Santander Consumer USA Holdings Inc.
Q4 2018 Earnings Call Transcript

Published: 30 Jan 2019

[Operator:]

Good morning, and welcome to the Santander Consumer USA Holdings Fourth Quarter 2018 Earnings Conference Call. At this time, all parties have been placed into a 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, and thank you for joining the call everyone. On the call today we have Scott Powell, President and Chief Executive Officer; and Juan Carlos Alvarez, Chief Financial Officer. Before we begin, 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 today. For further information concerning factors that could cause these results to differ, please refer to our public SEC filings. On today’s call, our speakers will reference certain non-GAAP financial measures that we believe will provide useful information for investors. A reconciliation of these measures to U.S. GAAP is included in the release issued today January 30, 2019. Please reference table 9 for today's press release on the appendix for further details on non-GAAP figures. For those of you listening to the webcast, there are a few slides to review as well as the full investor presentation on the website. And with that I’ll turn the call over to Scott Powell. Scott?

[Scott Powell:]

Thanks, Evan. Thanks everyone for joining the call. To start out I'll recap 2018 before turning it over to Juan Carlos for a more detailed review of our financial results. If you look at page 3 in the presentation, I think you'll see that 2018 was a year of strength and consistency for us at Santander Consumer. You can see that our net income was $916 million, which is $2.54 per diluted common share with an ROI of 2.2%. Last year was a really important year for us from a regulatory perspective. I'm sure you all know that the Federal Reserve terminated one of its enforcement actions against our parent, Santander Holdings USA, the 2015 Written Agreement. That Written Agreement was very comprehensive and covered things from governance to risk management and a variety of other oversight issues. Santander Consumer was an important part of that agreement. And it just shows you the progress that we have continued to make addressing legacy regulatory issues. And I would just say, again, that comes a year after the Fed terminated another one of its enforcement actions, the 2014, again, SHUSA Written Agreement, and we were happy to close that out the year before. We still have one more Written Agreement like that outstanding related to compliance. We call it the 2017 Written Agreement. And we've been working very hard to address those issues. So kind of net-net a really positive step forward for us last year on the regulatory front. From a capital perspective, we completed our inaugural $200 million share repurchase program shortly after the end of the quarter, and we increased our quarterly dividend from $0.05 to $0.20. From an originations perspective, obviously a really strong year, our total originations were about $29 billion, which is up 43% year-on-year. And we have strong increases across our loan and lease products. And importantly, we continue to maintain our pricing discipline across all those segments. We kicked off a very important strategic component, which was SBNA, Santander Bank, originating loans to Santander Consumer that started in July. We originated $1.9 billion of loans for Santander Bank. And that's a great program. It's good for our service for others program. It's also good for our partner, Chrysler. That program will replace the sale program we have at Group. Last year we did $2.9 billion of loan flow to the Group. And like I said, that'll be replaced by this new program, this new flow program with SBNA. It does demonstrate -- both of those programs do demonstrate the value of collaboration across Santander entities. From a funding perspective, we remain a leading ABS issuer. We did $13 billion ABS last year, which demonstrates the strength of our ABS platforms. Credit performance, credit performance remains strong. When you look at our year-end delinquencies compared to a year ago, we're 30 basis points lower. Net charge-offs in 2018, came in at 8.5%, which is down 50 basis points from the prior year. Recoveries continue to be strong. Auction plus recovery rate was 47.3%, which is up 100 basis points from the prior year. And then we'll talk more about this on the call, but our TDR balances decreased $900 million year-over-year. And last year was a really, really strong year for our partner, Chrysler. They had record sales year in the U.S. They were up almost 10% in terms of car sales, really strong performance. So we'll give them a big shout out for that. And then our partnership with them over the course of the year, you see continued progress. So our penetration rate was up from 21% in 2017 to 30% in 2018. We originated about $19 billion of loans and leases through Chrysler dealers and we grew our floorplan business at SBNA 43% over the course of the year. So really strong results in supporting our partner Chrysler. So in summary, 2018 was a really good year for Santander Consumer. Certainly there is a lot of discussion about market uncertainty, especially over the last few months. But we remain very confident in the U.S. consumer. And things like job creation remain strong. So we're pretty positive going into 2019. And then just a word about the government shutdown, the recent shutdown was pretty minimal. We did help our customers that asked for temporary relief. I would tell you those numbers weren't significant relative to the size of our business. So we're hopeful. Obviously right now is a temporary period, where the government is open. We're hopeful it gets resolved. We think it's important to get resolved. As we go into tax season, that's a really strong origination season for us. And it also I think you all know is a period where our delinquency goes down. And our credit loss number goes down based on the strength of consumers' ability to pay. So hopefully we won't go through another government shutdown. So as we go into 2019, the initiatives that we put in place set us up well. We're going to continue to focus on operating at large financial institution standards. We're going to continue to focus on improving our service delivery for our dealers and for our consumer customers. Maintaining pricing discipline, ensuring that we get paid for the risk that we're taking is paramount. And we continue to focus on that. And we're going to maximize our current relationships and continue to look for other opportunities out there in the market -- which we think are out there. And that includes building out parts of our digital strategy. So with that I will turn it over to Juan Carlos.

[Juan Carlos Alvarez de Soto:]

Thank you, Scott. Good morning, everyone. Let’s turn to slide 4 for some key economic indicators that influence our originations and credit performance. So building on what Scott said, we feel that the overall macroeconomic environment remains stable. Consumer confidence remains high and unemployment levels continued to be very low. So while we’re observing a prolonged economic expansion, these microeconomic factors continue to point to a constructive consumer lending environment. 2018 U.S. auto sales exceeded expectations, expectations that we had coming into the year and industry experts are now forecasting a moderate, only a moderate decrease in 2019 which is a level still indicative of a stable market for new vehicles. While we believe that economic conditions are more resilient than recent market volatility might indicate, we will remain vigilant throughout the year. On slide 5, there are few key factors that can influence our loss severity and credit performance. And we’re pleased to see that our auction recovery rate, which represents all auto related recoveries from the auction lanes increased to 47.6% from 43.4% in Q4 last year. Our recovery rate, which includes no metal [ph] related proceeds, bankruptcy and deficiency sales was 47.3% in the quarter compared to 46.3% the same quarter last year. Additionally, non-prime securitization data, including net loss and delinquency trends remained stable compared to last year. Turning to slide 6, we’ll cover originations. As Scott mentioned, 2018 has been a good year for originations. We had year-over-year increases in originations during each quarter of 2018, albeit working from a low 2017 base. Core loan originations increased 51% in the fourth quarter compared to Q4 last year. Chrysler loan originations increased 63% in Q4. Chrysler lease originations increased 64% during Q4, and all of this led to full year originations of $28.8 billion, up 43% year-over-year. Looking at -- looking ahead to 2019, we expect application levels to grow again, building off the momentum in 2018. With this growth we must remain disciplined with respect to the risk return profile of our non-prime originations. We also expect to continue to support FCA prime loans with our SBNA programs, while maintaining a strong presence in lease. We are also monitoring the evolving government shutdown situation carefully as it could impact tax references on limit applications and funding and potentially impact delinquency. Moving to slide 7, the Chrysler Capital annual penetration rate for 2018 averaged 30%. This is an increase from 21% during 2017, achieved the initiatives we set forth to support our FCA dealers and the SBNA program we put in place during 2018, as well as FCA’s strong line up leading to record sales, as Scott mentioned. Dealer floorplan balances also increased 43% year-over-year and 13% quarter-over-quarter. In addition to loan and lease, floorplan is another key pillar of our FCA offering and provides an opportunity to collaborate with Santander Bank. As we look ahead into 2019, we aim to build on the progress made in 2018 by remaining focused on optimizing our relationship, continuing to drive improvement in our FCA dealer satisfaction scores and refocusing our efforts on loyalty programs collaborating with FCA to drive another strong year of sales. Turning to slide 8, the serviced for others platform generated a $107 million in servicing fee income during 2018 and $27 million during the fourth quarter. During 2018, our brother, Santander Relationship generated almost $5 billion in assets for serviced for others platform. $2.9 million through the Santander Flow sales and the $1 billion mentioned through our new SBNA agreement. We expect the SBNA agreement to drive this serviced for others platform moving forward in addition to any potential new relationships or opportunities similar to the $1 billion portfolio conversion executed during 2018. Slide nine contains some highlights from the quarter for your reference. But if we turn to slide ten, we can review our financial performance for the quarter. Keep in mind we’re looking at year-over-year comparisons that last year our financials were impacted by tax reform and other significant items. Please refer to table nine of this morning’s press release for further details on these non-GAAP items. Interest on finance receivable and loans increased 6% year-over-year, driven by higher average total loan balances and higher APR. Net leased vehicle income increased 82% due to continued growth in lease balances and good off-lease performance. Interest expense increased 32% versus the prior year quarter, primarily driven by the increase in benchmark rates over the period, and by lower contribution from our derivatives portfolio. Provision for credit losses increased to $691 million in Q4, 2018 from $598 million in Q4 2017. This increase is driven by a combination of higher balances and lower modification levels during the quarter. This quarter the other income lines had a loss of $33 million driven by $146 million of held-for-sale adjustments related to the personal lending portfolio, which is comprised of a $109 million of customer charge-offs and $37 million increase in market discount due to seasonally higher originations. It's important to point out, you can see this in the appendix of the presentation, slide 22, that the personal lending portfolio earned approximately a $170 million before operating expenses and taxes for the full year 2018. Continuing to slide 11, the fourth quarter early and later-stage delinquencies buckets, both decreased by 30 basis points or more, compared to Q4 last year. On the bottom portion of the slide our RIC gross and netted loss ratios increased 100 and 30 basis points respectively in the quarter compared to Q4 last year. As a reminder the prior year quarter was impacted by modification efforts that we provided to customers following the 2017 hurricanes, while the 2018 storms did not have a comparable impact to modifications. Let’s move to slide 12, to review the loss figures in dollars. Net charge-offs for RICs decreased compared to Q4 last year. I will briefly address the components of the book. $81 million increase is driven by higher gross losses due to a higher gross charge-off rate. Average loan balances were up more than $2 billion year-over-year and this drove another $31 million increase. The $32 million decrease in the other category is driven by a few items including a positive mark in the value of our repossessed inventory. Turning our attention to provisions and reserves on slide 13, at the end of Q4, 2018, the allowance for credit loss totaled $3.2 billion, a decrease of $65 million from last quarter, which represents an allowance to loans ratio of 11.4%. The allowance ratio is down 30 basis points from the end of the prior period and down a 150 basis points versus the end of 2017. Let me address the components of the reserve book. The allowance increased $293 million due to new originations in the quarter, $77 million increase due to unfavorable performance adjustments, $33 million increase to TDR migration, and $468 million decrease due to liquidations and other, which includes payoffs and charge-offs. Let’s move to slide 14, and as you can see TDRs have continued the downward trend we have seen throughout the year. TDR balances have decreased approximately $380 million versus last quarter and almost $1 billion versus the end of 2017. As we mentioned earlier lower modifications this quarter compared to last year led to lower TDR balances and added to the sustained downward trend in balances. Slide 15 we can cover the operating expenses which this quarter totaled $256 million for an expense ratio of 1.9%. And keep in mind for comparisons that last year's figures were impacted by certain significant items. During Q4, 2018 we also incurred lower operating expenses, as we put some legacy legal matters behind us with a better than expected outcome. The full year 2018 expense ratio fell 2.1%, an improvement from 2017, as we maintained expense discipline throughout the year. Turning to slide 16 now, our liquidity remains robust with total funding of more than $45 billion. During the final quarter of the year we sold an additional $2.2 billion in asset backed securities and ended the year with a total of more than $13 billion in ABS issuance. This reflects the highest volume of securitization SC has ever executed in a single year and will remain the leading insurer of retail auto loan ABS in the market. Equally as important, during the year we also renewed a 100% or $10 billion in committed revolving funding dedicated to fund newly originated loans and leases. Finally turning to slide 17, our CET1 ratio at the quarter end was 15.7%, down from 16.4% at the end of last year. Subsequent to quarter end we completed our 200 million share repurchase program and we're also declaring a $0.20 dividend. As we head into 2019, we feel our strong liquidity and capital position will support continued progress towards a more efficient balance sheet while allowing us to take advantage of the opportunity the market offers. In terms of guidance, looking ahead to Q1, 2019, my comments will be first relative to Q4 of 2018. We expect net finance and other interest income to be 2% to 3% higher, driven by higher balances and rates. Provision expense is expected to be $60 million to $110 million better due to normal seasonality. We expect total other income to be up $80 million to $90 million better, in line with seasonal patterns and lower Bluestem balances. Operating expenses are expected to be $10 million to $30 million worse. As I mentioned a moment ago following the resolution of some legacy matters we incurred lower operating expenses and we don't expect a similar benefit for Q1 of 2019. Now as we look ahead to the full 2019 we also wanted to share with you what we are expecting for some key metrics in our financials versus full year 2018 performance. So for the full 2019 we expect net finance and other interest income to be up in the mid-single digits benefiting from higher balances. Our net charges off ratio should remain in the mid-8% assuming relatively stable used car prices. We expect our 2019 expense ratio to remain stable around current levels, our effective tax rates to be slightly better than 2018. Before we begin Q&A I'd like to turn the call back to you, Scott.

[Scott Powell:]

Thanks, Juan Carlos. So looking ahead to 2019, our priorities are similar to what we talked about last year and over the last year we've made significant progress, fine tuning our risk and pricing models and improving our operational processes, which really led to another strong year in operations in 2018, which shows up on our originations and our delinquency numbers too. So continuing into 2019 we remain very focused on improving customer service, both at the dealer level and for consumers. And we really believe the combination of all these initiatives improves our competitiveness in the market. We are continuing to develop full spectrum lending and servicing platform across a variety of products, including loan, lease, floorplan and third party servicing in support of our relationship with Chrysler. And again, these initiatives together will make us more competitive in market, and especially make it easier for dealers to do business with us. This should position us well for a good year in 2019, and a strong origination period during the tax season. I did want to mention one more thing, which is our commitment to the communities where we live and operate. We're very excited to be expanding our community commitment, doubling it from where we were last year through our innovation here at Santander Consumer. So with that, we're ready to open up for questions. Operator, over to you.

[Operator:]

[Operator Instructions] And our first question comes from Jack Micenko with SIG.

[Jack Micenko:]

Good morning. Scott, leading off of the big picture question, any update on the Chrysler capital FCA discussion and their goal to look for a captive?

[Scott Powell:]

Yes, somehow I knew that would be the first question. Thanks for the question, Jack. A little bit of an update, which is, as we've said before, we continue to operate under existing contract. Our discussions with Chrysler are ongoing. I would say they are constructive and we are talking about a number of things, including optimizing the contract that we have.

[Jack Micenko:]

Okay, understand you can't say much more than that, but that's appreciated. On the buyback, is there anything you can do before '19 CECL on the -- now that you've exhausted the 200 [ph], we have to wait till June then to see on the buyback because the cap ratios haven’t come down all that much and I think you're still at around -- is that a 12 or 12.5 targets if I remember correctly?

[Juan Carlos Alvarez de Soto:]

Yes. Thank you. 12.5, that remains in place and the answer is no, we can't. We have to wait through the next submission. I think like we've said in previous calls, and we think that we have -- we've made the progress on the regulatory front, we have the balance sheet, strong balance sheet also to support further progress, when we make the new submission, but we have to go through the process through this SHUSA submission.

[Scott Powell:]

Yes. And just add a little bit to that, and probably more than you want to know which is technically speaking, you can file an amended capital plan with the Federal Reserve, if you want to do something off cycle. But given that the regular capital plan is due at the beginning of April, the likelihood of getting an amended capital plan through their process is pretty low. So as Juan Carlos said we will be going through the regular capital plan cycle with Federal Reserve.

[Jack Micenko:]

All right. Great. Thanks for taking my questions.

[Scott Powell:]

Yes. Thank you.

[Operator:]

And our next question comes from Moshe Orenbuch with Credit Suisse.

[Moshe Orenbuch:]

Great, thanks for the guidance for a number of those metrics into '19, that's extremely helpful. Maybe just to expand on that a little bit, how should we think about the reserve build or release, given the fact that you are seeing substantially lower TDRs. At the same time you're also growing loans, like how should we kind of think about that?

[Juan Carlos Alvarez de Soto:]

Yes, I think, we'll stake with what we've said in prior calls. You've seen the coverage ratio declining, mainly driven by the lower TDR balances. What we've seen in Q4 in terms of lower TDR balances should continue through the early part of 2019 before they stabilize sometime mid-year. When that happens, then we can expect a little bit more of a stable allowance ratio. I think we continue to have that view today.

[Moshe Orenbuch:]

Got it. That's very helpful. Thanks. And just, if memory serves, I think you had said three months ago that you were looking for up 1% to 3% net interest income this quarter, and it was kind of more like, down very, very slightly. Did something change and how do we think about that in the context of what we're looking -- what you're looking for, in terms of some accelerating growth into '19?

[Juan Carlos Alvarez de Soto:]

Nothing fundamental has changed. We continue to be able to pass along a higher rate environment to our customers, but not as fast as the interest expense increase. With regards to what we expected, as you have seen we did have more charge-offs in the quarter leading to somewhat higher non-accruals. And we also had less contribution from our derivatives portfolio in the quarter, okay. But nothing fundamental has changed, as you can see in our in our guidance for next year, mid-single digits should be in line with what we were anticipating before the quarter.

[Moshe Orenbuch:]

Perfect, thanks very much.

[Operator:]

And next we'll hear from John Hecht at Jefferies.

[John Hecht:]

Good morning. Thanks very much guys. I guess a little bit of a follow up from the prior question. I mean Q4 this year, we did see a greater than normal seasonal pick up in charge-offs. I think the gross charge offs were up 180 basis points from Q3 to Q4. And they are usually around 1%. I mean, is there anything behind that or is there just a greater seasonal influence in Q4 now, or is this mix difference or anything we can point to there?

[Juan Carlos Alvarez de Soto:]

Yeah, there's definitely seasonality. But remember that last year Q4 '17, we provided a lot of extensions, Q3, Q4 provided a lot of extensions. And we provided much less extensions, same period in -- of 2018. So the lower extensions, lower modifications has an impact on the charge-offs. We're constantly reviewing or servicing practices to make sure that we're assessing the willingness and ability to pay of our customer and making sure that we're doing the right thing by them. So that would have an impact on lower delinquency, higher charge-offs, as well as a lower inflow into PDRs. As you can see, by our guidance, we're still expecting a relatively stable charge-off ratio for next year.

[John Hecht:]

Okay, thanks very much. And then Scott, remind us where you -- if I recall, you have one final regulatory agreement that needs to be accounted for. Can you give us an update on your standings there?

[Scott Powell:]

Yeah, thanks, John. I mean, it's hard to talk publicly about them. The one that is outstanding, which I mentioned in my opening comments is the 2017 written agreement about compliance. And it is -- if you read through it, it is holding company SHUSA level compliance issues, straight on through -- into Santander Consumer. I would tell you that, we've invested a lot in the space, both at the holding company and here in Dallas. We feel really good about the progress we're making. I referenced those other two enforcement actions because those are also signs that we are very focused on addressing these issues and making progress. And so I can't really give you any guidance on when they'll be closed out, except to say we put a lot of resources against that. We continue to be focused on it. And look -- it goes to operating at large financial institution standards. And we're absolutely committed to get there and resolve that.

[John Hecht:]

And what would it -- what flexibilities it would afford you, if and when it gets released?

[Scott Powell:]

It's part of the overall regulatory assessment of Santander Consumer and Santander in the U.S. And so it's one component of the regulatory view of Santander in the U.S., that's what I can say.

[John Hecht:]

Okay, thank you guys very much.

[Scott Powell:]

Thanks, John.

[Operator:]

Next up, we'll hear from Mark DeVries at Barclays.

[Mark DeVries:]

Hey, thanks. Had a question about the guidance for the mid-single digit growth in 2019 on the net finance and other interest income. I think you were up more like 9% year-over-year this year. Just wondering of that mid-single digit growth implies either, slower balance growth or some NIM pressure or little bit of both?

[Juan Carlos Alvarez de Soto:]

We’re -- I mean a lot of the originations that we’ve done, especially in the later part of the year will benefit 2019. We’re still -- I will learn more [ph] this afternoon perhaps, but we’re still baking in one or two additional hikes. So if we continue to see a higher rate environment, as you know that would still be a headwind for us. So there is some of that baked in this forecast. If it turns out that we get a pause, especially on the short end of the curve, there should be a benefit to this.

[Mark DeVries:]

Okay. Got it. That’s helpful. And then Scott based on your comments that you provided updating us on the FCA situation, should we take it to mean that some of the progress that you’ve made improving your penetration at Chrysler maybe makes the option of optimizing existing contracts more viable that it might have felt like six months ago?

[Scott Powell:]

Yeah, I think so. I mean I wouldn’t presume to speak for Chrysler, but I think the progress we’ve made over the last year is pretty significant. They had, as I said, and you know that they had a really solid sales year, company is doing really well. And yeah, I think that is part of the discussion.

[Mark DeVries:]

Okay, great. Thank you.

[Scott Powell:]

Yeah. You bet.

[Operator:]

Next up, we’ll hear from Eric Wasserstrom at UBS.

[Eric Wasserstrom:]

Thanks very much. Juan Carlos just to follow up a little bit on the loss guidance, are you also anticipating a -- effectively a stable gross charge-off rate relative to last year?

[Juan Carlos Alvarez de Soto:]

We are guiding on net, so net should be stable and gross should also be relatively stable because we’re talking about stable used car prices. So it falls -- it would kind of fall on the same lines, yes.

[Eric Wasserstrom:]

And the -- and now that you’re -- it sounds like you’re moving to a little bit more of a conservative modification posture, the seasonality of the loss experience in 2019, should that basically follow 2018 as well?

[Juan Carlos Alvarez de Soto:]

You could have some lag impact of -- the lower modifications done in 2018 could impact the early part of 2019, but you’re still going to have the same seasonality trends by and large.

[Eric Wasserstrom:]

Okay. And then just lastly on the TDRs, recognizing that you’ve just talked about how you’re doing a little less in terms of mods, but just given that 2018 was a much larger vintage than 2017 in terms of mod units, how do we think about that year-over-year?

[Juan Carlos Alvarez de Soto:]

Still the size is going to be the main driver. So the -- I think the important thing is that when we talk about the expected outlook for those TDR balances, doing less modifications might just add to the underlying trend, but we still expect them to stabilize sometime during the mid-part of the year, it might be at a lower base, at a lower level, but still we should have the same type of trend. 2018 is that much of a bigger vintage than 2017.

[Eric Wasserstrom:]

Okay. Thanks very much.

[Operator:]

And our next question comes from Steven Kwok at KBW.

[Steven Kwok:]

Hi. Thanks for taking my question. Just wondering on the personal loan portfolio, are there any updates around like the sale of it and how should we think about the results into your 2019 guidance?

[Juan Carlos Alvarez de Soto:]

Yeah. So we continue -- no real update there. We continue to explore alternatives that will make sense for this portfolio which remains as available for sale. And then in terms of our guidance for next year, it’s still included in there. In terms of our general guidance even though it’s our intention to work out the regional transaction, you’re looking at a relatively flat performance.

[Steven Kwok:]

Got it and then just around the finance charge what’s your assumptions around originations growth and then the overall portfolio the retail installments contract growth?

[Juan Carlos Alvarez de Soto:]

Yeah, so in terms of -- like I said there are the fact that we’ve had significant growth in 2018 will support the increase of net finance and other interest income in 2019. In terms of originations there is a specific level of originations that we want to guide. But you could think of them as some growth in terms of applications and somewhat stable in terms of the model right. They are important thing for us when it comes to originations is making sure that we get the right risk adjusted return when we think about our core. Like I said earlier the prime paper is for us, a service progress line okay we’ll especially with the new SBNA platform none of that really touches our balance sheet anymore. And then at least we want to do is maintain an important presence.

[Steven Kwok:]

Got it. Thanks for taking my questions.

[Juan Carlos Alvarez de Soto:]

Thank you.

[Operator:]

And next up we’ll hear from Chris Donat with Sandler O’Neil.

[Christopher Donat:]

Good morning thanks for taking my questions. Just wanted to ask one about the tax rate both for the fourth quarter and then looking forward is there anything unusual with the tax rate coming in around 27% and I know you said it would be sort of lower for the full year just trying to think is 21% sort of the right number or 22% or I appreciate help quantify or…?

[Juan Carlos Alvarez de Soto:]

Yes so yes there were some in Q4 there were some one-offs where we adjusted our accruals for how some state supply certain components of the tax reform, just like adjusting the way we’re accruing. For 2019 we expect the effective full year rate to be somewhat better than the call it 23% we’ve seen in the full year of 2018, so somewhere below that.

[Christopher Donat:]

Okay, and then for Scott your comments -- or maybe for both of you, comments on the impact of the government shutdown so far. Magnitude is less than what we’ve seen from say the hurricanes, is it I think you said minimal impact or small was trying to get a sense and then we should be a little bit worried though going forward just because it might impact the timing of tax refunds right?

[Juan Carlos Alvarez de Soto:]

Yeah, Chris, exactly the level of hardship deferments extensions that we did for folks during the government shutdown was significantly lower than what we did even in last year’s hurricane season. So that’s why very small impact on delinquency and another other metrics, so very small. But you’re right, I mean the bigger concern is what happens during tax season both orginations and then collections because that has a big impact on our delinquency rate and ultimately our loss rate during that period. So we’re hopeful there that we get the issue settled.

[Christopher Donat:]

Okay, got it, thank you.

[Scott Powell:]

You’re welcome.

[Operator:]

Next up, we’ll hear from John Rowan at Janney.

[John Rowan:]

Morning guys. Just one question from me, as far as the recovery rate, I mean there’s been gains over the past year. Looks like it slowed down a little bit in the fourth quarter. Are there any -- in your guidance it almost sounds like you’re looking for flat recovery rates. Is there -- are there any programs that you can do, any change in the way you repossess vehicles, where maybe we can do a little better and no continue to improve the recovery rate?

[Scott Powell:]

Yeah go ahead, Carlos.

[Juan Carlos Alvarez de Soto:]

No, I think the first it should be we said that we’ve continued to see good auction performance. There was supposed -- we were expecting we talked about it last quarter we’re expecting some normalization we had an unusually strong summer, unusually strong Q3. We saw some of that but we still feel good about the performance that we are seeing and our expectation going forward is still a there should be I think the industry economists have talked about maybe a 1% decline in 2019 in terms of used car prices. So we do expect a relatively stable recovery performance in 2019.

[Scott Powell:]

Yeah, and John we're always looking for ways to be more efficient and get better results in the auction lanes, and we think we're pretty good at that. We're always looking for ways to improve it. That would move things only at the margin. Just to be the optimist in the room Juan Carlos pointed out that the outlook for 2019 is down 1%. So just keep in mind that outlook last year was for used car prices to be down 4%, 5%, 6% something like that. And we actually ended up 3%. So I always take those things with a little bit of -- a lot of salt actually. And you know based on our view of the strength of the consumer and the demand for used cars we're pretty optimistic. But that's our guidance.

[John Rowan:]

Okay, thank you.

[Operator:]

And next question comes from Rick Shane at JPMorgan.

[Richard Shane:]

Hey guys, thanks for taking my questions this morning. I just wanted to circle back on Bluestem. The approach historically has been to considering selling that contract and that portfolio. We are now basically a year from the expiration of the initial part of that contract and then potential renewals. As we approach that point, will you guys instead of negotiating with a third party buyer negotiate with Bluestem about potentially having them not exercise those options?

[Juan Carlos Alvarez de Soto:]

Yes. I think that extension would go until 2022, okay. What I can tell you about the process there is that we explore with -- together with Bluestem in partnership a number of different alternatives. Just making sure, and always keeping in mind that we're not just selling a portfolio, we're selling a basically a flow agreement as well. So there isn't a whole lot that I can tell you there other than we explore all the alternatives from different angles. But they have the ability to extend that until 2022.

[Richard Shane:]

Got it. And again look you know I recognize that there's a distortion between the optics and the economics of that relationship. But does it make sense as -- and again the contract close in April 2020 with a two year extension. I don't know if it's two, one year extensions or a two year extension but does it make sense to try to buy them out of that extension?

[Juan Carlos Alvarez de Soto:]

Again we're looking at all alternatives. I have to really…

[Richard Shane:]

Got it. Okay, thank you guys.

[Juan Carlos Alvarez de Soto:]

Thanks for your questions.

[Operator:]

Our next question comes from Betsy Graseck at Morgan Stanley.

[Betsy Graseck:]

Hi. Good morning. Couple questions, Juan Carlos, I think you mentioned you've got one or two rate hikes in your forecast or in the base case that you provided to us. I'm wondering if there were no rate hikes, could you give us a sense as to what that NII guidance would be?

[Juan Carlos Alvarez de Soto:]

It will probably be on the -- I'm giving you, say a yearly outlook of mid-single digit. We're still liability sensitive. It would depend on how our hedging would initially perform and how we adjusted. But it would certainly be a benefit. When you look at our financials you'll have our Q and certainly our upcoming K, you'll have the sensitivity analysis that we have for 100 basis points rate chart [ph] in there. So we can work from there. I would just say the - in the better end of the guidance.

[Betsy Graseck:]

Okay. Because looking through the quarter results today, it looked like the funding costs might have been impacted a little bit more than prior quarters for the level of interest rate hike. I don't know if you would agree with that, or if there's anything specific to this quarter, that's not likely to be repeated going forward.

[Juan Carlos Alvarez de Soto:]

Yes, yes. Betsy, it's specifically we had less with regards to interest rates -- we have less of a contribution from our derivatives portfolio because of the moves that we saw, especially call it late November and December, okay. So the mark-to-market component of the derivative portfolio wasn't as beneficial as what we had cut in the past.

[Betsy Graseck:]

Okay.

[Operator:]

And next question comes from Arren Cyganovich with Citi.

[Arren Cyganovich:]

Thanks. With respect to CECL, we've started to get some financial companies to provide some ideas of the magnitude of increase and volunteer allowances, 11.4%. Do you have any preliminary thoughts on how much that allowance might have to go up to for with respect to CECL?

[Juan Carlos Alvarez de Soto:]

We're not providing a specific guidance yet. We like all our peers are working on making sure that we are ready by this time next year which we will be. We expect to running be parallels sometime mid-year or so. At this point, I can't give you a specific number. We also are looking at how -- kind of a related topic is how CECL will impact capital ratios, especially regarding how CECL might impact or our CCAR submissions going forward, right. So that NPO [ph] that came out give us a little bit more clarity but I think there's still a more analysis to be done in going for the final thoughts. As we look at our 2019 submission, as you know CECL is not in there. And then later in the year we hope to be able to provide more clarity there.

[Arren Cyganovich:]

Okay. So you don't anticipate having any change to your plans for capital in this upcoming submission?

[Juan Carlos Alvarez de Soto:]

No. Not in this upcoming submission.

[Arren Cyganovich:]

And then just one quick modeling thing, you had mentioned there was a benefit in the expenses for a better outcome in legal, can you -- what's the magnitude of that?

[Juan Carlos Alvarez de Soto:]

So we don't talk about specific legal matters. But some of them have received some press. All-in-all, the impact would be, call it the benefit would probably be somewhere between 10 and 20.

[Arren Cyganovich:]

Okay. Thanks.

[Operator:]

Up next we'll hear from Vincent Caintic at Stephens.

[Vincent Caintic:]

Hey, thanks. Good morning, guys. It's great to see the continued pressure on this [ph] growth. So two questions on the near and long-term. So when you think about the long-term, what do you think this is the rate, penetration rate? And when I think about the -- when we think about the near-term, just want to get a sense of the pipeline from FIAT [ph], if you've seen a lot of campaign and subvention activity recently. It seems like there's a lot of recent model rollouts that have done well like the RAM pickup truck and there's going to be some new rollouts coming out soon. So just want to get a sense of any campaigns? Thanks.

[Scott Powell:]

Yes. Thanks Vincent. So yes --I think on the penetration rate question, I think we've gotten kind of to a more reasonable place. I mean, so I, yes, I mean, first half year was a significant improvement from where we were, from 21% to 30% on average. So I wouldn't -- we look to continue to improve that, certainly. But to answer your second question, we don't control [indiscernible] convention and other bonus incentives that are put into the market. And so I can't really give you a good answer on that one just yet. Certainly, in the case of our partner, Chrysler, they do have some really cool models coming out. So we're hopeful there.

[Vincent Caintic:]

Thanks. And secondly just on the charge-off rate. So this quarter you had charge-offs, net charge-offs 30 basis points higher year-over-year. Just kind of wondering what might have driven that. And then how that compares to the guidance of charge-offs being flat year-over-year in 2019?

[Juan Carlos Alvarez de Soto:]

Yes, I think that that goes to the point we made earlier about how, when you look at a Q4 '18 verses Q4 '17, that charge off level ratio was impacted by just providing lower modifications in Q4 '18. If you normalize for that or when you include that, you will have a better delinquency and higher charge off ratio for the same period of time. That was one of the big drivers in the quarter.

[Vincent Caintic:]

Thank you very much.

[Operator:]

And next we will hear from Jeffrey Elliot at Autonomous Research.

[Scott Powell:]

Hey, Jeffrey.

[Jeffery Elliot:]

Good morning. Thanks. Hi. Good morning. Thanks for taking the question. I've got one more on Chrysler. The tolling agreements that you put in place to kind of waive the statutes of limitations originally back in the summer that was due to expire in December. Can you give us an update on what's happened there and what the implications of that are?

[Scott Powell:]

Yeah, I mean, we're just very focused right now with them on continue to support their sales and working more closely with them. And honestly, I don't anticipate any changes to that. And like I said, with respect to the other conversations, those are constructive conversations and cover a range of things. So …

[Juan Carlos Alvarez de Soto:]

I mean specifically to the tolling agreement is expired.

[Scott Powell:]

Yeah. Sorry, Jeffrey. You still there?

[Jeffery Elliot:]

What purpose was that serving while it was in place from, I guess, June or July through to the end of last year?

[Juan Carlos Alvarez de Soto:]

Like we said back in in the summer that tolling agreement just was simply there to have a period of where we could have the discussions while preserving the status quo for both parties as of April 30. So a certain period impact. That tolling agreement was in place for a number of months. And it has expired. Nothing to it is, the really the discussions are evolving in the way that as Scott described.

[Jeffery Elliot:]

Great. Thanks very much.

[Juan Carlos Alvarez de Soto:]

You're welcome.

[Operator:]

And our last question comes from Kevin Barker at Piper Jaffray,

[Kevin Barker:]

Good morning. You've discussed some of the early indications of the performance of the 2018 managed versus 2017. How that impacts your loss guidance for 2019?

[Juan Carlos Alvarez de Soto:]

Yeah, well, first, we should say the 2017, right. We have talked about the vintage for -- in prior calls. We said that we expected it to continue to perform somewhere between 2015 and 2016. And we're definitely seeing that. For 2018 we would expect it to be in the same neighborhood. And also it's a vintage that's a bit larger than 2017. We're getting the right risk adjusted returns, the right profitability. So all of that together support our guidance of the net charge off ratio for 2019 in somewhere in the mid-8%,

[Kevin Barker:]

Okay. And then to follow up with some of the CCAR comments and CECL as well. Can you discuss any of the -- or potentially expand upon some of your discussions with the rating agencies and how they're going to treat CECL, or if you had any early discussions on what could happen?

[Juan Carlos Alvarez de Soto:]

Nothing really meaningful to talk about at this point with regards to the -- specifically to the rating agencies.

[Kevin Barker:]

Thank you for taking my questions.

[Scott Powell:]

Thanks Kevin.

[Operator:]

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

[Scott Powell:]

Great. Thanks everyone for joining the call, thanks for your questions, thanks for the interest in our company. As always our investor relations team is available if you have follow up questions. And we look forward to speaking to you next quarter about our progress. Thanks.

[Operator:]

And this does conclude today's presentation. We thank you for your participation. You may now disconnect.