Santander Consumer USA Holdings Inc.
Q2 2015 Earnings Call Transcript

Published: 30 Jul 2015

[Operator:]

Good morning, and welcome to the Santander Consumer USA Holdings Second Quarter 2015 Earnings Conference Call. At this time all parties have been placed into listen-only mode. Following today's presentation, the floor will be opened for your questions. [Operator Instructions] It is now my pleasure to introduce your host, Kristina Carbonneau, from the SCUSA Investor Relations team. Kristina, the floor is yours.

[Kristina Carbonneau:]

Good morning and thank you for joining the call. On the call today we have Jason Kulas, Chief Executive Officer and Jennifer Davis, Interim Chief Financial Officer. Before we begin, as you are aware, certain statements made today such as projections for SCUSA's future performance are forward-looking statements. Actual results could be materially different from those projected. SCUSA has no obligation to update the information presented on this call. For further information concerning factors that could cause these results to differ, please refer to our public SEC filings. Also on today's call, our speakers' may reference certain non-GAAP financial measures that we believe will provide useful information for investors. A reconciliation of those measures to U.S. GAAP is included in the earnings release issued today, July 30, 2015. 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 Web site. Now, I will turn the call over to Jason Kulas. Jason?

[Jason Kulas:]

Thank you, and good morning, everyone. Today I will discuss our second quarter highlights and ongoing strategic initiatives. I will then turn the discussion over to Jennifer for a detailed review of the quarter's results. And then open up the call for questions. Our second quarter results are highlighted by strong earnings growth, positive credit performance and robust originations in asset sales. During the quarter, SCUSA earned net income of $285 million or $0.79 per diluted common share compared to net income for the second quarter 2014 of $246 million or $0.69 per diluted common share. This equates to net income growth of 16% from the prior year second quarter. While earnings growth, credit performance and returns are all positive, you will notice some increase in the amount of provision dollars and in the allowance ratio. As you know, we continue to deploy prudent provisioning practices, it's important to remember that because of the seasonality in our forward looking provision model, at the end of Q2 there are more losses covered all else equal than at the end of the prior quarter. SCUSA's net charge-off ratio for the quarter was 5.3% down from 6.7% last quarter and down from 5.8% during the same quarter last year. However, the provision increase $133 million to $739 million up from $609 million in Q1 2015 and the allowance ratio will increase 93 basis points to 12.4% up from 11.5% in Q1 primarily due to the seasonality impact in the models. The allowance ratio is also up from the same quarter prior year primarily due to our now designating most prime assets as held for sale. The removal of these assets from the held for sale – held for investment population subject to allowance leaves only the higher margin loans driving up the allowance ratio. The charge-off ratio was favorably impacted by recoveries brought forward through bankruptcy and deficiency sales. After adjusting for these sales during the quarter, the ratio is flat to the same quarter last year. A flat charge-off ratio is good news considering the portfolio shift toward lower credit higher margin loans year-over-year. The delinquency ratio is 3.6% at the end of the quarter, up seasonally from 3.2% last quarter and slightly down from 3.8% at the same time last year. We continue to see stability and performance as we maintain disciplined underwriting practices and adhere to strict ROA hurdles. Total originations this quarter were $7.6 billion compared to originations of $7.4 billion in the first quarter. While competitive, we believe the market overall is still rational and we continue to have confidence in our ability to originate attractive assets that meet our return hurdles. We retained a significant amount of attractive assets over the past year. Net finance receivables loans and leases including held for sale assets increased 3% quarter-over-quarter and 19% year-over-year. We've also demonstrated our ability to sell assets to third parties when appropriate and retain the servicing. Our service for others platform grew 17% quarter-over-quarter and 64% year-over-year. We continue to optimize the mix of assets we keep on our books versus those we sell and service for others. SCUSA continued to demonstrate strong returns this quarter. Return on equity was 28.2% down from 33% during the same quarter of last year due to the addition of retention of equity over the past year. And return on assets this quarter was 3.2% down slightly from 3.4% during the same quarter last year due to the provision build associated with the growth and asset balances. Regarding our capital levels, SCUSA's tangible common equity to tangible asset ratio continues to increase totaling 11.5% as of the second quarter end up from 10% at the end of Q2 2014. I would now like to turn to Jennifer for a review of our financial results. Jennifer?

[Jennifer Popp:]

Thanks, Jason, and good morning, everyone. We are pleased with our strong start to 2015 as it positioned us well for the second half of the year when we historically experienced seasonally worse credit performance and higher expenses. Net income for the second quarter was $285 million up 16% from the same quarter last year. Interest income from retail installment contracts also increased 16% to $1.2 billion up from $1 billion during the same period last year. Net lease vehicle income increased to $74 million this quarter up from $40 million in the second quarter of 2014 and up from $60 million last quarter as originations in our leased portfolio continue to exceed sales and [net offs] [ph]. This quarter we sold $756 million in lease assets that we will continue to service consistent with our other asset sale agreements. Interest income from personal loans totaled $112 million this quarter flat with prior quarter and up from $84 million during the same period last year. Additionally, fee income from this portfolio totaled $49 million this quarter including interest and fees, our total adjusted yield from this portfolio was 29.4% this quarter down about 150 basis points from prior quarter due to a shift in mix toward installment loans. Moving to origination, as Jason mentioned, we originated $7.6 billion in loans and leases this quarter including more than $2.7 billion in Chrysler retail loans, $1.2 billion of which were prime and the remaining $1.5 billion non-prime. We also originated $1.7 billion in Chrysler leases. The Chrysler penetration rate as of June 30 was 28% down from 30% in March; it's still strong relative to the competitive market for prime assets. As interest rates increase and prevention dollars become more of a driver, we expect to report upside to our Chrysler penetration. Moving on to expenses, during the second quarter, operating expenses increased 20% to $253 million from $211 million during the second quarter last year. Increase is primarily driven by strong average managed asset growth of 30% year-over-year. Our expense ratio for the quarter was 2.1% down from an expense ratio of 2.3% in Q2 of 2014. We expect the expense ratio to be relatively stable, however, in the second half of the year we expect expense dollars to increase because credit trends seasonally worsen in the third quarter and fourth quarters, our servicing and collection efforts become more labor intensive. Turning now to liquidity, we demonstrated our ability to place assets across a broad investor base evidencing consistent and diversified access to liquidity during the second quarter through the execution of $4.5 billion in securitization across our three distinct platforms as SDART, DRIVE and CCART including $732 million sold through the residual; $1.5 million of advances on new and existing private term advertising and revolving facilities; $995 million in sales through our monthly flow program; a $253 million additional sale of prime [loans] [ph] to a new counter party; $756 million lease sale and $66 million in proceeds from bankruptcy and deficiency sales. This quarter included a second securitization from our relaunched DRIVE platform, which was well received and over subscribed. The DRIVE platform is the first [deep] [ph] subprime platform in the market to include money market class of bond a testament to both the strength of our originations expertise and our sponsorship as a servicer. SCUSA now has three active and distinct securitization programs which allow us to reach a deep investor base and further diversify funding sources. We retain the first loss provision in the DRIVE transaction and consolidate them on to our balance sheet just to do our asset deals. During the quarter, our asset sales totaled $2.8 billion driven by monthly flow programs, the Chrysler capital CCART securitization flow through the residual and our second, third party of bulk lease sale. Asset sales were up from last quarter is $1.5 billion as we continue to focus on growth in our capital light servicing business. During the second quarter, we also executed several bankruptcy and deficiency asset sales realizing $66 million in proceeds. The majority of these proceeds is a pull forward of income from future quarters while some of the proceeds would have hit the quarter anyway. Our periodic bankruptcy and deficiency sales provide an opportunity for SCUSA to realize cash flow earlier in the life cycle of the assets, while focusing our efforts on servicing receivables more core to our strategy. As a result of the continued asset sales, our portfolio of asset service for others increased to $13.1 billion at quarter end from $8 billion at the end of the second quarter 2014. Servicing fee income totaled $28 million for the quarter up from $22 million in the second quarter of 2014. Investment gains for the quarter which are primarily comprised of gains on sales totaled $87 million up from $22 million during the same quarter last year. These gains are primarily driven by this quarter's CCART transactions. While the timing of these transactions and other sales and the amount of gain on sale are highly dependent on market conditions and therefore difficult to predict, these transactions are recurring and core to our strategy. We continue to generate substantial liquidity as we move into the third quarter. Last week we closed our third DRIVE transaction of the year raising $665 million and again issuing a money market class. In [the quarter] [ph] completed our first sale of seasoned non-prime retail installment contracts through the sale of SDART residuals we previously have retained. As of June 30, these assets were reclassified from held for investment, to held for sale in our balance sheet leading to a release of loss provision. While our strategy generally is to retain higher margin non-prime paper on the balance sheet these assets were aged and we saw this transaction as an opportunity to continue to expand our consumer finance marketplace. Additionally, because the assets are non-prime the associated servicing fee is higher than for the rest of our service for others platform, which is primarily comprised of prime assets. We have inserted a new slide in our investor presentation to highlight the importance of our service for others platform and this particular sale will be reflected in that slide [indiscernible]. Before we begin Q&A, I would like to turn the call back over to Jason. Jason?

[Jason Kulas:]

Thank you. Looking back over the second quarter, we continue to originate attractive assets and produce strong net income. Our strategy remains the same. We will continue to leverage our efficient scalable infrastructure and data to underwrite, originate and service profitable assets. We remain committed to optimizing the mix of retained assets versus assets sold and serviced for others. While there may be some noise in the numbers from quarter-to-quarter due to asset sales, these sales are core to our strategy and they will enhance our capital life, higher ROE, serviced for others platform. We are determined to work with third parties and Santander to achieve efficient funding. We will also have a continued presence in prime markets through Chrysler Capital. And finally, in a dynamic regulatory environment, we remain focused on compliance excellence. Regarding regulatory matters, it was recently announced that our parent company Santander Holdings entered into a written agreement with the Federal Reserve. The agreement does not affect SCUSA's ability to conduct regular business and it is not related to non-prime auto lending or our servicing capabilities. We are committed to working with SCUSA to remediate any issues that Fed has outlined related to governance, risk management, capital planning and liquidity risk management. Earlier this month, we announced the election of our new Board of Directors. I sincerely thank our former Directors for their service and I wish each of them the best going forward. Our new Board has 13 total members including six Independent Directors and brings some extraordinary skill set to the company. And we are also excited that Tom Dundon will continue to serve our company as a Director. In summary, we have evidenced our ability to produce strong results in the first half of the year. If the market trends are favorable enabling us to continue our recent success with asset sales and growth in the service for others platform, net finance and other interest income in the second half of the year should be approximately in line with the first half of 2015. In the second half of the year, operating expenses will seasonally increase, but we expect expenses for the full year to increase at a slower rate than the growth in our managed assets. The first half of 2015 has been exceptional. And we are on track for a solid year. With that, I would like to open the call for questions. Operator?

[Operator:]

We will now open the call up for questions. Please limit yourself to one question and one follow-up question. Thank you. Our first question comes from Cheryl Pate of Morgan Stanley. Your line is open.

[Cheryl Pate:]

Hi. Good morning. Just a couple of questions. First on the allowance and I appreciate sort of the detail that you provided this quarter in terms of mix shift as well. Just wondering if you can help us think through, obviously credit remains pretty good and a little bit better than year ago levels. Can you just talk a little bit about your expectations on recovery rates and how you think about that as that flows into the reserve build process?

[Jason Kulas:]

Sure. That's an important component of our reserve build process because we do assume in our provisioning process that recovery -- the recovery rate environment is lower than it is today so that seems to amplify the impact. But also we think positions us well for any shocks in the system related to recoveries. Our recoveries are lower than they were this time last year they kind of marginally inched down over the course of the last year. And we expect that to continue to some degree over the coming year just due to supply/demand factors in the industry that I think have been pretty well publicized. So we do expect again some weakness there but its gradual weakness and it won't be a surprise for the business. It is something that we are more than provisioned for.

[Cheryl Pate:]

Right. Okay. So already well reserved for. And then just a second question I had, obviously, you haven't been able to manage excess capital and that is starting to weigh a little bit on profitability though ROEs are still high. I guess can you maybe help us think about how you balance sort of the growth and the servicing for others which has really sort of started to ramp up versus opportunities to grow the balance sheet and maybe that's a little bit what we are seeing and in sort of the mix shift here in terms of deployment of capital?

[Jason Kulas:]

That's right. It is a big driver of some of the changes you see in the numbers because we did have an opportunity this quarter to sell a large amount of assets to third parties and retain servicing. And our approach is still what it has been. And that is to be opportunistic, where we see opportunities to have relationships with buyers who want to own assets that we originate. And as importantly or more importantly want us to service those assets for them. And so we had a lot of success in the near term continuing to grow that business and we think that's a real highlight. The balance sheet also grew, but it grew at a lower rate and what we would expect going forward is more of that. The primary driver for that is that if you look at the real growth opportunity in this business over time, it is going to be in prime and super prime type paper through the Chrysler relationship. And that's paper that we think is much more attractively held on someone else's balance sheet with us remaining on a servicer.

[Cheryl Pate:]

Okay. Great. Thanks very much.

[Jason Kulas:]

Sure.

[Operator:]

Your next question comes from the line of Eric Beardsley of Goldman Sachs. Your line is open.

[Eric Beardsley:]

Hi. Thank you. Just wondering how much of the reserve build this quarter for auto would you a tribute to mix shift or seasonality and if there was any change in the month or reserve coverage?

[Jennifer Popp:]

There is no change in the month of reserve coverage. And the majority of the build -- the vast majority of the build was just seasonality.

[Eric Beardsley:]

Got it. And you mentioned that of the $66 million in proceeds from the deficiency sales, some of that was pull forward from future quarters, but some would have been realized in the current quarter. Do you have any idea of how much actually would have been realized in the second quarter?

[Jennifer Popp:]

About a quarter to a third of that amount would have hit the quarter anyway.

[Eric Beardsley:]

Got it. And then just lastly, I guess, how do we think about the reserve going into the second half of the year given that I think you had a little bit more of the seasonality coming in the third quarter than you do in the second? Should we expect to see a similar ramp up in the reserve coverage?

[Jennifer Popp:]

There is some ramp up in the third quarter. But by the end of the year, that does turn around. By the end of the year we are looking for 16.5 months over two first quarters which are historically our -- seasonally our best performing quarters.

[Jason Kulas:]

The real key to the answer to that question though, just to clarify one point on that is, is the mix of retained assets. So if we continue to be successful in selling assets to third parties and growing this servicing business the way we have that's going to leave what's remaining on the balance sheet a very different mix than what we had earlier this year and more in line with what we have now. So to that extent, the allowance ratio, even though you do see a provision build in the third quarter due to the seasonal factors and forward looking 16.5 month model and you get some of that back in December, just a mix of the assets will lead to those -- that allowance ratio being as elevated as it is today in that scenario. To the extent that changes, it would change and be lower. But the key for us is, there is a very direct -- and I know [I last on you] [ph] but there is a very direct relationship between provision and allowance and yield and profit and those kind of things. And for us, it's less about the amount of the yield and more about performance versus expectations and as you can see the performance story is really good. Credit trends are improving not worsening in subprime.

[Eric Beardsley:]

Okay. Great. Thank you.

[Jason Kulas:]

Sure.

[Operator:]

Your next question comes from J.R. Bizzell of Stephens Incorporated. Your line is open.

[J.R. Bizzell:]

Yes. Good morning and congrats on the quarter.

[Jason Kulas:]

Thank you.

[J.R. Bizzell:]

Jason, I guess the main question, just looking at building on that point about the credit performing well and slightly better than your expectations, just wondering, general consumer trends, what you are seeing. How is your consumer and then maybe building on that kind of parlaying into the competition question, what you saw on the quarter around competition and how you are kind of thinking about it for the remainder of the year?

[Jason Kulas:]

Okay, sure. So, we will start with consumer trends. Here the consumer trends are really positive right now. Obviously, unemployment is a good story today. Gas prices are still low and that benefits the consumer. So the consumer story is really positive. That combined with the quality of the assets we are financing and the fact that these assets are running longer and being more reliable in those kind of trends I think combined for a good story. As we interface with the consumer. On the competitive front, the competitive comments are kind of all over the board. If you look at, you have some people who have said they are cautious, you have some who have said they are actively seeking more exposure and then some people in between. And the net result for us is as we still think the environment is as stable as it has been. Where we see that very directly, as when we get an application and we receive just under a million applications a month. When we receive an application and we put a price and structure on it, if we are able to get a reasonable percentage of those applications closed and for us that's low, but still reasonable relative to what our expectations would be that tells us that the market is being pretty rational. And that's still the story today. And that's the story we have been talking about for the past couple of quarters and it's still true today.

[J.R. Bizzell:]

Great. And I guess switching gears and Chrysler is continuing to perform well and continued to mature that portfolio, just wonder, I know the penetration rate went down. It feels like maybe that was a little bit of seasonality just because of the tax season but wondering how that relationship is going. Any commentary around that relationship and then kind of how you are thinking about it for the remainder of the year?

[Jason Kulas:]

The relationship is really strong. One of the -- I think one of the corner stones of the relationship is a very ongoing active dialogue at senior levels. And so we got a steering committee made up of senior people on both sides that meets very frequently. We have got another one of those meetings coming up in the next couple of weeks. And so that ongoing active dialogue is really productive. You have the normal tension between a manufacturer and someone who is providing the captive or preferred finance service agreement for that captive. And obviously those conversations happen. But at the end of the day our goal is the same. They want to sell more cars and we want to finance more cars. The market is really competitive right now for prime. And that is something that they acknowledged on both sides. And so over time, as prevention dollars become are more meaningful and direct more business our way, we are going to have a tremendous amount of upside. In the meantime, the market is very competitive for them at the upper parts of the credit spectrum and driving sales growth and so it's a positive story for them all the way around.

[J.R. Bizzell:]

Great. Thanks for taking my questions.

[Jason Kulas:]

Sure.

[Operator:]

Your next question comes from the line of Vincent Caintic from Macquarie. Your line is open.

[Vincent Caintic:]

Hey, good morning, guys. Thank you. And Jason and Jennifer, congratulations on the good results for your first quarter as CEO and CFO. Just actually wanted to take a step back with you leading Jason. Do you foresee anything changing now that you have taken the reins?

[Jason Kulas:]

We are having a lot of discussions among strategy and not just among our management team but also with our Board. I spoke a little bit in the prepared comments about our Board and the quality of our Board. And the level of dialogue we are having and that is real positive. But I think one thing that is important to talk about in answering that question is the connection between our former CEO and me and the ongoing dialogue we have been having about this business for over 20 years. Many aspects of the strategy of this business were developed together with Tom and I discussing the business literally every day for a long period of time. So for that reason, I don't expect a lot of big changes in strategy. We saw the business eye to eye. We developed and grew the business together and I believe in the strategy that we have, which is at its core, what we always talk about. That's just making sure that every single loan we originate has the right price and the right structure so the company continues to be positioned to perform through cycles. We really differentiated ourselves from 2008 when times were very tough and we were in a position not only to talk about the performance of the core business, but from a position of strength to make a lot of acquisitions and that's where we plan to be in future cycles as well. So strategically I think that's going to be the story. As we look at different parts of the business and where we want to emphasize and deemphasize and those kind of things, at the very core we are going to be focused on what I lead with which is what is our best way to maximize the opportunity we have with the applications we receive and the applications we book will be the one with the best opportunity to help us achieve those goals.

[Vincent Caintic:]

Great. Got it. Thank you. For, I guess, the mention about the regulatory compliant environment, do you foresee expenses increasing on that front? I know you talked about servicing the second half of the year. But how you see the compliance environment going forth?

[Jason Kulas:]

Yes. So expenses, we do expect expenses in the second half to be higher, mainly driven by just seasonal factors as delinquency goes up in the third quarter and fourth quarter. We have higher expenses related to that because the servicing work is more labor intensive. We do though expect some continued marginal increase in our expenses related to regulatory and compliance matters just because we are committed to having that be a core competency. And so it's a very active ongoing dialogue. We continue to add staff. But one of the comments we made in prior quarters is, we have such a large expense base and such an efficient operation that if we have increases in staff related to those kind of things or increases in expenses related to a compliance, it tends not to move the needle on the overall look and still leave us in a position where we are among – at least among the most efficient if not the most efficient in the industry.

[Vincent Caintic:]

Great. Got it. Thanks very much.

[Operator:]

Your next question is from John Hecht of Jefferies. Your line is open.

[John Hecht:]

Great. Thanks very much, guys. First, Jason, you gave some guidance on net interest margin for, I think the second half of the year. Could you restate that? It came and went too quick for me to get down on paper.

[Jason Kulas:]

Sure, John, happy to do that. The comment I made in the prepared remarks was that we expect the second half to be roughly in line with the first half on the top line. And – but, the big caveat there is the first part of the statement which is, that is assuming that we continue to have the success that we have had in selling assets to third parties. So if we continue to have the momentum we have there, then there is not a lot of growth there, but you are benefiting and growing the service for others platform. We can't predict gain on sale and those kinds of things. And obviously, we manage the business and minimize gain on sale, but net-net that would be a really good result and also make for a strong year. To the extent we are not as successful doing that or again because of the economics we choose not to do it, clearly the story would be different and the second half would be much stronger than the first on that line. So it's one of those answers that we have to caveat with, it really depends very heavily on what we decide to sell.

[John Hecht:]

Okay. That's very helpful. Second question, it's about credit, I guess, but the technical factors on credit. Number one on that is, where are we in the flow arrangement on selling bankrupt receivables? And the second part of that is, what would you expect just because there is a varying recovery rates because of that flow arrangement, where would you think gross charge-offs in the auto book would be in the second half of this year versus second half of last year?

[Jennifer Popp:]

I will take that one. On the flow agreement we actually, had this disclosed last quarter that we had a commitment from a buyer on $200 million. We actually executed that. In the second quarter to increase to 275 and we were about not quite 60 million into that, so still over $200 million to go. As you noted, these agreements and these sales pull forward recoveries but as they became a bigger part of our strategy, there is some back and forth between what is being pulled in to the current quarter and what was pulled out of the current quarter to a prior quarter. So overall, we don't necessarily expect a significant impact in any given quarter on our net charge off rate from these sales.

[John Hecht:]

Okay. And the gross charge off – I mean on a percentage basis in the second half of this year versus last year?

[Jason Kulas:]

The gross charge-off trends, again, I'm going to depend on what's on the books. What we are seeing right now is a stable environment and a stable performance environment and credit trends are very solid. But we also, so, if we have a lower mix of assets and that lower mix of assets after a nice first half of originations that was really geared to non-prime for what's on the balance sheet and what we are reserving for and what we are experiencing losses on. Obviously, we would see an increase just because of that, as those assets make their way through the curve. So I think it depends. I would say all in, we are going to see stability there and not any massive increase other than what you would see from normal aging through cycles and those kind of things.

[John Hecht:]

Perfect. Thanks very much, guys.

[Jason Kulas:]

Sure.

[Operator:]

Your next question comes from the line of Mark DeVries of Barclays. Your line is open.

[Mark DeVries:]

Yes. Thanks. Jason, I just want to clarify some of your comments around the top line. Were you indicating that you expect second half total revenues to be kind of flat from the first half or were you just referring to asset sales?

[Jason Kulas:]

No. I was talking about the net finance and other interesting income lines of the top line.

[Mark DeVries:]

Okay. So one of my questions is just -- I was hoping to get a better sense of what we should expect for asset sales going forward. This is obviously a very big quarter. Should we expect with some lumpiness in there for you to continue to sell assets at that pace and any comments you can provide on the mix and the type of margins we might expect to see would be helpful.

[Jason Kulas:]

I agree with the way you said it. We do expect to continue doing it and there will be some lumpiness to it just because you can't perfectly time when these things happen. But we do expect to continue to do it. We just think there is such a tremendous opportunity for us and the way we are positioned in the market to be able to continue to grow that service for others business. That combined with where the originations are headed going forward as we know where the growth is coming from and the prime part of the Chrysler business. We think those two combined for continued growth relative to what might be on the balance sheet. And, again, I think what you look to is probably closer to what happened this quarter. We saw some growth in both. But the growth in the balance sheet was marginal. Growth in the service platform was a real highlight.

[Mark DeVries:]

Okay. Will the amount you look to sell in part a reflection of how aggressive the bids are for the assets? If the returns are really high, will you look to sell more?

[Jason Kulas:]

That's a good question. And I think we have to deal with that as we see it. If you look at the mix of what's on the books today, other than an opportunity here and there like we saw with the aged SDART paper. One of the things we spent some time talking about in the past is -- one of the reasons we don't sell subprime paper is because the range of expected outcomes on performance is too wide and so that volatility gets priced in early on just after origination. But as that pool ages, the predictability of performance is much stronger and the pricing is much more rational. And so for us, we should continue to see deals like that continue to happen now that we have done one. So we will do those from time to time. But dipping significantly below that or I guess closer to the origination part of those assets would be less likely. So I think it's more about the growth going forward than it is about digging into current balance sheet size. Although, again, we have to look at the opportunities as we see them. And if one presents itself as attractive, we will look at it because there is another dynamic here and that it does have an attractive servicing fee associated with it that relative to servicing prime assets is really attractive.

[Mark DeVries:]

Okay. Thank you.

[Jason Kulas:]

Sure.

[Operator:]

Your next question comes from the line of Moshe Orenbuch of Credit Suisse. Your line is open.

[Moshe Orenbuch:]

Thanks. Sorry to keep beating this up. But sounds like your actual gross loans on a period end basis grew about just under 15%. I mean do you think that the growth rate on the balance sheet for the year will be at that level or below that level as we get into the second half?

[Jason Kulas:]

No, I don't think. I mean year-over-year, obviously, we got nice growth. Quarter-to-quarter, it was -- we still had growth, but it was lower, closer to the 3% or so range. I think that's – it would be closer to that than the year-over-year comparison just because of the opportunity we are seeing in the market. And obviously, the caveat to that is, if the market is not there to the extent it has been, the answer to that question would be different but that's what we see going forward.

[Moshe Orenbuch:]

Got it. Okay. And could you talk a little bit about just your outlook for how aggressively you are going to pursue the installment loan opportunity relative to the past. Is it getting more so or less so. How should we thing about that?

[Jason Kulas:]

Personal loans, what I would say about personal loans right now is that – it's a small business. It hasn't grown in the last couple of quarters to the extent -- compared to what it might have grown in prior periods, it hasn't grown as much recently. And -- but, the business still has very solid returns and is a good attractive business for us. So just not a lot of news this quarter to report on it.

[Moshe Orenbuch:]

Okay. Thanks very much.

[Jason Kulas:]

Sure.

[Operator:]

Your next question is from Eric Wasserstrom of Guggenheim Securities. Your line is open.

[Eric Wasserstrom:]

Thanks very much. Jason, can you talk a bit about what progress occurred in the period in terms of further or deeper penetration into non-Chrysler origination channels?

[Jason Kulas:]

We talked in the past about a relationship we have with another manufacturer that has gone well for us year-over-year. And that relationship continues. And so that's still a real bright spot. We also -- as we always have, we are continually looking for pockets in the market where we can tweak structure or approach and still get a really nice risk adjusted return but pick up additional business. And we have seen some of that. In the first half of the year, the non-Chrysler, non-prime business has grown because of some of those efforts. How much that continues to grow from this level forward is difficult to tell. But, we continually look for those opportunities. And I would say our growth in non-Chrysler, non-prime relative to our expectations going into the year has been really strong, much stronger than we expected.

[Eric Wasserstrom:]

Great. And just to follow-up on the compliance issue for a moment, is there anything that you can do on a SCUSA level that will influence how the federal reserve in particular is viewing the compliance challenges that face SHUSA?

[Jason Kulas:]

I think there is. One of the things that we spent a lot of times talking about at SCUSA is the fact that we have to continue to improve what we do and the way we do it. So we got good systems in place. We got good controls. We have good data and we leverage the data to make good risk decisions. And we have very efficient -- very efficient operating platform that allows us to be a cost leader in the industry. All those are really positive things. But if we do all those things and we don't get some of the other factors right that the regulators are very focused on, like making sure that we have good documentation for the way we do things, making sure that our relationship with SHUSA, the bank holding company is set up in a way that they can demonstrate true oversight over what we do and true knowledge over what we do, then we've failed, right so. We can be a really good efficient operator and in the eyes of the regulator not be successful. That's just not an option for us. So yes, we play a big role in that. And our intention is to continue to make improvements there and own the problem, even though maybe the letters aren't addressed to us, we are a big part of the organization and we intent to be a part of the solution.

[Eric Wasserstrom:]

And just more directly on that issue of oversight and knowledge of SCUSA's activities at the holding level, has anything changed there because it seems -- correct me if I'm wrong, I think there is still only one -- you are the only sort of link between the two organizations still on a board basis. I mean is there any evolution to that being contemplated?

[Jason Kulas:]

Well, we do have some common -- we do have some common Board members which I think is good. But as importantly, we also have a lot of interaction with just on a day-to-day management basis we have a lot of interaction with people at SHUSA. Again, they have to -- it's big focus from regulators to know that when they look at – when they look to SHUSA to understand our business and what we are doing and how we are doing it, that they can get very clear direct answers. It's not acceptable to just get us on the phone and have us answer the question which we can typically do. They need to be able to answer the questions themselves. And where the organization is today on that issue versus maybe even just a year ago is light-years ahead again where we were. But I think if you have asked that same question a year from now, it will be even farther down that path. It's just -- it's more about communication than anything else. It's not necessarily how we operate our business on a day-to-day basis because again, we have proven we can do that very effectively through cycles. And when you stress our business, the business under stress performs pretty well in all the scenarios we run. It's much more about just the day-to-day tactical relationships and communication and we are spending a lot of time trying to make sure we get that right. So almost every major functional head of a group or department within SCUSA has a counterpart at SHUSA that they are connected to and have regular conversations with.

[Eric Wasserstrom:]

Thanks very much.

[Jason Kulas:]

Sure.

[Operator:]

Your next question comes from the line of Charles Nabon of Wells Fargo. Your line is open.

[Charles Nabon:]

Hi, Jason. Thanks for taking my question. I know you touched on the sales of -- asset sales as a driving factor for margin expansion and you've also alluded to the pursuit of non-Chrysler non-prime channels. But I wanted to get a sense for -- on a relative basis how those factors are driving the expansion of the yields on retail contracts and how we should think about that going forward?

[Jason Kulas:]

Well, so why don't we approach this in a couple of ways. I think if you look at performance for the quarter relative to the sales we did and relative to some of the designations and the way things are held on the books. One of the things we mentioned is a provision release related to one of the accountings for one of the sales we did. And, we did have, for example, a $63 million pretax benefit through the provision line on a transaction that was designated as held for sale at the end of the month and then closed T plus 3 a few later in early July. So that's a significant benefit to the business. But it's also something we view as pretty core to the business. These are transactions that we expect to be recurring and we should have going forward we should have many more of them. We can't predict exactly what the impact will be, but while we are doing those, we are also originating assets that have really strong margins and from a provision timing basis we are building provision on those. But as that story plays out, they are going to help us drive some really -- we think, some really attractive earnings growth in the future because of the margins associated with them. And then that combined with the fact that when we sell assets that are farther down the credit spectrum to the extent we have more opportunities to do that and we think we will, we are driving a higher fee percentage on the servicing business which we think, as we continue to grow it, it's going to be viewed as really attractive because of its capital friendly approach.

[Charles Nabon:]

Great. Thank you. And as a follow-up, could you comment on strategic initiatives you might have in place with regard to expanding your flow partnerships or manufacturer relationships?

[Jason Kulas:]

I can. I mean at least generally. We -- I think it's cultural for us. We are always working on tests with different partners. You will see from time-to-time we announce a new partnership with an OEM or with a partner. From time-to-time we announce that maybe one of those partnerships has ended. But the point is, that we are always testing them. We are always thinking about ways to be involved with new partners and new sources of applications. One of the things we think we are really good and effective at doing is being in a position to garner more applications. So doing things that provide incrementality on the applications we received so that our conservative approach to credit will continue to result in growth and assets that we book. So I think we are going to see more of those types of opportunities going forward. The ones that end up making the difference will be the ones that made economic sense and some of them, when we test them, turn out not to make economic sense, but at any given time we have got many of those different types of test on.

[Charles Nabon:]

Great. Thanks for the color.

[Jason Kulas:]

Sure.

[Operator:]

Your next question comes from the line of Patrick Buckley of UBS. Your line is open.

[Patrick Buckley:]

Hi, everyone. Congratulations to the new management team. I just had a quick question on the $66 million bankruptcy gain on sale. Could you describe what the UPB associated with that was? And if we try to figure out what the NCO rate for the quarter would have been without some of the pull forward? How would we think about that and what rate would you have expected?

[JenniferPopp:]

The net charge-off rate would have been very flat with second quarter last year. So we turned in a net ratio of 5.3% for Q2 this year versus 5.8 last year. But, without the impact of the sales we would also have 5.8% this year. And then as far as the --

[Jason Kulas:]

Reactive balance is small because – for example on the deficiency sale, deficiency sale has balances that are much higher but they are not active balances. So you wouldn't see an impact. But, I think Jennifer got that.

[JenniferPopp:]

On the BK sales, they are a little different than the pure charge-off assets until we saw those for anywhere from $0.28 or so to $0.40 on the dollar. And then like Jason said, on the pure deficiency sales is very low pennies on the dollar that we get. So total UPB we are talking a few hundred million related to the 66 million proceeds.

[Patrick Buckley:]

Great. Thank you so much.

[Operator:]

Your next question comes from the line of David Ho of Deutsche Bank. Your line is open.

[David Ho:]

Good morning, guys. Thanks for taking my question. Circling back on your comments on competition, to acknowledge that seems like the industry comments are all over the place. But, what do you think is the biggest risk to competition and kind of the below 600 FICO range and how do you think that will trend given kind of what we are seeing macro wise and are we kind of seeing the right pricing, your average APRs are up year-over-year and quarter-over-quarter, but how are rates for that type of business compare versus historical and your expectations.

[Jason Kulas:]

Sure, David. The biggest risk for us is more of an opportunity cost because what happens when things get really competitive in deeper subprime is what we find is that the people are willing to do things for margins and returns that we don't think are sustainable through cycles. So we just tend to pull back. And so we go through a period where we are not able to book as many loans as we would like to book. But we know that -- we sort of know how that story ends and we wait it out and it comes back to us. But that's not the case today. But I think that would be the biggest risk just because obviously we feel like we have great momentum there. And to the extent that that happened, we would take a little bit of a step back in originations and wait it out. We think there are some factors in the market that will continue to delay that. Even though sort of previous cycles might tell you otherwise and the regulatory environment, the cost of making sure you are compliant with the things you need to be compliant with. If you look at the ownership structure of a lot of the bigger lenders and their attachment to banks and the increasing regulatory environment on banks. There are a lot more controls in place than there were in previous cycles. And we view that as really positive because what that means is that it probably contributes to some rationality, some maybe new entrant that may come in and tend to be aggressive because they have some money to put to work. Some of those aren't coming in and the ones do are being cautious because they can't 100% quantify the costs associated with making sure they get compliance right.

[David Ho:]

Okay. Thank you. And once the compliance is right-sized and regulatory kind of understanding of how the ongoing costs are more visible going forward, do you think there would be more liquidity in that downstream market? Certainly not from the bank's per se but certainly from some of the alternative players as you think about kind of clearing that hurdle.

[Jason Kulas:]

That's what we have seen in prior cycles where you see that people notice that returns are strong and they are attracted to the space and they convince themselves that a small return times a lot of loans equals a big nominal profit and that's a really good idea. And then that plays itself out and they don't have enough margin to withstand the downturn and end up needing to sell or getting out of business. And so, that's what we have seen happen in prior cycles. That's what we have been able to avoid. We are going for pretax returns of 4% plus on that kind of business. And the range is probably, 2 to high single digits. And we get to 2 when things go really bad. And then when things turn around, the loans we originated when times are bad end up being high single digits and hopefully average are close to what we are trying to go for. With that approach we tend not to have those big shocks where we lose – we go through a period where we lose a lot. But that, history tells you that will happen again. But I think it's with the caveat that you just said which is, I think, it's going to be delayed because it's going to take a while for all this compliance and regulatory discussion to settle itself. I'm not sure when that happens because I think it's a difficult part of the market to quantify. And the smaller and less sophisticated you are -- it's even more difficult to quantify.

[David Ho:]

That is helpful, Jason. Thank you.

[Jason Kulas:]

Sure.

[Operator:]

Your last question comes from the line of Chris Donat of Sandler O'Neill. Your line is open.

[Chris Donat:]

Hi, good morning. Thanks for taking my question. I wanted to ask to help sort of frame the discussion on the allowance, if you could give us some color on your mix of assets as you move the non-prime off your balance sheet, can you give us color on where we were a year ago what, say, percentage of your gross receivables were prime then? I'm just trying to understand what's -- how much of a shift we have really seen in your receivables?

[Jason Kulas:]

Our investor presentation on the Web site, if you look at Slide 22, this is a slide we introduced a couple of quarters ago that we continue to show because it does a good job, I think of answering that question. So if you look at, for example, percentage of the business less than 540 a year ago, it was 26.7% versus 29% today. If you look at 540 to 599, it was 32% a year ago versus 35.8% today. So you can really see that migration down market. We feel like we are doing it in a way that makes sense because we are doing it with conservative structures and we are seeing -- we are just capitalizing on the opportunity in the market. So it could very well go back the other way next year if the opportunities are in a different place. But, we have found it really attractive to migrate the business in that direction for what's on the balance sheet. And then obviously what contributes to that as well as, if we have more opportunities to sell assets, what's left tends to be lower in mix as well so it's really a combination of those two things and not just one of them.

[Chris Donat:]

Okay. So as you go through this shift and I think about the comment you made earlier in the call about the guidance for the second half of the year on net interest. It seems like you got growth in your receivables and what I think should be higher yield on those receivables. Am I missing something there? That would seem to point to higher revenues in the back half of the year.

[Jason Kulas:]

I'm actually – I'm glad you asked that question because if you look at – because there is – if you look at another slide, if you look at Slide 5.

[Chris Donat:]

Yes.

[Jason Kulas:]

You will notice the APR on the retail installment contract business, on the auto business, is going up, is going in the direction you would expect. What is confusing is the top line yield on earning asset is not. It's actually down year-over-year. And the reason for that is, that line includes the lower yielding lease assets. So if you remove that impact, the yields are actually what you would expect to see.

[Chris Donat:]

Okay. And so you have seen some growth in the lease assets and is that – okay, so that growing share from lease contains the overall yield, okay.

[Jason Kulas:]

That's right.

[Chris Donat:]

Got it. All right. Thanks, Jason.

[Jason Kulas:]

Sure.

[Operator:]

There are no further questions at this time. I will now turn the call over to Jason Kulas for final comments.

[Jason Kulas:]

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

[Operator:]

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.