind, do you mean that it remains sort of at this level relative to the 11-ish percent level in the past or – because it’s actually sort of improved over the past couple of quarters despite higher rates?

[Juan Carlos:]

Yes, it's improved, but I think don't expected to go back up very quickly into 11% for sometime.

[Eric Wasserstrom:]

Okay, thanks very much.

[Operator:]

Betsy Graseck from Morgan Stanley, your line is open.

[Betsy Graseck:]

Hi, good morning.

[Scott Powell:]

Good morning.

[Betsy Graseck:]

Just a follow-up to that how do you think about the reserve with regard to the upcoming CECL?

[Scott Powell:]

Yes, I think we're still obviously waiting for [indiscernible] in terms of capital. It will be presented it will be a gradual implementation. And it won't be part of our CCAR submission, for example, until 2020 submission. So for the time being, we're just running internal analysis, but we obviously feel very good about the strength of our balance sheet and capital rates in terms of being able to do.

[Betsy Graseck:]

You totally have significant amount of excess capital, so that's not the real question here. I guess the question is do you feel that your portfolio – your ALR would have to move higher to reflect the average duration in the book and to what extent does CECL coming in incent you to move even up a little more up FICO than you are today?

[Juan Carlos:]

No, we're not – Betsy, we're not underwriting as Scott said. We remained in our sweet spots, and we haven't moved our buybacks but just for CECL in particular. So we're not making that type of decision yet.

[Betsy Graseck:]

Okay and maybe I just follow-up with question on recoveries obviously another very strong quarter here. I'm just wondering how you're thinking about the go-forward on recoveries. Do you – given the trends that you see in your book, do you feel that there is continued improvement in recoveries likely here over the next several quarters or year?

[Scott Powell:]

Yes, Betsy, I wouldn't say we’d expect – they are really good right now. So I wouldn't expect them to get even better. I really believe the recovery rates driven by the strength of the economy and the demand for vehicles in the economy. So with unemployment hitting in all-time low, it's really driving a lot of that demand for new and used cars. So our expectations are that stay at least at this level for a while given the strength and the economy. And there are things to worry about as we talked about before obviously depending upon how the tariffs and the trade stuff plays out that could be a concern. But as we sit here today, I think our expectation isn’t up or down. Is that fair Juan Carlos?

[Juan Carlos:]

Yes, that’s fair. That's fair. We also had – well, that's on all-time recovery. On recovery class we've also seen good trends there, which continued to support the overall recovery rate. And remember also monsoon payment, monsoon book right, which speaks again to the economy…

[Betsy Graseck:]

I totally get that, and I know that you have an assumption for what price – auto prices are likely to be in your allowances and in your anticipation of recoveries at the beginning of the call, Scott, you mentioned, used car price flat to plus one or two if I heard correctly. So is there a delta there between what’s embedded in your allowance estimates versus what you're expecting now of used car prices flat to plus that should persist over the next couple of quarters, I guess, that's the underpinning of the question?

[Juan Carlos:]

In our allowance, there are many variables that going into our allowance. We haven't made any significant sense in that particular component. So there is no…

[Scott Powell:]

It's based on the actual performance it's not based on any future assumptions.

[Betsy Graseck:]

Okay, thanks.

[Scott Powell:]

Yes. You’re welcome.

[Operator:]

We’ll move next to Mark DeVries from Barclays.

[Mark DeVries:]

Hi, thanks. I'm not to beat the dead horse, but I had a recovery question. So I was hoping to better understand what drove the widening disparity between the auction-plus recovery rate and the auction-only and obviously was a pretty substantial benefit to you. How sustainable do you think the drivers are of that?

[Juan Carlos:]

Yes, we're having more success in recoveries like deficiency, recoveries initiatives with the dealers. And also for example, in recoveries post charge-off includes as well. So it's been a pretty good trend for the first half of the year better than we anticipated. And again, we don't see anything specific changing around it. But the sales – has been a better than expected during half of the year.

[Mark DeVries:]

Okay, got it. Thank you.

[Operator:]

David Scharf from JMP Securities, your line is open.

[David Scharf:]

Good morning, thank you. Thanks for taking the questions. Two things, Scott, I'm wondering just digging in a little more into the strength in volumes really year-to-date. You have mentioned on a few calls, streamlining the underwriting process, making things a little better for dealers. I'm wondering if you can provide a couple of tangible examples of that and whether or not you saw any noticeable change in the capture rates lately to support that.

[Scott Powell:]

Yes. Yes to all the above, David. So our capture rates are up, which is nice to see, because I think that reflects – that reflects dealers confidence or APRs are up and our capture rate is up. So that reflects their confidence and then our improved ability to deliver for them. And to give you – just to give you a few examples. We’ve increased our auto decisioning rates on implications we receive, which certainly makes it easier for dealers. We’ve enhanced our overall dealer management program to make that better for dealers. And then, the other important thing we did is with our underwriting and credit teams, we actually find them up by region. So that we’ve regionalized our underwriting teams just to give you a few examples.

[David Scharf:]

Got it, that's actually very helpful. A follow-up, just maybe a cleanup question for JCD. The tax rate, I believe it came in noticeably higher than the 21% guidance for the year that was rolled out. And then maybe you can update us on how we ought to be thinking about that for the full year?

[Juan Carlos:]

Thanks for pointing that out, Dave. You’re right. We still expect tax rate to be slightly higher than 21% as we indicated previously. This particular quarter there was a one-time catch up on one of the states applies their state tax and how we catch up for it. So it was a one-time deal on that front.

[David Scharf:]

Got it. So the second half of effective tax rate should be sort of arguably a little bit below 20% you think?

[Juan Carlos:]

We expect it to be slightly higher than 21%, which is what we’ve guided in the past.

[David Scharf:]

Okay, thank you very much.

[Scott Powell:]

You’re welcome.

[Operator:]

John Rowan from Janney. Your line is open.

[John Rowan:]

Good morning, guys.

[Juan Carlos:]

Good morning, John.

[John Rowan:]

I think you’ve had enough questions about recoveries. I have kind of a more specific question. There is a story in one of these auto industry papers about you guys changing or mitigating impound for our losses in Florida. I'm wondering if that – it made me think it was a pretty significant number and I'm wondering if that actually had any impact to you guys, and whether or not, if so if there is opportunity to move that mitigation strategy to other states? Thank you.

[Scott Powell:]

Yes, I guess – I'm not sure on that specific case, maybe Juan Carlos knows. I'm not sure on that specific article. I thought I read everything, but you just got one. But we do have – we brought in – we’ve been supplementing the talent we have in operations and we have a really good operations team on the origination side and the collections and servicing side. And they are always looking for ways to optimize what they do and improving recovery rates and those numbers. So not sure on that one, we might have to get back to you on that one. But if there are – we're constantly looking for ways to optimize and improve our process. And they are up and moving the needle on a huge way. But every little game we make, even our scale is important to us.

[John Rowan:]

The article I'm referring to talks about when you guys acquire a car through abandonment and then you’re overcharged for repair that was never completed. Basically said, there was quite a bit of money, that's basically again this type of fraud. I’ll send you guys the article, but I was just curious that was material. It made it sound like it was actually pretty much a real number.

[Juan Carlos:]

Not specifically, but I mean, some of those are the initiatives I was talking about where you try to recover for dealer efficiencies. So we have made a lot of progress on that, but it's not specific to our article.

[Scott Powell:]

But we would certainly get back to you on how material that is.

[John Rowan:]

Okay. Thank you.

[Operator:]

Geoffrey Elliott with Autonomous Research. Please go ahead.

[Geoffrey Elliott:]

Good morning. Thanks for taking the question. Could you talk about the decisions you made on capital, in particular, how you arrived at the split between dividend and share repurchases. I guess, I usually, think about companies with more volatile earnings paying out more in buyback and less in dividends, and it was kind of surprised to see the split interest in your thinking and then how you got that.

[Juan Carlos:]

Yes, we went – and the way we have discussed it in the past with you always trying to reach or – first of all, let's say, let's remember, we're very happy with the significant progress we have made in this submission. And then, as we’ve discussed before, remember that we operate – we do our analysis here and then we do have to frame it within few stuffs overall capital submission. In this particular case, we have said, also in the past that it's important for us to get to a dividend payout that was more in line or more reasonable, more normalized. We feel that the $0.20 per share it gives us that type of dividend payout. And then, when considering the amount of capital buybacks, we consider a number of things, including the overall submission of SHUSA, but also the market capacity or own capacity internally. So through it all arriving at a significant impact, significant improvement in terms of total payout for the shareholders.

[Scott Powell:]

And I think – Geoffrey, I think I may have said this in some of the prior calls, but given where we've come from with respect to the regulatory issues we had on our to-do list, we made great progress, and closing out the Fed 2014 agreement, specifically related to the capital actions was good. And there is part of this sequencing events includes building confidence with our regulators. And so the process Juan Carlos described is right. And you can put that against the backdrop of us continuing to our credibility with the regulators. And capital plan approval we got this year, I think is a good reflection of that. If that makes sense.

[Geoffrey Elliott:]

Thank you. And then a quick one on Chrysler; the tolling agreement that you’ve entered into recently. Can you explain exactly why you are doing that? It kind of sounds like it's allowing statutory limitations to be extended. So does that kind of advice that this is going to drag on for a while?

[Juan Carlos:]

The tolling agreement just ensures that both SC and FCA are free to carry on the ongoing exploratory discussions without compromising any of the rights under the MP LFA under the Master agreement, okay. The date that was – that you might have seen in the tolling agreement, the extension to December 31 is [indiscernible] adequate. It doesn't speak to anything other than that. And it could be changed in both parties or amended both parties of the group.

[Scott Powell:]

Yes. And I think we’ve been very open and very candid about the discussions that we have with our important partner at FCA about performance under the Master contract. And it's – we talk about it a lot. That tolling agreement just provides for those discussions to continue in that same spirit.

[Geoffrey Elliott:]

Great. Thank you.

[Juan Carlos:]

Yes.

[Scott Powell:]

You’re welcome.

[Operator:]

We’ll move next to Steven Kwok from KBW.

[Steven Kwok:]

Thanks for taking my questions. Most have been answered. Just following up on the last question around the CCAR processes. As we look out into the next couple of years and given where your very strong capital ratios, how should we think about the percentage of capital that's going to returned handing it to the next CCAR. It would appear that you are still building capital despite your most recent capital asset of returning $200 million plus the dividend raise?

[Juan Carlos:]

Yes. As I said before, we expect and hope to continue to make progress. This was the inaugural buyback program. It's a very important milestone for us. We hope to continue to make more progress, but we have to go through that process, okay. Clearly, this is a company that's able to accrete capital, although, this quarter sequentially you might have noticed that the capital ratio was down from 20 basis points due to tolling growth. But you're right, we expect to continue to make progress and increase payout, but always within the framework of the capital branding process that we have internally and with the regulators.

[Steven Kwok:]

Got it. And just as it relates to CECL around the capital ratios, are you guys holding perhaps a buffer to take in account the impact from CECL?

[Juan Carlos:]

No, I think, if somebody asked me like going into the CCAR submission, if we have made any – we have incorporated that into the planning. And I said, no, at the time, but that's still the case. I'm sure the NPR soon becomes finalized in future submissions. They will come more into the analysis, obviously, but not at this moment.

[Steven Kwok:]

Okay. Great. Thanks for taking my questions.

[Juan Carlos:]

Sure. Thank you.

[Operator:]

We’ll move next to Kevin Barker from Piper Jaffray.

[Kevin Barker:]

Good morning. I noticed the FICO score has been down and the yields remained relatively strong this quarter. Is there any change in your underwriting appetite or what type of risk you're willing to take so far this year versus what your appetite was in 2017?

[Juan Carlos:]

Yes. So a couple of things. The EPRs are up, the yields are down, but that has to do more with the average balance, for example, the TDR – the impact of the interest on TDR non-accruals, okay, but the APR is up in that regard. So we have been able to price adequately for the higher rates and for the rates that we're ongoing.

[Scott Powell:]

And looking at those, Kevin, looking at those FICO trends, there is a lot that goes into the assessment of risk. FICO is always a good general measure over time. But I'd just say that one way to look at it, collaterals an important part of it. The short answer to your question is, we haven't – our risk appetite hasn't changed up or down and kind of our sweet spot and optimize our pricing within that pretty stable credit box, I would say.

[Kevin Barker:]

Okay. And then in regards to some of the TDR migration. I noticed that the percent of 2017 TDRs as of 2Q 2018 is below the percentage in TDRs in the 2016 vintage from this time last year. And so it would appear that the 2017 vintage has less TDR migrations than 2016? Was this impacted by some of the servicing practices changes that you’ve implemented in beginning of 2017 and you’re starting to see better credit performance as the 2017 vintage ages compared to 2016?

[Juan Carlos:]

Scott already alluded to that, maybe two-part answer there. In line with what we were asked before the 2017 – all of the 2017, the entire year is included into the calculation where we should expect that the curve that we have in the presentation to improve. More specifically regarding to the TDR rolls, we haven't seen any meaningful difference in the roll rate into TDRs from the 2017 vintage compared to the average supplier. So nothing meaningful there. In regards to the performance of the 2017 vintage, it's true that – you are right, the operational issues that we had in early 2017 saved on bank health. But the full year of our originations is included in that metrics. We should see a better performance.

[Kevin Barker:]

Thank you very much.

[Juan Carlos:]

Yes.

[Scott Powell:]

You’re welcome.

[Operator:]

There are no further questions at this time. I would like to turn the conference over to Scott Powell for final comments.

[Scott Powell:]

Great. Thanks everybody for joining the call. We appreciate the interest and the very good questions. We'll obviously be available for follow-up questions, and we look forward to speaking to you again. Thanks very much. Have a good day.

[Juan Carlos:]

Thank you.

[Operator:]

That does conclude today's teleconference. We thank you all for your participation.