Santander Consumer USA Holdings Inc.
Q3 2015 Earnings Call Transcript

Published: 29 Oct 2015

[Operator:]

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

[Evan Black:]

Good morning everyone 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 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. 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, October 29, 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’ll turn the call over to Jason Kulas. Jason?

[Jason Kulas:]

Thank you, and good morning, everyone. Today I will discuss our third quarter highlights and ongoing strategic initiatives. I’ll 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 third quarter results are highlighted by positive credit performance, robust originations and successful asset sales. During the quarter, SCUSA earned net income of $224 million or $0.62 per diluted common share, up from net income for the third quarter of 2014 of $191 million or $54 per diluted common share. Let’s begin by addressing the movement of the personal lending assets and held for sale. As noted in the press release this morning, during the quarter we undertook a strategic evaluation of all of our lines of business. And going forward, we do not intent to retain personal lending assets on our books. Our personal lending portfolio is performing well. However, after strategic review we’re committed to focusing on our auto platform. We believe over the long-term it is more appropriate strategy for the Company to focus on the much larger and core auto portfolio, including loans and leases. To maximize the value of our balance sheet, we will concentrate on the auto business and our commitment to Chrysler. The auto assets also align better with our strategy to optimize the mix of retained assets and assets sold and serviced for others. As we continue to have asset sales success generating capital efficient, servicing fee income. We delivered a notice of termination to a peer-to-peer personal lending platform company, but we continue to be part into various other agreements under which we purchased specified volumes, personal loans originated by third parties. We will continue to perform in accordance with the terms and operative provisions under those agreements. At this point, we are in the process of engaging investment banks to assist in the sale of all installment and revolving personal lending assets. Going forward, all personal lending assets will be designated as held for sale. As for the specific impact of the third quarter as a result of the transfer of personal land lend held for sale, we released the allowance for credit losses associated with the personal loan portfolio and recorded a lower of cost or market adjustment. This was reflected as a charge-off against allowance for credit loss for a subset of loans within the personal loan portfolio. The net impact of this redesignation of our personal loan portfolio was a decrease to provision expense of $14 million. Another item I want to discuss is the change in the provision methodology this quarter. After extensive analysis, this quarter we removed the seasonal volatility from our provision model. Provisional expense increased by $5 million to $744 million this quarter, from $739 million in Q2 2015 and decreased from $770 million during the same quarter last year. Under the prior methodology, this quarter's provision expense would have been higher, and we would have likely seen a reduction in the provision line in the upcoming fourth quarter. Adjusting for any external factors, this is no longer the case. As the mechanics of the provision model change, shift to the seasonality benefit we’d have received in the fourth quarter to the third quarter. In other words, the lower expense what we were expected to see in the fourth quarter due to model seasonality, we no longer expect to occur. The provision model and associated volatility has been a focal point each quarter since the IPO. As we move forward and continue to refine our model, we hope this provides more clarity around our loan loss provisioning and it should be less fluctuation from quarter-to-quarter. The model refinement this quarter caused a reduction in provision expense which changed later into a $0.23 EPS benefit after tax. The allowance ratio also decreased by 59 basis points to a 11.8%, down from 12.4% in Q2, primarily due to the movement of a personal lending assets to held for sale and the model refinement this quarter. Total originations this quarter were $7.6 billion in line with originations in the prior quarter and up from $7.4 billion during the same period last year. We believe the market overall has become slightly more competitive, particularly in lease where some competitors have been more aggressive in all-in lease pricing. We also want to remind everyone we put a lower cap on our rates for dealer compensation in October 2014. We believe this is a competitive disadvantage on certain deals that are closed among bidders as many of our top competitors allow higher dealer mark up levels. We also -- we’re also seeing increased pricing competition in some areas of nonprime. While we remain disciplined in our origination approach, we’re also being more cautious given market conditions. However, we continue to have confidence in our ability to originate attractive assets that meet our return hurdles. Net finance receivables, loans and leases, including held for sale assets increased 2% quarter-over-quarter and 18% year-over-year. We’ve also demonstrated our ability to sell assets to third parties when appropriate and retain the servicing. Our serviced for others platform grew 13% quarter-over-quarter and 44% year-over-year. We continue to optimize the mix of assets we keep on our books versus those we sell and serviced for others. SC's net charge-off ratio for the quarter was 14.4%. However, after adjusting for the lower cost of market adjustments on loans sold and held for sale, the adjusted net charge-off ratio totaled 8.7%. This is up from 5.3% last quarter and slightly higher than 8.4% during the same quarter last year. While still higher than SC's historical profile, the credit profile of our retained book has moved slightly toward lower credit, higher loss loans with better structures. The delinquency ratio for retail installment contracts was 3.8% at the end of the quarter, up seasonally from 3.3% last quarter and slightly up from 3.7% at the end of the same quarter last year. We continue to see stability in performance as we maintain disciplined underwriting practices and adhere to strict ROA hurdles. SC continue to demonstrate strong return to this quarter. Return on asset this quarter was 2.5%, in line with 2.5% during the same quarter last year. And return on equity was 21.1%, down from 23.9% during the same quarter last year, due to the additional retention of equity over the past year. Regarding our capital levels, SC's tangible common equity to tangible assets ratio continues to increase as we retain additional equity. At the end of the quarter, TCE to TA totaled 11.8%, up from 10.4% at the end of the Q3 2014. As part of the transformation to align further with our parent company, and the bank holding company framework, we are also reporting our common equity Tier 1 ratio. The CET1 for the end of the third quarter totaled 11.2%, up from 10.8% last quarter and up from approximately 9.4% during the same quarter last year. We review our capital target in periodically and we’re in line with our current target. I’d like to turn now to Jennifer for a review of our financial results. Jennifer?

[Jennifer Popp:]

Thanks, Jason, and good morning, everyone. We are pleased with our year-to-date performance as it positions us well for the remainder of the year when we historically experienced seasonally worst credit performance and higher expenses. Net income for the third quarter was $224 million. Interest income from retail installment contracts increased 15% to $1.2 billion up from $1 billion during the same period last year. Net lease vehicle income increased to $93 million this quarter, up from $63 million in the third quarter of 2014 and up from $74 million last quarter. Interest income from personal loans totaled $114 million this quarter flat with $112 million last quarter and up from $86 million during the same period last year. Additionally, fee income from this portfolio totaled $47 million this quarter including interest and fees, our total adjusted yield from the personal lending portfolio was 28.2% this quarter down from 29.4% in the prior quarter. Moving to originations, as Jason mentioned, we originated $7.6 billion in loans and leases this quarter. This included approximately $3.1 billion in Chrysler Capital retail loans, $1.7 billion of which were prime loans. We also originated $1.6 billion in Chrysler Capital leases. The Chrysler Capital penetration rate as of September 30 was 25% down from 28% in June; but still strong relative to the competitive market for prime assets. As interest rates increase and prevention dollars become more meaningful, we expect to report upside to our Chrysler Capital penetration. Moving on to expenses, during the third quarter, operating expenses totaled $287 million and our expense ratio was 2.3%, which includes a $22 million nonrecurring expense related to the departure of our former CEO. Excluding this one-time expense, adjusted operating expenses for the quarter totaled $265 million, up 31% from the third quarter last year. This increase was primarily driven by strong average managed asset growth of 26% year-over-year. The adjusted expense ratio for the quarter was 2.1%, excluding the one-time expense, up from 2% during the same quarter last year. Quarter-over-quarter the growth in average managed assets exceeded the growth in OpEx consistent with our outlook at the end of the last quarter. We continue to expect the expense ratio to be relatively stable, however, in the fourth quarter we expect the usual seasonal increase in expense dollars as servicing 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 third quarter, we have execution of $3 billion in securitization including the third and fourth transactions of the year on our relaunched DRIVE platform. $1.7 billion in seasoned nonprime residual sales, $1.3 billion in sales to our monthly flow programs; a $987 million of advances on new and interesting private term amortizing facilities. During the quarter, asset sales totaled $3.1 billion driven by two seasoned nonprime residual sales, the first of which was announced in Q2, but settled in Q3. We generally aim to retain higher margin paper on the balance sheet. However, as mentioned in prior quarters, these assets were aged and the sales provided further growth for our serviced for others platform.\ It is important to recognize that these sales were executed at a premium to book value. The resulting gain is reflected as a decrease to provision rather than in the investment gain plan. Additionally, because the assets were nonprime, the associated servicing fee is higher than for the rest of our serviced for others platform, which is primarily comprised of prime assets. Asset sales were up from last quarter’s $2.8 billion as we continue to focus on growth in our capital efficient servicing business. As a result of our continued success in selling assets, the serviced for others portfolio increased to $14.8 billion at quarter end, up from$10.2 billion at the end of the third quarter 2014. Servicing fee income totaled $36 million for the quarter, up from $21 million in the third quarter of 2014. As we enter the final quarter of the year, we continue to generate substantial liquidity. Earlier this month, we closed our fifth nonprime SDART securitization of 2015 and a transaction that was upsized, offering approximately $1 billion in securities in addition to our continued focus on our current liquidity and funding initiatives. In an effort to further diversify liquidity sources over the next several quarters, we will aim to issue unsecured corporate debt. Over time, this additional source of liquidity could increase the cost of funds depending on market conditions. It will further diversify the capital structure of the organization, improve our liquidity position, and further demonstrate our financial independence. We also will incur additional interest expense related to the cost and amount of liquidity we received from our parent company, a bank holding company with specific liquidity requirement. This liquidity will enhance our ability to weather market stress. Before we begin Q&A, I’d like to turn the call back over to Jason. Jason?

[Jason Kulas:]

Looking back over the third quarter, we believe that our decision to focus on our core auto business will allow us to continue to develop and realize the full potential of our nonprime and Chrysler Capital platforms. As we gradually replace the personal lending assets, it is important to recognize there will be a timing issue associated with the upfront provisioning expense. Additionally, as the personal loans are sold and replaced with auto asset, there could be a potential timing gap between revenue forgone on sold assets versus the revenue received on newly originated assets. In summary, we’ve evidenced our ability to produce strong results year-to-date. Similar to the prior quarter’s expectations, if market trends are favorable enabling us to continue our recent success with asset sales, 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. Losses and operating expenses are expected to continue to increase through the end of the year inline with typical seasonal patterns and we continue to expect expenses for the full-year to increase at a slower rate than the growth in our managed assets. And finally, we remain upbeat about our ability to perform over the long-term as we show up liquidity, grow capital, and continue to put our customers and our people at the forefront of everything we do. With that, I’d 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 Mark DeVries at Barclays.

[Mark DeVries:]

Yes. Thanks. I just want to clarify the actual changes to the provision accounting. Are you essentially just changing the seasonality factors today, but keeping the months coverage effectively the same? And if so, is it right to assume there is still kind of punitive element to growth here, or you’re charging off 16 months or so of losses upfront without getting the earnings?

[Jennifer Popp:]

Yes, we did keep our coverage level consistent and just to remove the seasonality factors so that as we move from quarter-to-quarter it doesn’t matter as much overly at all of what quarter you’re facing. So we’re at a typical September 30, pay 16 month coverage, would pick up two fourth quarters, which are worse quarters. Now picking up two fourth quarters doesn’t matter, because we’ve de-seasonalized the loss forecast for each of the months in these quarters, but the overall level of coverage about the same.

[Mark DeVries:]

Okay, got it. So, more a comment that a follow-up question, but I commend you on making that change. I think its going to help dampen some of the volatility. I think there are a couple of other elements to provisioning that I think it would be helpful to clarify for investors going forward and one of them is this whole issue of the fact that, because you’re taking 16 months or so coverage right now there is a punitive element to growth and that’s particularly relevant in this quarter where your growth was very strong relative to other quarter. So I think that was actually a big driver of your provision number in the quarter after the adjustment. And the other element is just the extent to which you maybe moving up or down the credit curve. So any kind of disclosures you guys could provide going forward on kind of what the long characteristics were of what you added in the quarter relative to what you have I think would be helpful on helping people understand that?

[Jason Kulas:]

Okay. Thank you for that feedback.

[Mark DeVries:]

All right. You got it.

[Operator:]

Our next question comes from the line of Cheryl Pate at Morgan Stanley.

[Cheryl Pate:]

Turning around that interest income second half of this year versus first half, I guess, maybe you can help us think about a little bit more in detail, I would think if we’re keeping more of the deeper subprime on balance sheet and sort of accelerating some of the sales on the prime side that should drive actually higher net interest margin and we’re seeing growth in the portfolio. So could you just help us reconcile those comments a little bit more?

[Jason Kulas:]

Sure. Happy to. So yes, I mean, obviously as we look forward, if we continue to have success selling assets that we made the statement about the relative first half, relative to the second half, I think you’re right. Depending on the mix of assets on the books, that answer could be slightly different I think. We’ve seen a lot of that shift already though in the yield of the assets that are on the books. So you can see that the increase in yield year-over-year on retail installment contracts that are on the book. The question going forward will be what is the trend and what does that look like going forward. And I’ll just say, we continue to take the approach to the market that we always had in that regard, meaning we develop what we think is the right price and right structure and it slopes with credit. And then the market gives that’s what they give us relative to what the competitors are doing what they do. So, what we’re seeing this year is, early this year we had a nice pick up in nonprime originations. And in this quarter we gave a little bit of that back. Our capture rates in nonprime fell back a little bit as there were some additional price competition in nonprime. And so if that trend continues, then we’d expect it to be maybe slightly up the credit scale from what the originations over the course of 2015 were. If that moderates, then it maybe similar, but what we tend to take what the market gives us and our approach to sales is kind of similar. We look at the economics of the sales. We back turn a lot of things including not just the purchase price, but the ongoing servicing fee. Income will get and try to make the right decision.

[Cheryl Pate:]

Okay. Thanks. That’s helpful. And then just my follow-up, I just wanted to make sure I understand what’s going on with the gain on sale line. And I think you mentioned something coming through the provision line in fact. Can you just clarify that a little bit further?

[Jennifer Popp:]

Yes, sure. So we had basically two basic types of asset sales this quarter. So we have SDART residual sales and those are of aged assets that we had already put an allowance on. And we sold them at a premium to book value, but lower than par, lower than unpaid principal balance. And so when that happens, the accounting rules require to run that net gain through as a change in provision to effectively releasing the entire allowance and then running the difference between par and the purchase price through as a lower cost to market adjustment. So it doesn’t show up in the investment gains line. The other type of sales we did this quarter were our typical flow sales with our two main flow partners whether there -- so very shortly after origination when there hasn’t been time for the price to move much as that all off par, so they generate very low -- lower on gains on sale and that’s the only thing that’s going through the gain on sale line.

[Jason Kulas:]

Another factor I would add is we didn’t do a CCART transaction this quarter and those have intended to be beneficial to that line as well.

[Cheryl Pate:]

Right, okay. All right. Thanks very much guys.

[Jason Kulas:]

Thanks.

[Operator:]

Our next question comes from the line of John Hecht at Jefferies.

[John Hecht:]

Thanks very much. I guess a couple of questions that are displayed on some priority questions. First of all, is there a way you can give us the specific provision adjustments in the quarter related to number one the accounting change and number two, the accounting adjustments relative to the asset sales. I think you put something in the press release I think it would have been $807 million, is that the right number that we should get to normalize this?

[Jennifer Popp:]

Yes, the main impacts were the seasonality change had a $134 million impact. And then the residual sales had a $38 million impact.

[John Hecht:]

And both of those were benefits, correct?

[Jennifer Popp:]

Yes. Yes.

[John Hecht:]

Okay.

[Jennifer Popp:]

And then the personal ones had $14 million and those were all positive. So we have a $186 million buyback.

[John Hecht:]

Okay. And then second question -- okay, that’s perfect. And then second question is I apologize, I missed some of the prepared remarks around the accounting change, but I understand the concept. But just thinking forward, should we -- it serves the modeling, so we now -- should we now just think about take seasonal charge-offs because I think everybody knows that those go up in the second half of the year. And then just some model charge-off seasonally and that assumes some ALL level in so for fourth quarter we would just assume our charge-offs and ends whatever ALL level we would have, the missing link would be the provision, is that the way to think about how we should forecast this going forward?

[Jennifer Popp:]

Yes, in general, I would say while we were able to take up the seasonality from the forward look. Obviously like you said, can take it out of charge-offs and we also can’t control the seasonal levels on delinquency and when there is higher delinquency and more a delinquent asset is going to have a higher loss forecast, regardless of seasonality compared to a current asset. So we’d expect that the allowance ratio would move up a little bit in the fourth quarter and probably land somewhere between where we’re now and where we’re at the end of the second quarter even with that seasonality renewable.

[John Hecht:]

Okay. That’s helpful. I guess that’s it. I will get back in the queue. Thanks.

[Jason Kulas:]

Thanks, John.

[Operator:]

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

[Moshe Orenbuch:]

Jason, you had made some comments about the competitive environment. I mean, are you seeing some of the large banks coming? I mean, where is that change coming from and do you think it’s persistent or how do you kind of think about the competitive dynamic here?

[Jason Kulas:]

Sure. Happy to address that. I think this is a little bit of a developing story. We are encouraged by obviously the stability of performance we’re seeing and that’s where you tend to see competition sort of impact things over a longer period of time. And so the performance is really coming in very stable and inline or close to what we’ve expected. But we're looking at something on a competitive front that we are watching very closely and I wouldn’t pick out one individual competitor across the board. But what we are seeing is on lease. In general what’s happening is as we look at individual transactions what appears to be happening is people are taking a little bit more aggressive view on residuals and may be partially offsetting that with what they do on act fee and the money factor rate and those kinds of things, but the net results is a lower payment. And so in a little bit more aggressive approach to lease. So we felt that in this quarter and we are really digging into that to see how we think that trends. We are also seeing a little bit more price competition in nonprime. And in fact, it's that kind of greater than 550, maybe even greater than 580 nonprime book of business where we are seeing players across the board starting to be little bit more aggressive on price. We saw that influence. One of the things we talk about a lot on these calls is, we get a direct -- we get direct feedback every day on our captures rates with all the applications we see. And our capture rate on those types of deals is a little bit lower in the third quarter than it was in the second. So what that tells us again is that competition has picked up a little bit. People are being a little bit more aggressive and it's something we want to watch very closely.

[Moshe Orenbuch:]

Great. And I apologize, I missed the first couple of minutes of the prepared remarks. Did you kind of give any background as to the decision to kind of exit the personal loans business? I mean, I think you can kind of say about what kind of pushed in that direction?

[Jason Kulas:]

Sure. This has been a ongoing discussion for us for a couple of quarters, this idea of looking at everything we do from a strategic standpoint, and looking at what's core and what’s not core and where our focus should be going forward to create the most value. And this is a process we went through and the management team, the Board, everyone involved of assessing again everything we do. And the result for us was we want to get back to basic. We want to focus on our core business, the things that we feel like where we have the most strength. Auto clearly is that for us. And if you look at the personal lending business it's a profitable business, it is a small business and we don't service the assets of the bulk of the assets. So it's not really core to our operations. And as we look at the opportunity we have, partially in our core business as we look for incremental opportunities, but in a big way with the opportunities we still have in Chrysler and the tremendous amount of upside we have there, we thought it was prudent again to get back to basics and focus on that.

[Moshe Orenbuch:]

Great. Thanks very much.

[Jason Kulas:]

Sure.

[Operator:]

Our next question comes from Vincent Caintic at Macquarie.

[Vincent Caintic:]

Good morning. Thanks very much. Just to put a finer point on the new provisioning methodology. Could you give us what the first and second quarter provisioning and maybe the EPS numbers would have looked like if you had used your new methodology at that time?

[Jennifer Popp:]

We don’t have the exact numbers handy, but this Q1 kind of thinking through what the 16 month forecast will look like from the end of each of those periods compared to the beginning of the period, we -- in Q2, our delinquency, our provision, typically get worse and so we’d have had a pick up there. And then, Q1 would be …

[Jason Kulas:]

Slight release.

[Jennifer Popp:]

… yes, slight release. So in effect we’re smoothing what used to be kind of a build throughout Q2 and Q3 and more of a release in Q4 and Q1.

[Jason Kulas:]

And as you know, Vincent, this volatility was a real issue for us from quarter-to-quarter. So we’ve in Q1 and Q4 we had really good news and in Q2 and Q3 we had noise to explain, because of the self imposed way that we look at the forward look. So what this would just do is take those out and we would have the normal seasonality and the business as Jennifer referred to earlier were in the second half, clearly have high delinquency and those kinds of things. But we wouldn’t double the impact of that by the way we look at our forward look.

[Vincent Caintic:]

Right. Got it. I’m just trying -- kind of putting a -- maybe a framework on how to think about 2016, but that makes sense. And then kind of a second question, when you’re talking about you’re shifting your balance sheet now away from the unsecured loans and also maybe a little bit more deep subprime in the past and then the prior Investor Day you talked about a 4.0% ROE on your business, but how do you think about that now as you’re kind of shifting towards the -- maybe a more focus on subprime loans?

[Jason Kulas:]

I think more recently we’ve talked about and in term -- we talk about that in terms of 3.5% to 4% pre-tax ROE on a business. The personal lending business is incrementally slightly higher than that, and so -- but we still expect on a pre-tax basis to kind of be in that 3.5% to 4% range, that’s how we originate the business, that’s what we expect when we put it on. Clearly we had some success this year with non-prime originations. And so we expected over time that will result in really profitable performance on that book even that of higher losses and provisions to come with, with it being lower in the credit spectrum. What I would say is, even that move though is still significantly up market than where we were before. We launched Chrysler capital in May of 2013. So what I would expect going forward is we still performed consistent with that same range that kind of 3.5% to 4% pre-tax ROE kind of low-to-mid two’s ROE with the ROE being impacted by the build in capital base, but still very profitable on a relative basis as you look across the industry.

[Vincent Caintic:]

Okay, great. Thanks so much, guys.

[Jason Kulas:]

Sure.

[Operator:]

Your next question comes from the line of J.R. Bizzell at Stephens Incorporated.

[J.R. Bizzell:]

Good morning, and thanks for taking my questions. Jason, I’ve kind of wanted to build on your comment at least on the ABS platform, just wondering if you could give us an idea of kind of that market appetite. Are you still seeing the demand that was kind of seen in the first half of the year, and kind of your expectations on a go forward basis on that platform?

[Jason Kulas:]

We really are. The market is -- continues to be strong, the demand for our paper in the market is also very strong. We’ve had a lot of success continuing to launch off of all three of our major platforms, the CCART, DRIVE-in, SDART platforms and we expect that to continue for the rest of the year as well. And what I would say is, if we see any movement at all it’s some slight movements in spreads where people are demanding a little bit higher spread for the paper they’re buying, but I wouldn’t say that specific to us. I think that’s kind of across the board in the industry, and its only marginal. The seniors are widened in the 20 basis points or so range and the stocks have widened in the probably 40 to 50 basis point range. But other than that, we’re seeing a lot of demand and we continue to have a really good report with our investor base who sort of knows what to expect from us when we issue deals and tends to be interested when we come out with the next one.

[J.R. Bizzell:]

Great. And then last one for me and most have been asked, recovery rates you saw a pretty nice move in recovery rates in the first half of the year and then in this quarter you saw a little, a trickle down and some of your peers out there have been talking about the recoveries a bit. Just wonder if you could give us an update on what you’re seeing and kind of your expectations there?

[Jason Kulas:]

Sure, we’re seeing what everybody is seeing, and its -- if you adjust for seasonality. So if you look at the same quarter last year, we are slightly down. I think it’s in that kind of 1% range or so, and so we would expect that to continue. The first part of this year was very strong. We expect the first part of next year to be very strong as we typically see when there’s a lot of demand, tax return season, those kinds of things and so we’ll see that. But over time I think our expectation is that incrementally recovery rates continue to get lower. We don’t see any big drastic drop coming, we see it being fairly marginal and steady, and that’s what we expect when we both originate the new loans that we put on the books as well as when we put provisioning in place. So we shouldn’t be surprised by any continuation of the negative trend in recoveries. But again, I think if you adjust for seasonality it’s really not that bad, it’s still relatively high and only slightly down year-over-year.

[J.R. Bizzell:]

Excellent. Congrats on the quarter.

[Operator:]

Our next question comes from the line of Eric Beardsley at Goldman Sachs.

[Eric Beardsley:]

Hi. Thank you. Just, I had a follow-up on the provision methodology, would your total provisions for the year change under the new methodology or are you just shifting from quarter-to-quarter?

[Jennifer Popp:]

It wouldn’t change at all. That’s in your question. It’s purely a shift from quarter-to-quarter and help take out that noise that we’ve continually had to explain each quarter since the IPO. But overall in any given 12 month period it would be exactly the same.

[Eric Beardsley:]

Okay. And so you had mentioned there is actually $186 million benefit to the quarter from provision, so I guess, if we were to think about that then on an adjusted number, I mean what -- I guess what kind of reserves to loans could we have thought about going in to the fourth quarter or are you at that level now or you would have ended up?

[Jennifer Popp:]

It will go up a little bit in the fourth quarter, but that’s just because of the seasonality of delinquencies. The one timer impact this quarter were things that are basically going away. So seasonality went away, and then the personal lending, assets moved over to held for sale and therefore out of the portfolio that’s being provisioned for, and then on the auto side we had some lower cost to market marks that primarily onto the third residual. So those are all efforts, obviously that has been sold there held for sale. So what we have left is our base except for having to think about the fact that in Q4 the delinquency will move up a little bit which should move the allowance ratio up somewhat.

[Eric Beardsley:]

Got it. Was any of the $442 million increase in charge offs from the accounting was, I guess, saying that in the auto charge offs or was that all on the unsecured consumer?

[Jennifer Popp:]

It was primarily on the personal loan assets, there were --there was about $64 million on auto which is primarily the residuals.

[Eric Beardsley:]

Got it. Okay. That’s helpful. And then, I guess, just back to the first half versus second half, any eye guidance and if I was looking at where you already were for the first two quarters roughly $2.4 billion of net finance income, you did 12.66 this quarter, I guess, they’d be perfectly flat that implied somewhere around 11.34 for 4Q, I guess that will be down 10% from the third quarter. Am I thinking about that right?

[Jason Kulas:]

Yes, that’s a good clarification. I think when we say -- when we say flat we mean sort of generically flat. We wouldn’t expect a big pull back in the fourth quarter.

[Eric Beardsley:]

Okay. So, I mean, are we flat to 3Q -- I mean, I guess unless you get some sale done before the end of the year here?

[Jason Kulas:]

We haven’t said specifically what the number is going to be and it does depend on sales. I would say directionally the second half is going to be in line with the first half, but I think to your point it’s probably slightly above the first half even if we continue to have success selling assets.

[Eric Beardsley:]

Okay. And then just lastly on the lease residual, I guess, if I recall you have an advantage on the residual through the Chrysler relationship. So are people actually under pricing the advantage you already have?

[Jason Kulas:]

We don’t want to go as far as to say we think people are under pricing the business. The approach that a lot of competitors, we’re seeing from some competitors in the market has been a little bit more aggressive than it was in prior quarters, and so we are evaluating that. And yes, people are taking a more aggressive view on residuals, like I said they’re taking some of that back through how they look at money factor and acquisition fees and those kinds of things, but the net result is a more aggressive approach to the business which we certainly felt in our capture rates in the quarter. So, I would say we’re still reviewing that and not quite ready to say that people are being unreasonably aggressive. They’re just being more aggressive than they were.

[Eric Beardsley:]

Got it. Okay. Great. Thank you.

[Operator:]

Our next question comes from the line of Rick Shane at JPMorgan.

[Rick Shane:]

Thanks guys for taking my question. I just want to go back to the comments about expectations for recovery values and also one the things we’ve observed that there’s been a pickup in TDRs over the last 12 to 18 months. I’m curious if there’s been a policy change there or what's driving the increase in TDRs and how do you feel about that? Is that sort of a management tool in light of potentially declining residual values?

[Jennifer Popp:]

Okay. On the TDRs the total or the percentage of the portfolio is increasing slightly as you noted, that -- we don’t see that as a bad thing. We have two primary tools that we use that, and that being classified as TDRs first of all are extensions, and then the special kind of modification we have called the TRIP temporary reduction in payment. We have shifted it towards using the TRIPs more than the extensions although we still do use both because of the better performance on the TRIPs. So when a customer qualifies and that seems to fit their financial situation that’s what we’d like to do, and because those do perform better they tend to stay on the books longer which is again a good thing, that means they’re not charging off. So, that stickiness of those assets is causing a little bit of an uptick in TDRs. It’s not because of any change in strategy as far as how we’re handling customers that are in financial difficulty, and we also don’t see it as a big increase. And in fact you’ll see when we file the queue later that we -- that our TDRs are actually down because that’s got residual pool sales that we did, had some significantly aged prime assets which tend to have a pretty high proportion of TDRs in there.

[Rick Shane:]

Okay. So do you mind being a little bit more specific on the numbers? You said the percentage is up and you alluded to where it will be for Q3. Can you put some context around that?

[Jennifer Popp:]

Yes, I mean when I say up …

[Rick Shane:]

[Technical difficulty].

[Jennifer Popp:]

Sure. Yes, it’s trending very slowly up. We did see about $600 million drop from Q2 to Q3 again because of those SDART residual sales.

[Rick Shane:]

Okay. I guess, we’re about to see the queue. I would like to circle back on the decision around personal loans as well and I think in some ways its -- love to hear the rational is a look back as a way to look forward. So, when I think about your decision to exit that business, I would describe I think there are probably four potential explanations. One is, that it’s a lower ROE business, but Jason said that its not. The second would be that it would be a more volatile ROE over time and then it’s less predictable. The third would be that you just don’t get the operating leverage there that you would on adding the installment loans. And then the last is that, given the higher liquidity in capital requirements that you just feel like deploying that incremental capital back into the core auto lending business makes the most sense. I’m curious what of those four really drives this, and the reason being we want to think about how to model the business going forward, is all that capital going to go into auto and how is it going to impact ROE?

[Jason Kulas:]

I think it would probably be the fourth more than any of the others and the reason I say that is because, if you think about this from just the perspective of we’ve got a finite amount of liquidity and capital, and we want to allocate that in the most efficient way possible in the way we think creates the most value over a long period of time. We think that those resources are better spent on the business that we know we’ve got the most upside in. We’ve been growing personal loans, but growing off of a very small base. We think that business is probably more core to others than it would be to us, and we can say the exact opposite about auto and particularly Chrysler. We think we’ve got a tremendous amount of upside there and really want to dedicate our time and our resources and our capital to making sure we play that out to the fullest extent. So, I think it’s probably the fourth more than any of the others.

[Rick Shane:]

Hi, Jason and I apologize I know I’m taking a lot of time here with some long questions, but that brings a really interesting point which is that, when we think about most of the consumer finance companies that we follow right now, their biggest issue is excess capital and lack of opportunity and it doesn’t feel that way for you guys. Is it because of the core opportunity you see or do you think that you are because of the regulatory regime, capital constrained in a way that a lot of other specialty financing consumer finance companies are not?

[Jason Kulas:]

Well lets talk about capital for a second, because if you look at I think clearly we consolidated in sort of bank holding company and we are subject to all of the capital rules that banks are we talked about the CET1 calculation and how we’ll be performing to that reporting and those kinds of things. If you look at the capital we’ve grown, just that what we’ve done to the capital base of the company in the last year, its gone up considerably, and I think what that’s reflective off is our ability to produce large amounts of income and that’s a real positive thing. What we’ve shown over a long period of time is that capital tends not to be a limiting factor for us because what we’ve shown in the past is that we could pay dividends and grow capital at the same time, and so -- so its not necessarily that this is being driven by regulatory issue or regulatory capital constraint, those kinds of things. What I would say is our assessment of the capital we have today is -- or the required capital on the business today is exactly in line with where we are. What that means is, we probably shouldn’t expect a big step back from this level. But it doesn’t mean we’re under -- what it also says is that we’re not under a lot of pressure to substantially increase at this point. So given that I think we’re going to have the ability to continue to grow capital going forward and to have some choices with what we do with that capital. I think also though that we’re in an evolving environment where capital requirements and institutions like ours is a big topic of conversation. So I wouldn’t say this is a -- any sort of a precursor to any announcements on that front. Its something we’ll continue to discuss and we do actively discuss. We’re about to go through a new CCAR process that will generate a whole new set of requirements on the business and whatever those are, I think we’ll be able to operate within and even if the result is higher capital. I think this is not driven by any of that. I think this is really simply driven by the fact that we know we’ve got just under eight years remaining on this Chrysler contract. We know that our capture rates are going to go up over time. For all the factors we’ve discussed before and because of that we want to make sure we’re in a position to be able to handle that effectively because again we -- we think that represents the most upside in our business the most, the biggest value creating opportunity we have. It’s really simply that and not any other regulatory or those kinds of discussions.

[Rick Shane:]

Great. That’s very helpful and I apologize to everybody for taking so much time. Thank you.

[Jason Kulas:]

Thank you.

[Operator:]

Our next question comes from the line of David Ho with Deutsche Bank.

[David Ho:]

Hi. Good morning. I appreciate the increase guidance comments. I just had a question on your confidence in terms of growing the core auto book in light of some of the unsecured is going away and some of the competitive comments particularly with non-prime increasing. Does that make it harder for you to grow subprime auto assets and keep them on the balance sheet and offset some of the unsecured?

[Jason Kulas:]

That’s a good question. We tend to talk about the core non-prime auto part of our business as a mature business and the reason for it is, some of the factors we’re seeing right now. We had some success this year growing that business and we capture really wide net and we get that business from many different sources and it’s a business that we like and we’ll continue to be a big driver for us. We don’t think of that business as a growth business. I would say outside of for some new partnership that may come along, a new proprietary flow of applications, those kinds of things. We just view it as a real solid high performing business and the way we maintain that is to continue to be as conservative and rational in our approach to placing and structuring it as we always have been. And so what that means is we’ll go through times where we have to book less of it. And so, I think the direct answer to your question is, we have seen a little bit of a pick up in price competition in a portion of that business. I would say below 550 not as much, in the 550 to 640 range we have seen a pick up. And so even if that trend continues I would say, yes we would be looking at lower capture rates for the period of time if that continues. But we would be very comfortable with that. I would say we would look at that less as, as a negative in terms of not being able to originate enough business and more of a chance to show again that we’ve got discipline and we’re going to do the right thing regardless of what the competition is doing. So what we see right now is, we’re booking a good percentage of that business and it’s slightly lower than it was in the second quarter, but its still very, very solid. And so, we can't -- we’ll just have to watch it. We can't really project exactly what's going to happen from this point forward. We’ve seen the competitive environment stay fairly rational. We have no reason to believe that’s going to change in any great way but since we saw a slight change we wanted to mention it.

[David Ho:]

Okay. That’s really helpful. And then back on the capital, what do think the current target is or bogie for the whether its CET1 or TCE, I know there’s not a lot of regulatory pressure right now, but just thinking about the mix of your balance sheet and potential changes to the regulatory environment?

[Jason Kulas:]

Our current target is about where we are, it’s in that 11% CET1 range. What we don’t know is what the future holds and how that number might change. We don’t expect it to go down. We expect that, we’ll at least need to have the level of capital we currently and wouldn’t want to speculate on any other levels that we might have going forward.

[David Ho:]

Okay. Thank you very much.

[Jason Kulas:]

Thanks.

[Operator:]

Our next question comes from the line of Jason Arnold at RBC Capital Markets.

[Jason Arnold:]

Hi, guys. Good morning. I’m just curious if you’d give us a little bit more color on personal loan valuation methodology. I guess specifically the marks that you guys took on the transfer to help for sales is where these loans trade or do you have some other assumptions baked in there? And then, I guess could you also tell us a bit more about where you’ll be required to purchase going forward on a flow basis and how you anticipate disposing of those loans that you have and prospectively?

[Jennifer Popp:]

Sure. We have multiple portfolios within the personal lending portfolio as a whole and so we took a look at each one individually. We’re at various points in the potential sales stage with each one, some much farther along than others, all of them far enough along that we do have good indications of value or a range of value on each portfolio. So we were able to get comfortable with where we should mark that as of September 30, and as we noted it was very, very close to where our net book value was, a very slight premium to where we had the loans, net of allowance.

[Jason Kulas:]

On the part of the question related to the additional originations going forward we expect to book, we do have agreements in place on the revolving side of the business and so that’s where you’ll see continued originations. The revolving side of the business does have a little bit of a pick up during the holiday season and so we’ll see higher revolving originations in the fourth quarter for example than we’ve seen in the past couple of quarters. And what we’ll plan to do with those originations is mark them as we have the ones currently on our books has helped for sale and look to find a buyer for those. I guess the good thing is that’s a big part of the process that we go through every month with a big part of our business on the auto side. So we’ve got a team set up to identify buyers for assets and looking for a flow. To the extent we find a buyer for the existing pool of assets who wants to be a part of that flow in any way, we would entertain those discussions. But I think the clear message we want to send right now is we have partners, we have agreements in place and we intent to live by those and continue to do those originations.

[Jason Arnold:]

Okay, great. And I guess in terms of kind of gauging size, I think the originations there this past quarter were $160 million or something like that and you’ve said that they go up seasonally. Is that kind of ballpark -- is there a ballpark range that you can kind of give us in terms of what to expect for originations on the flow side?

[Jason Kulas:]

If you look at what happened last year, the fourth quarter was -- or if you look at what, if you compare this year to what happened last year you would see that number go up into the $300 million or so range, but that is a very broad general -- I mean that’s not a specific projection but it would be substantially higher than what we’ve seen in the past couple of quarters.

[Jason Arnold:]

Okay, great. And then just another one, you’re taking up the noise from the seasonal change on provisioning and all that on the credit side. Just curious if you can talk about credit performance in general and perhaps your expectations respectively here I know there is mix potential and volume potential that can kind of change that, but just some additional perspective that would be helpful.

[Jason Kulas:]

We spent a lot of time as you know looking at credit performance and we do a lot of vintage analysis on that. And so what we’re seeing if you look at the vintages over the past couple of years if that -- all of the vintages are performing in line or close to in line with exactly what we expected I would say, if you go back a couple of years, we got some vintages going slightly below the line which is from a loss perspective which is for the good. If you look more recently you’ve got some of the vintages slightly above the line but not in anyway that would concern us. I would say still generally in line with our expectations, so that’s a really positive sign. But its one of the reasons why we watch competition so closely because we know that over time increased competition and a more aggressive approach to the market just in general by the market will result in worst performance since we want to make sure we’re always ahead of that. But again nothing that’s a big cause of concern right now. The message is still really what its been in prior quarters which is we’re seeing stable performance, we’re seeing capture rates in line with what we would expect for the price in the structure we’re putting on the loans. Where we’re seeing a little bit of change is just in the competitive environment on how things are priced. If you look at capture rates in the third quarter relative to the second specifically in some of the areas of non-prime, kind of near-prime and also lease we’ve seen a drop based on what the competitors are doing relative to what we’re doing. And so that’s something we’re watching very closely but back to core performance looking at it on a vintage basis and watching it very closely, no big cause for concern and if we -- and we’ll continue to report on that as we move forward. So if some of those vintages that are slightly above, weren’t even higher we might express a little concern but that’s not the direction we see it going at this point.

[Jason Arnold:]

Okay. Great color. Thank you. I guess just to follow-up on that, the newer vintage being slightly weaker as you mentioned, is that a product of recovery rates or frequency of delinquency assumptions or maybe you can offer a little more color on that.

[Jason Kulas:]

It’s a little bit of frequency, severity is -- I would say it’s a little bit of both probably. And again it’s not really even measurable and it’s really too early to say that not on the line. What we generally say is its in line with what we expected because if you look at -- if you drew the lines for example, if we had a white board in front of us, you drew the expected line and you drew the actual line so far on some of these vintages what you would see is -- what you’d see is just a slight tick above the expected line. If we could always projected that close we’d be really happy with that outcome.

[Jason Arnold:]

Makes sense. Okay. Thanks very much.