Santander Consumer USA Holdings Inc.
Q3 2016 Earnings Call Transcript

Published: 9 Nov 2016

[Operator:]

Good morning and welcome to the Santander Consumer USA Holdings Third Quarter 2016 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 from the SC Investor Relations team. Evan, the floor is yours.

[Evan Black:]

Good morning, and thank for joining the call. On the call today, we have Jason Kulas, President and Chief Executive Officer; and Izzy Dawood, Chief Financial Officer. Before we begin, 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 this call. For further information concerning factors that could cause these results to differ, please refer to our public SEC filings. On today's call, speakers may reference certain non-GAAP financial measures that we believe provide useful information to investors. A reconciliation of those measures to U.S. GAAP is included in the earnings release issued today, November 9, 2016. For those of you listening to the webcast, there are few user-controlled slides to review as well as a full investor presentation on the Investor Relations website. Now I'll turn the call over to Jason Kulas. Jason?

[Jason Kulas:]

Thank you, and good morning, everyone. Today, I'll discuss our third quarter highlights and provide an update on our key strategic priorities. I'll then turn the discussion over to Izzy for a detailed review of the quarter's results and then open the call for questions. Turning to slide 3 of our investor presentation to share some of the key highlights from the third quarter of 2016. We are pleased to report solid results for the third quarter and through the nine months ended 2016. Our assets are producing strong risk adjusted cash flows. Our capital base is solid and our focus on keeping our business simple, personal and fair is positioning us for continued success. During the quarter, SC earned net income of $214 million or $0.59 per diluted common share. Adjusting for a one-time tax benefit, EPS would have been $0.56. Return on assets and return on equity were 2.2% and 17.1% respectively. Auto originations including loan and lease totaled $5.2 billion this quarter, down from the prior year quarter due to our disciplined underwriting standards in a competitive market, and increase competition with banks in the prime space. Lower volumes and the mix shift toward higher credit quality originations year-over-year are not the result of a strategic shift in the business, but instead reflect ongoing changes in the competitive landscape of the market. Because we price and structure assets in all parts of the credit spectrum at levels that we feel are appropriate for the risk, we are pleased with the assets we are booking. As these more recent originations come in, they impact APR immediately and should also positively influence charge-offs and delinquency in the future. SC's retail installment contract net charge-off ratio increase to 8.7% up 50 basis points year-over-year, driven by slower portfolio growth, the 2015 originations and lower auction recovery rates. Slower portfolio growth driven by lower originations decreases the denominator of this ratio and decreases the balance of loans that are newer and have not yet experienced delinquency or charge-off. During the quarter, our track record of rating agency upgrades continued, demonstrating the strength of our ABS platforms. In total, 90 ABS tranches were upgraded this quarter by Moody's, S&P and Fitch, positively impacting more than $7 billion in securities across multiple SC ABS platforms. Turning to page 4, here are some key economic indicators that influence our originations and credit performance. While there has been some volatility in both measures, U.S. auto sales and consumer confidence remain high. U.S. GDP growth is in line with the recent historical range and employment levels continue to be favorable. These metrics are strong indicators of the health of the economy and the U.S. consumer. Furthermore, gas prices remain low, helping the financial strength of the consumer. And these factors combined with the strength in the liquidity markets and access to funding have driven continued competition. So, we remain disciplined in this environment. On page 5, there are a few key factors that can influence our loss severity and credit performance. The Manheim Index remains elevated, evidencing the health of the broader used vehicle market. This quarter we added the National Automobile Dealers Association or NADA Index, which more closely tracks our recoveries, because it is not seasonally adjusted and the vehicle mix is older, unlike the Manheim Index. SC auction-only recovery rates are trending down and in line with the NADA trends. However, auction plus recovery rates which include insurance proceeds, bankruptcy and deficiency sales and other recoveries are stable year-over-year. Additionally, non-prime industry securitization data, including delinquency and loss show these trends are relatively stable to moderately higher. Turning to page 7. Average managed assets increased 3% versus the prior year quarter. Auto originations during the quarter totaled $5.2 billion, down 31% from the prior year quarter. Originations with FICO scores below 640 in our Core and Chrysler Capital channels decreased 29% and 38% versus the prior year quarter. More recently, Core originations increased 19%, as we implemented various targeted pricing optimizations that allowed us to be more competitive in certain pockets. Chrysler Capital loans above 640 and leases decreased 40% and 39%, respectively versus the prior year quarter. Throughout our history, we've experienced ebbs and flows in our originations. This quarter, we continued to see a decrease in our market share versus last year, indicating that we remain conservative relative to some other lenders. However, our market share has remained relatively constant versus last quarter. Our volume is a function of our pricing strategy that is based upon the most up-to-data information available to ensure we achieve our return thresholds. As we have done historically, we will continue to optimize this strategy as we receive new information. Sustainability and delivering for our partners through cycles is key. We are committed to booking loans with attractive risk adjusted returns that will perform through cycles and create shareholder value. In the prime space, we've lost some market share to banks, and we're working on ways to address that. We're very excited to share with you that we are finalizing a strategic agreement with Banco Santander to originate and flow prime and near-prime retail loan assets. This agreement will provide the opportunity for SC to become more competitive in the prime space and should benefit our overall relationship with Fiat Chrysler in our Chrysler Capital volume. Increased prime volume and asset sales would in turn be beneficial to our service for other strategy. Turning to slide 8 and further drilling down into our auto originations mix. In the third quarter, our originations continued to move towards higher credit quality loans. Loans with FICO scores 600 and above, increased at 49% of retail installment originations, up from 45% in the prior year quarter. These higher credit quality originations led to a slight increase in the percentage of new vehicle originations, as noted on the bottom portion of the slide, and will also impact APR. In addition, the average loan balances decreased as we continue to monitor loan-to-value closely. The mix of our new and used assets is a positive for the diversification of our business. Moving to slide 9, the Chrysler Capital penetration rate as of September 30th was 19%, down from 22% in June. We remain the largest finance provider for Fiat Chrysler. Chrysler Capital is a focal point of our strategy and we continuously seek out strategies to enhance and grow our relationship with FCA. This quarter, we continued to increase the amount of dealerships participating in our dealer VIP program. This program allows dealers to earn additional rewards based upon achieving certain volume thresholds. And our plan is to roll it out nationwide in 2017. We continue to have success in our lease program and are refining our end of term process as more leases mature. And finally through Santander Bank N.A., we've increased our dealer receivables originations 50% year-to-date versus the same period last year, compared to 2015. This is important to our relationship with our Chrysler Capital dealers as we expand our suite of services and become an even more valuable partner for FCA. Turning to slide 10. Our serviced for others strategy continues to generate stronger results. Servicing fee income, totaled $36 million this quarter, as we continue to deliver value through this capital efficient platform. The decrease in the portfolio versus Q3 2015 to $12 billion at quarter end is primarily driven by lower originations and asset sales. Looking ahead, we expect to grow the serviced for others platform by increasing our Chrysler Capital penetration and by executing the strategic agreement with Santander. I would like to turn now to Izzy for a review of our financial results. Izzy?

[Ismail Dawood:]

Thank you, Jason, and good morning, everyone. Let's turn to slide 11 to review this quarter's financial results. Net income for the third quarter was $214 million or $0.59 per diluted common share. Adjusting for a one-time tax benefit related to the re-characterization of historical losses for tax purposes, EPS would have been $0.56. Net leased vehicle income increased 47% as we continue to see growth in our leasing portfolio with FCA. Total other income this quarter was $27 million, which is net of approximately $96 million of lower of cost or market adjustments related to personal lending, that I will detail on the subsequent slide. Operating expenses for the third quarter were $284 million, an increase of 9% versus the same quarter last year, driven by higher repossession and compensation expenses. Moving on to slide 12, which highlights our performance excluding the impact of personal lending. Further details can also be found in the appendix of the presentation. Interest on finance receivables and loans decreased slightly year-over-year and quarter-over-quarter, due to a mix shift towards higher credit quality assets with lower APRs. Interest expense increased 26% versus the prior year quarter, driven by the increase in benchmark rates and spreads. One month LIBOR increased more than 30 basis points from September 2015 to September 2016. Cost of funds on ABS and third-party amortizes also increased approximately 70 basis points. Total assets also grew by 11% versus prior year quarter, which increased interest expense. Turning now to slide 13, we will further drill down into total other income. Reported total other income was $27 million in the third quarter 2016. The impact of lower of cost or market adjustments of personal lending of $96 million include, $114 million in customer defaults, offset by a net reduction in market discounts of $19 million as balances decreased versus the prior quarter. Normalized investment losses for the quarter were $4 million, reflecting the impact of flow sales. After including servicing fee income and fees, commission and other, normalized total other income was approximately $129 million. Turning our attention now to provision and reserves on page 14. The allowance-to-loans ratio was 12.4% as of the end of this quarter, down from 12.6% at the end of the prior period. On the bottom portion of the slide, you will see at the end of the third quarter 2016, the allowance figure totaled $3.4 billion, down $23 million from the end of the prior period. Drivers of the decrease include

[Jason Kulas:]

Thanks, Izzy. In July, we executed a subservicing agreement with our Puerto Rico entity, Santander Consumer International or SCI. This entity will provide further geographic and time-zone diversification as well as increase proximity to existing servicing vendors, which facilitates improved oversight. Under the agreement, SCI will manage the servicing strategy of the performing portion of our loan and lease portfolio. The service center operations will begin by the end of 2016, and we will continue to ramp up our presence on the island through 2017. We are excited about this expansion of our serving platform and we will provide further updates on our progress going forward. We will also provide further clarity to any potential changes to our consolidated effective tax rate, once we finalize discussions with our advisors. Regarding technology and innovation, we continue to leverage our online direct-to-consumer platform, RoadLoans.com. Since the end of Q3 2015, more than $180 million or approximately 1% of our originations have come from this platform. We are excited about the foundation, we have in our RoadLoans platform, as we believe digital platforms will become increasingly important to the consumer finance base in the future. Our commitment to building a culture of the compliance and putting customers at the center of everything we do is the foundation of our continued success. As highlighted on slide 6 of our investor presentation, this is a core component of our strategy, along with a continued focus on vehicle finance, service for others, liquidity and funding. We remain confident in our ability to execute on our business plan and deliver value for all our stakeholders and customers through market cycles. We believe the key is to creating future shareholder value line continuing to approach credit with disciplined and indentifying new and better ways to be simple, personal and fair with our customers, employees in all constituencies. With that, I'd like to open the call for questions. Operator?

[Operator:]

Thank you, sir. We will open the call for questions. [Operator Instructions] Thank you. And for our first question, we go to Moshe Orenbuch with Credit Suisse.

[Moshe Orenbuch:]

Great. Thanks. I was, sort of, hoping Jason that you could kind of talk a little bit about the shift in originations, are these the loans that you're finding, kind of, the best as you decided to move into higher quality or do you find that these are the best returns overall, and when you think about the competitive environment, what could cause this to change, would you have to go higher or where you could go back deeper, how do you think about those things?

[Jason Kulas:]

Sure, so the shift in originations is partially due to some actions we took on our part, to look at the risk return trade off in some of our subprime originations earlier this year. But it's also partially a factor of the competitiveness of the market. And so, to your question, I think it's good for us to cover both of those. So, we get because of our presence in the market through our core business, our legacy business and also with Chrysler Capital, we get applications up and down the credit spectrum, from deep subprime through super prime applications. And our process of feeding information on what we're seeing in performance back into the way we structure and price loans continues today just like it always has, and so because of that, where we're setting the price and the structure for each individual loan, no matter where it is on that spectrum is a pricing structure we'd be happy to have. I will say that the mix of business we're getting today, as we've talked about, is a higher mix of business that long-term will have a lower loss profile, at a yield that we think make sense for that loss profile and because of that we're really happy with the assets we're originating today. I think what could change that going forward is, if they are parts of the subprime universe, what we're seeing today is a lot of people in this market where liquidity is plentiful, really up and down, they're competitor less, right. So for banks obviously, you can access cheap deposit funding, and even for non-banks you're accessing very efficient liquidity markets, which maybe up year-over-year, but even in the near-term have improved for at least most of the issuers. And because of that you've got people with liquidity looking for yield and that tends to increase competition as you move down the credit spectrum. So to the extent that those factors change, we could see incremental opportunities in nonprime going forward. For the bulk of our core business it's sort of – we have to constantly second guess ourselves on where we're pricing and structuring, but once we've done that, we have to be comfortable with what we get and then we'll take what comes to us as the market shifts. With Chrysler Capital, it's a little bit different story. And the reason we continue even at our current level of penetration which is lower than where we were last quarter to be really upbeat about that relationship, is we can't do some things to influence that. So if you think about share in Chrysler going forward, the things that we're doing, we think over the long-term will contribute regardless of the competitive environment we're in to the amount of business we do. So our increasing presence with dealers through both the VIP program and with floorplan, our originations on the floorplan side through our partnership with Santander Bank are up 50% through nine months of 2016 versus that same period in 2015, that's just tremendous improvement that will over time, as we continue it, bring more business to us. This relationship that we're – or this agreement that we're working on with Santander to originate more prime assets is also something that we think will benefit that relationship over time. So we think we can do some things regardless of the rate environment, the competitive environment to help ourselves see much higher levels of originations going forward and we're excited about that. So that inevitably would shift the mix of originations up market. But what's on our balance sheet, we see it sort of staying – at least from what we can see right now because we're a month into the next quarter, we don't see it changing very much from what you see in our kind of, recent experience of origination. So, continuing to be slightly up market. So, I'll leave my answer at that, I'm sure there's much more to discuss on those topics. But we really think that what we're doing now is good and we're constantly looking for ways to do more of it and we think we've got some ways to do that.

[Moshe Orenbuch:]

Got it. Just as a quick follow-up. Maybe you could expand on the profitability of Bluestem because I guess I'm looking at the numbers you have here, it seems like it, kind of, has before expenses a contribution in the teens million dollars in the third quarter and if you're going to take another $80 million plus LOCM write-down, it's tough from outside to see, how that's profitable. So, maybe you could, kind of, qualify that and talk about your plans on that?

[Jason Kulas:]

Sure. So, Izzy you can add on to this as well, but I'll give an initial answer to that. So, that business, as you look at the performance over the course of a year is still profitable. So, in that regard, the delay in the sale process, sort of, the amount of time the sale process is taking to get through, that delay has been a profitable delay for us. In the fourth quarter, clearly as you have a seasonal buildup of those assets, you do end up with a mark on the income that you end up making up in the other quarters. But all-in, that's a profitable business for us as long as it's sitting on the balance sheet.

[Moshe Orenbuch:]

Okay. Thank you.

[Ismail Dawood:]

And Moshe, I think you hit on it, on page 24 of the presentation, you have a couple of quarters of information. So, when you add it up for the full year, it remains profitable even with the mark that we have to take on yield originated balances and that's consistently kind of our experience with that portfolio since we've had it, so nothing has really materially changed from that aspect.

[Moshe Orenbuch:]

Thanks.

[Operator:]

And for our next question, we go to John Hecht with Jefferies.

[John Hecht:]

Morning, guys. Thanks. A little bit of a follow-up from Moshe's last question. In terms of originations, I think the last two quarters you've been down 30% year-over-year, so I would guess that it attenuates maybe consistent market share changes this quarter to last quarter. What do you guys see based on the competitive environment and your origination focus, what do you guys see over the next few quarters, is that a reasonable year-over-year change until you annualize that or how should we think about that? And then how should we think about how that impacts balance sheet kind of growth and the held-for-sale category – excuse me, the held-for-investment category as well?

[Jason Kulas:]

One of the things we're really pleased with is our recent performance. We did identify some pockets of the market where we felt like we were overpriced a couple of months ago, and we've seen in the last couple of months a benefit to portions of our originations from that move. And with returns on the assets we think are the right returns, so that's a positive thing, and we think the way that, that continues into the fourth quarter is that you would typically see a seasonal decline in originations in the fourth quarter. We would expect that if we had a decline, a seasonal decline net of our recent success on some of those pricing initiatives, you wouldn't see what would be typical from us, so we are encouraged by that. But as we look into our internal forecast for 2017, our expectation is that we will continue to increase originations and that we can do that at margins that make sense across the board.

[Ismail Dawood:]

Yeah. And I'll just add John. You mentioned about the HFI versus HFS, primarily what fits in our HFS, our held-for-sale category is going to be assets either going to flow to our partners or what we anticipate securitizing through our CCART platform. And those generally trend to be prime assets or near-prime assets and that has not changed or shifted from our perspective.

[John Hecht:]

Great. That's very helpful color. Thanks. Jason, you did refer to the held-for-sale, well, going back to held-for-sale of Bluestem, maybe do you have any update about the sales process there?

[Jason Kulas:]

Sure. So we still are going through the process, as we talked about earlier this year, the process is much more complex than the one we went through for installment lending. And so by necessity, it's taking longer. Having said that, it is taking longer than we originally anticipated. But we're still committed to the process, we're actively engaged with people who are interested in buying the portfolio and playing a role in the ongoing originations. And so those discussions continue, so as soon as there's something to announce on that we will. Having said that, we also have to make sure that what we do is also the right financial decision for the company. And so we'll be careful to make sure that we keep that in mind as well as we go through the process.

[John Hecht:]

Great. Thanks, guys.

[Jason Kulas:]

Sure.

[Operator:]

And for our next question, we go to Chris Donat with Sandler O'Neill.

[Christopher Donat:]

Good morning, guys. Thanks for taking my questions. Just wanted to circle back one thing with the comment on how the rate increased a year ago weighed on interest expense. But we're not seeing any real improvement on APRs. Is that just not the way it works with the loan business or was there some mix shift there that did not cause the APRs also lift a little bit with higher benchmark interest rates?

[Ismail Dawood:]

Right. So there are couple of things, Chris, by the way, that's a great question. A couple of things have happen happened. One with the benchmark rate increase in the spreads, those, kind of, hit immediately. So as you're probably aware, we are somewhat liability-sensitive. So we see that impact on, interest expense right away. On APRs, obviously we passed on as much as we can on to our APRs, but that takes some time for us to start accruing that income, obviously because we have an older portfolio and a different APR. And additionally, I think what influenced the APR as you compare it year-over-year, it's just the mix shift to a higher credit quality. So that also had an impact on APR.

[Christopher Donat:]

Okay. Got it. And then as we think about – trying to think the right way to ask this question. But I appreciate the detail on the allowance for loan losses and the TDR migrations and the qualitative reserve, I guess big picture looking forward, should we expect these TDR migrations and changes to the qualitative reserve to be, sort of, lumpy on a quarterly basis or smooth, I know you can't be too precise on numbers, but just looking philosophically?

[Ismail Dawood:]

Yeah. That's a good question. So as you would imagine, as the portfolio ages over time and we work with our customers to help them with any temporary financial hardship, a loan may migrate to TDR and as the portfolio ages over time more and more loans will migrate there. That's further impacted by the fact that our originations last several quarters have been less than prior year. So there is a mix shift between TDR and non-TDR as well. We try and keep a close eye on it, but it is, as to your point really tough to nail down or predict. What we really keep a focus on is our overall allowance relative to our loans to ensure that, that reflects appropriately based on the credit performance that we're expecting.

[Operator:]

For our next question, we go to Steven Kwok with KBW.

[Steven Kwok:]

Hi. Thanks for taking my questions. I guess the first question was just, how should we think about the net charge-off as we head into next year, understanding given that now you're originating higher quality loans, it's impacting your yields today, but there should be a benefit down the line on the charge-off rate side. So, is there a way if you could help us think about that?

[Ismail Dawood:]

Sure. So, intuitively you're correct. As we migrate to – a couple of things. One, as you migrate to a higher credit quality mix, your charge-off should be less, that's accurate. Second, as our 2015 deeper subprime vintage seasons, that will be a less of a factor into our net charge-offs. So, on a nominal term that should help. At the same time, there is a denominator effect when you talk about the ratio. If our loan originations don't increase, you will see net charge-off ratio get impacted just because your denominator is slow – is not growing as fast. But overall from a vintage-by-vintage or like-for-like, we would anticipate charge-offs being better with the higher credit quality mix.

[Jason Kulas:]

And just a follow-up on that. One of the things we're working on internally that we'll be discussing in more detail probably at an upcoming conference or when we have an Investor Day in 2017, is to show some scenarios of different paces of originations to actually illustrate what that impact is because if you take vintages of originations over time and just assume different volumes with the same exact credit profile of origination, what you'll see, obviously I know you know, is that at different paces of – so if you keep it flat versus if you have a declining pool or an increasing pool, you have extremely different outcomes on what you report as your net credit loss and your delinquency. Even though the underlying vintage credit performance is exactly the same in all scenarios. So this denominator effect is real and I think we've got some ideas for how we can better illustrate that going forward.

[Steven Kwok:]

Got it. And then just a follow-up around the used car prices. Did you guys – what are your assumptions around how that trends over the near term? I think there has been some concerns given some of the commentary within the industry. Thanks.

[Jason Kulas:]

Yeah. We do expect to see continued softness in recoveries, we account for that on how we price new business, we account for that on how we reserve for existing business. And I think for us the pace of change so far has been a positive, because it's been gradual and we would expect going forward for that to be the same sort of story, that it's declining but at a gradual pace. And really it's declining for reasons that are easy to track and follow, because it's about supply driven by an increasing penetration of lease and other types of structures in the market that are bringing more cars back. And as there's more supply, you should expect some softness in the prices. So setting aside seasonal factors where at certain times of the year, it's better than others, we would expect over the course of 2017 for recoveries to be lower than they were this year, similar to what's happened in 2016.

[Operator:]

For our next question, we go to David Ho with Deutsche Bank.

[David Ho:]

Hi. Thanks for taking my question. I fully appreciate the mix issues impacting the outlook for net charge-off rates, but if you take a step back and look at, kind of, the pace of credit normalization across the FICO bands that you're looking at sub-prime versus prime, can you elaborate on how quickly that's occurring, obviously the ABS data has its own mix issues as well. So I just want to get a better sense of how you're seeing like-to-like losses deteriorating?

[Ismail Dawood:]

Sure. So I'll start on that one. One place you can see that is, how we breakout our reserve build. So the $34 million that we attribute to performance, it is really what's in that category. So if you think about it, on a book of our size and a multi-billion dollar reserve, you end up with a $34 million difference this quarter versus last quarter on a similar book of business. And so that's probably where you see that. So I would say relative to the size of the our company, it's fairly minimal, but we are seeing that, right. We are seeing that kind of continued migration in credit. Having said that, I think the big offset in a business like ours is, I think the base where you start is that the changes aren't significant. But I think, the real positive for a business like ours is that the average life is so short, you can factor that information into newer originations and sort of, make sure, you're constantly pricing in what you're seeing in the market and that's what we're doing.

[David Ho:]

Okay that's helpful. And real quickly, obviously the Chrysler agreement, where you, kind of, size the servicing business in terms of scalability, you got to assume much higher penetration rates at this point in the agreement. Given some of the initiatives that you've put in place. How quickly do you expect penetration rates to grow, obviously new car sales are slowing, rates hopefully are rising a little bit, which makes them eventually little more attractive as well. How subscale are you in that business and if you continue to have a weak penetration rates, kind of what's your plan of action there?

[Jason Kulas:]

That's a good question. On the Chrysler business, we are as committed to that business today as we've ever been. And we're working jointly with FCA to continue to come up with ways that we can increase our penetration, because success for Chrysler Capital is good for both of us. And so, we'll continue to do those things that I mentioned earlier and also work on new ways to increase penetration. Probably the single biggest surprise, if you look at where we are today versus where we're expected to be, going back a couple of years or a few years is, what you mentioned, which is the rate environment. We assume that rates would go up at a faster pace than they have, which would've made the subvention dollars that mostly come to us much more meaningful in driving business to us. But the fact is that the rate environment has remained very low which has allowed non-preferred financial providers to be extremely competitive in lower margin prime and super prime type originations. And so, we do expect as you said, we do expect that to change over time. The talk this morning was that maybe rate increases get slightly delayed, but regardless of whatever pace it happens, we know how the story ends, and in the meantime, we're going to continue doing things to help ourselves, and not rely on when the ultimate day comes and rates go up.

[Operator:]

And for our next question we go to Mark DeVries with Barclays.

[Mark DeVries:]

Yeah, thanks. Following up on the Chrysler penetration issue. I mean I understand that, that they've been relatively happy with you guys despite being, well below the target penetration levels in part, because of an understanding that the low subvention dollars has impacted that, but given that, that's been an issue for a while, and you actually had a sharper pull back there than you did in your other channels. Just curious on whether Chrysler still remains, kind of, happy with the partnership of this line.

[Jason Kulas:]

We had a good opportunity to test that in the last week or so, when there was a speculative article on the status of the relationship, and we both came out with quotes reinforcing the nature of the relationship and the commitment to the relationship. So we've both commented publicly on that matter just in the last couple of weeks. But I would say from our perspective, the relationship is strong, but it also is very focused. I mean, on both sides, we want to do more business than we're doing today. We want to be more relevant with the universe of dealers. And as we, sort of, march through this process, that's happening. We'd like it to happen at a faster pace than it is, but the fact is, a 50% increase in origination of dealer floorplan this year versus the same period last year, that's a meaningful number, and it's a number that will make us – it will drive more business to us going forward. The dealer VIP program, the dealer rewards program, we will have that rolled out nationwide in 2017, we've been working on that for most of this year. And that process of piloting that program has helped us a lot in coming up with a program that ultimately we think will drive some incremental business and increase our share of what Chrysler originates. That's the goal, and we have to do it in a way that maintains financial discipline, and where we're getting the proper risk adjusted returns for the assets we've booked, we have to do that, that's a non-negotiable, but we think we can do both. We think we can continue to realize upside from this level going forward that will be a real positive to the story as we look out over the next few years. But this is a multi-year story, given that we don't know, what's happening in the rate environment, because that will obviously be a big help to the extent that happens at a faster pace than we expect.

[Mark DeVries:]

Okay. Got it. And with the pullback in originations, your capital is actually now accreting at an accelerating pace. Can you talk about what, if anything, you can do to leverage that growing capital base?

[Jason Kulas:]

So our capital is going up and that puts us in an interesting position, because we have more capital, than we've ever had in the history of the company. And from a financial stability standpoint, that's a real positive, if you think about how our company might be rated, if you think about how lenders and ABS investors will think about exposure to our company as an originator and seller of assets to them or as a servicer of assets. And so it really benefits – this higher capital base benefits our business. If you look at the return on that higher capital base, we still think it's a very solid return, given the rapid pace of increase in the denominator of that calculation. So there are some real benefits. As we look forward, our ability to distribute capital is going to be directly tied to what it has been, which is, we can't even entertain the discussion until we get to the point, where we're allowed to pay dividends and have capital distributions as part of the discussion. That ties very closely to the CCAR process and we continue to, as an organization throughout the U.S., make progress on all those fronts and we feel like, we're rapidly moving to a place, where that will be among the decisions we can make as a board. But we're not there yet and the work continues.

[Operator:]

And for our next question, we go to Rick Shane with JPMorgan.

[Richard Shane:]

Hey guys thanks for taking my questions this morning. I'd love to talk a little bit, I know we've belabored this already but the originations and I'm really curious when you think about the different inputs, in terms of driving the origination mix, whether it's price, term, down payment; where the real sensitivity lies, because I suspect it's a lot less price sensitive than we think about, but a lot more to do with things like term and potentially LTV. Can you, sort of, help us quantify that?

[Jason Kulas:]

Sure. The answer to that question really varies as you go up and down the credit spectrum. Price is a significant driver as you move up into prime and super prime, and it becomes less of a factor as you move down the credit spectrum. For us, we've tried to maintain discipline on a lot of the key credit factors that drive how we structure a loan. So, we've seen, term for example has not really migrated for us, like it has for maybe some other parts of the business or the competition. If you look over a fairly extended period of time, our terms have been relatively consistent. If you look at payment to income and LTV, we've tried to stay within a pretty tight band of originations in terms of how we structure that credit. So, we feel like, as I mentioned earlier, we go to this process constantly of second guessing what we're doing, because we don't – one thing we know for sure is that, we're always wrong, it's just a matter of how much. And as we factor in new information, we see and then we ask those questions, we work through the analysis and we come to an answer, we have to be steadfast on what that answer is. I think again for us, it really keeps coming back to competition. If you look at – we've made this comment in the past that, if you look at the top lenders versus the rest of the market, the top lenders fairly consistently over the course of the last, more than a year now, have been fairly consistently losing share to the smaller competitors. And there are always going to be periods of time where there are small exceptions to that where you have a couple of large competitors picking up share, while a couple are giving some up, and you've certainly seen some of those swings by us with some of the ebbs and flows of the market. But one thing that's remained true is if you take that larger group as a whole they've continued to lose share to others. And so I think as a group, we have to continue to maintain discipline and over time understand that there may be players in the market, who are seeing things we don't, and over time we'll see those same things. But there also could be players in the market, who are dipping down for yield and may not be permanent players, and that tends to wash itself out over time. So we have to resist the urge to panic and kneejerk when we go through those periods. We're certainly doing less non-prime business than we'd like to be, but we're going to be patient because we know it tends to come back around.

[Richard Shane:]

Look, I know the feeling of being wrong and how that feels, so I'm with you on that. And again I don't see it as a positive or negative at this point. I recognize the discipline and I think that, that makes a great deal of sense. It strikes me that the competitive landscape in the subprime and deep-subprime really is playing out on the down payment in LTV side, and I think given some of your expressed views on used car prices and expectations that seems to be where you're holding the line, and is that what you think is really shifting the market share away from you in the short-term?

[Jason Kulas:]

Yes. I think that's a factor for sure. But what I'd add to my earlier comments is – so yes, I agree with the statement you made, but the difference for us versus a competitor who isn't attached to one of the major brands is that, we've got some unnatural ways, that we can look at incremental originations. So even if that environment continues for a longer period than you would expect meaning, if people are really not requiring the right down payment, are really looking at LTVs that probably aren't sustainable through cycles that tends to correct itself over time. But if that takes longer than expected, I don't think that has to mean that the origination story for SC is not a good one because, we're doing some things on the FCA side, on the Chrysler side, that even if that doesn't change will bring up some incremental originations.

[Ismail Dawood:]

And Rick, one of the things you also see in one of the slides is our average loan balance has been slightly down, even though the new end use has gone up just slightly. So to your comment, there are places where we're holding the line, where we see, maybe the marketplace is pricing things differently than us?

[Operator:]

And for our next question, we go to Eric Wasserstrom with Guggenheim Securities.

[Eric Wasserstrom:]

Thanks very much. Obviously, I've heard all of your comments this morning. But can you just clarify for me, if you don't mind, how you're contemplating reserve adequacy on a go-forward basis, given both the mix shift, but also the intent around asset sales?

[Ismail Dawood:]

Sure. So in terms of asset sales, they are generally in our held-for-sale category. So we don't have to provision against it. So we'll put that aside for a second. When it comes to the overall adequacy of – as you're aware, we are using an approach where we have a TDR and a non-TDR balance and we have to acquire the appropriate coverage. With TDR, it's a lifetime coverage and we have information in our press release in the back that shows that, we have a coverage of about roughly 30% on those balances. For the non-TDR piece, which effectively you can call performing, that coverage is roughly 8%. And so, as the portfolio grows and the credit mix shifts over time, those coverage ratios will slowly shift as well. Overall in terms of what we indicated, we expect our overall loan loss of $3.4 billion to be flat to slightly lower next quarter that is reflective of the expected credit performance of the book we anticipate having, driven by the shift in credit mix as well.

[Eric Wasserstrom:]

Got it. And when you say shift, you mean that coverage will recede a little bit given the higher overall credit quality, is that right?

[Ismail Dawood:]

Yeah, so when I saw coverage I think about more nominal terms as supposed to ratio, just taking the denominator effect out of it. But yes, as our credit mixes we have originated is better than what we had in the past, slightly better, that directly influences the actual coverages for TDR and non-TDR books.

[Jason Kulas:]

It's really interesting as you think about the look forward. And we talked about some seasonal impacts in Q4 that are typical and on top of that the seasonal impact of the personal lending business. But then as you look into 2017, you know, as you look at what we think we can do on the originations front, as you look at net charge-offs and the trends there, where you're really seeing those peak, given the current mix of business we're originating. The 2015 vintages, as Izzy talked about earlier, are you know – their influence on the portfolio going forward will only decrease, will only shrink in terms of the credit quality of the portfolio. If you put all of these things together, you really can have a an upbeat outlook for what's going to happen going forward, and to the extent that changes either up or down from a credit perspective will be compensated for whatever that is, right. So, if we continued to migrate up market, it would be at returns that make sense and if we continued to – if for reason something shifted, which would be different than what we're seeing today and we book some incremental deeper originations, they would come with higher losses and a slightly different story than what we're saying on provisions, but we'd be compensated for that. But if we continue to do what we're seeing now and just do more of it, the credit story, the reserve story, the loss story is going to be one of stability and improvement.

[Ismail Dawood:]

Right. And one thing I just add, Eric, is also as we talk about the shift, it's really a shift within our subprime space. I don't want everybody to think all of a sudden we are moving from a subprime to more near-prime or prime, it truly is the elements within the subprime space which have varied degrees of returns. So that's where we see the pockets and where we see the risk return to be adequate and appropriate, that's where we'll try and take advantage of it.

[Operator:]

And our last question comes from Charles Nabhan with Wells Fargo.

[Charles Nabhan:]

Good morning and thank you for taking my questions. Just a couple of quick credit related questions from me. From a timing standpoint, when do you expect the loss contribution from the 2015 subprime vintages to moderate? And secondly, I was wondering if you could comment on any changes in behavior you might be seeing in the curing of later-stage delinquencies given the availability of credit, which some have commented disincentivizes later-stage delinquencies from curing?

[Ismail Dawood:]

Okay. So I'll take the timing aspect. So the 2015 vintage, for the most of 2015, we did originate loans with limited credit experience and high percentage of it as well as larger volume. So I think that will pick 12 months of season and work itself out. So, we'll see some impact of it definitely heading into next year, especially early part of the year. However, as the 2016 balances take hold of our portfolio and obviously 2017 vintages that will help moderate at least the ratio impact as well as the nominal loss impact. And change in behavior, that's an interesting one. So we do keep an eye on the delinquency rates, as well as the role rates that we see. So in the later stage delinquencies, we see stability that we probably haven't seen in the past. That maybe a function of couple of things. One, Jason mentioned, the overall health of the U.S. consumer, as well as of the U.S. economy. Second with the faster losses on the 2015 vintage, never get to the point of later delinquencies. So there will be lesser of an impact there as well. But overall, the late stage delinquencies, we don't see any real bifurcation positive or negative overall relative to, kind of, what we experienced in the past.

[Charles Nabhan:]

Context around the Banco Santander flow agreement, what we could expect, in terms of volumes and when you expect that deal to be up and running?

[Jason Kulas:]

Sure. At this point, we can't really talk in more detail about the nature of the agreement given that it's an ongoing discussion. But what we're excited about is, it really reflects our ownership structure and it shows that we are leveraging our unique ownership structure, particularly among non-prime auto competitors. It puts us in a position, we think to have a much more sustainable approach to prime and near-prime type business for the Chrysler platform, which benefits us in so many ways. It obviously is a big driver for service for others. And is a big driver for penetration in the relationship, at this point being more specific than that would be getting ahead of ourselves, but from a timing perspective as we move into early 2017, we'd expect to be talking a lot more about that.

[Operator:]

And we have no further questions in the queue at this time. I will now turn the conference over to Mr. Jason Kulas for final comments.

[Jason Kulas:]

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

[Operator:]

And again, ladies and gentlemen, this does conclude today's conference. Thank you for your participation. You may now disconnect.