Santander Consumer USA Holdings Inc.
Q3 2014 Earnings Call Transcript

Published: 4 Nov 2014

[Operator:]

Good morning and welcome to the Santander Consumer USA Holdings Third Quarter 2014 Earnings Conference Call. (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 Thomas Dundon, Chairman and Chief Executive Officer; and Jason Kulas, President and Chief Financial Officer. Before we begin, as you are aware, certain statements 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 the 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’ will refer certain non-GAAP financial measures which 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, November 4, 2014. 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 Tom Dundon. Tom?

[Thomas Dundon:]

Good morning. Thank you for joining the call. Today I will discuss our third quarter highlights and ongoing strategic initiatives. Afterward I will turn the discussion over to Jason for a detailed review of the quarter's results. We will then open up the call for any questions you may have. Third quarter results are highlighted by strong profitability. During the quarter SCUSA earned net income of $191 million or $0.54 per diluted common share compared to net income attributable to SCUSA's shareholders for the third quarter of 2013 of $111 million or $0.32 per diluted common share. This represents net income growth of 72% from the prior year, driving a return on average equity of 23.9% and a return on assets of 2.5%. This performance keeps us ahead of our EPS objective for the year. As expected, credit performance has continued to normalize as 2009 to 2012 vintages have become a smaller portion of our portfolio but we are currently being compensated for the risk. In the third quarter, total originations were $7.4 billion including $604 million in facilitated originations. This compares to total originations of $6.7 billion in the second quarter, including $595 million in facilitated originations. Last quarter we made a strategic decision to avoid certain loans in a highly competitive environment by tightening structure resulting in a reduced capture rate. This quarter total originations increased nearly 10% over the previous quarter. Volumes came in higher this quarter after implementing underwriting model changes, mostly on the Chrysler portion of the business allowing us to better identify attractive loan structure. We continue to look for opportunities to diversify our auto business highlighted by an increase in lease on originations two $97 million from $58 million during the prior quarter. We also remain focused on our unsecured lending platform. Our unsecured portfolio balance as of September 30 totaled $1.3 billion, up from $1.2 billion in the previous quarter. Total originations of $249 million were driven primarily by installment lending volumes increasing to $242 million, up from $193 million last quarter. We continue to see competition across the entire credit spectrum, pressure in used-car prices and regulatory developments in our industry. Compared to a more favorable learning environment in previous years, competition has driven margin compression. But we remain confident in our ability to originate loans with appropriate risk adjusted returns. We are maintaining our disciplined underwriting practices including underwriting to strict ROA hurdles as this approach is critical to our long-term profitability. Used-car prices continued to decline as they normalized from higher levels. In anticipation of the impact on recovery values, we are using lower recovery assumptions in our models than the current actuals. However we believe that as used-car prices decline, cars become more affordable for consumers which is a positive for our new originations. Moving on to regulatory developments during the quarter. We remain committed to the CCAR process in preparation of our parent company's capital plans submission in January of 2015. We are focused on enhancing processes related to risk management, governance and internal control. We believe it is critical to continue to integrate these processes into our DNA. We are also focused on leveraging feedback from various regulators, our external advisors and auditors to be more proactive in the way we think about regulatory issues that we have identified and how they may impact other areas of our business. Finally, the CFPB remains focused on dealer participation in fair lending and has recently proposed its larger participant rule. Regarding participation, we have procedures to monitor and impose controls over dealer participation and we perform analytics on dealer markup. With respect to fair lending, SCUSA implemented a fair lending program in 2009, well before the issuance of the larger participant proposal. So we have been regulated by the CFPB since early 2012. We have a robust compliance and regulatory framework and remain committed to working with the CFPB to ensure we are treating our customers in a fair and equitable manner. I would like to turn the call over to Jason for financial results. Jason?

[Jason Kulas:]

Thank you, Tom and good morning everyone. Let's go through the third quarter results in more detail. As Tom mentioned, net income for the quarter was strong coming in at $191 million, which represents growth of 72% from last year. This was driven by net finance and other interest income growth of 24% to $1.1 billion, up from $901 million during the same period last year. Interest income from individually acquired retail installment contracts increased 19% to $1 billion, up from $880 million during the same period last year due to significant growth in the portfolio. Net leased vehicle income increased to $63 million this quarter, up from $9 million in the third quarter of 2013 and up from $40 million last quarter. This represents an increase of 58% quarter over quarter as we continue to originate more release volume as Chrysler's preferred lender. Interest income from unsecured consumer loans grew to $86 million this quarter, up from $42 million during the same period last year. Moving to originations. As Tom mentioned, we originated $7.4 billion in loans and leases this quarter. These originations include $465 million of leases and $139 million of dealer loans originated for an affiliate. During the quarter we originated more than $3 billion in Chrysler retail loans, $1.7 billion of which were prime loans and the remaining $1.3 billion non-prime. We also originated $1.7 billion in Chrysler leases which includes $465 million in leases originated for an affiliate. The Chrysler penetration rate for the third quarter was 29%, slightly below the prior quarter despite stronger volumes this quarter as the Chrysler Group experienced strong sales. We continue to remain confident about the ongoing success of our agreement with Chrysler. The allowance for loan losses increased to $3.3 billion this quarter from $3.1 billion last quarter. It's important to note that because we carry approximately 17 months coverage on our vehicle loan portfolio, reserve levels are impacted by the forward-looking provision model. As an example, versus only 12 months coverage, the model captures the seasonally worse full fourth quarter of loan performance twice as the third quarter ends. The allowance to loans ratio increased to 12.3% this quarter from 11.6% last quarter. Consistent with our strategy to increase our service providers portfolio, our loan sale volume totaled 33% of our originations this quarter up from 26% last quarter. Much of the allowance to loans ratio increase is related to the credit profile of retained loans as this quarter we sold $1 billion in higher credit profile assets via our Chrysler Capital securitization platform. During the quarter as we sold these higher credit profile loans, the mix of lower credit profile loans remaining on the balance sheet required more upfront provision. The provision for loan losses increased to $770 million, up from $598 million in the third quarter of 2013 and up from $589 million last quarter. The quarter over quarter provision increase was mainly driven by the profile of retained loans, additional provision for the maturing unsecured lending portfolio and normal seasonal performance deterioration in the back half of the year. The year-over-year increase was also driven by these factors as well as having a much larger balance sheet overall versus the prior period last year requiring additional provision. Looking at credit performance for the quarter. SCUSA's net charge-off ratio increased to 8.4% from 5.8% last quarter and from 6.4% during the same quarter last year. The third quarter delinquency ratio increased to 4.1% from 3.8% last quarter and from 4% at the same time last year. The increase in both ratios quarter over quarter follows normal seasonal patterns and we expect this trend to continue in the fourth quarter as consumers divert resources toward holiday and vacation spending. Net charge-offs year-over-year also increased as prior vintages from 2009 to 2012 continued to run off. These 2009 to 2012 vintages outperformed expectations with favorable yet unsustainable yields. Current net charge-off levels are in line with our expectations. Recovery rates are also lower both year-over-year and in the seasonally lower second half of the year. However, as Tom mentioned we use lower recovery assumptions in our models. Moving on to expenses. During the third quarter operating expenses increased 15% to $202 million from $176 million during the third quarter 2013 as we continue to grow our asset base from the prior year. However, we continue to demonstrate industry-leading efficiency as our efficiency ratio improved to 16% from 18% during the same period last year, and from 17.4% last quarter. This is further evidenced by our revenue versus expense growth for the nine months ended 2014 versus 2013. On a GAAP basis, revenue growth lagged expense growth due to one-time IPO cost. However, excluding these cost, revenue growth outpaced expense growth. During the quarter and since our IPO in January, expenses have come in lower than expected and this has translated into a lower efficiency ratio. Given the cost associated with going public, the significant origination growth related to Chrysler and recent regulatory expenses, we expected higher cost. However, our efficiency and scalability are evident in our expense base leading to a better than expected ratio. Turning now to liquidity. SCUSA demonstrated strong access to liquidity via the execution of a $1.35 billion securitization from our core nonprime securitization platform SDOT. Our fourth SDOT transaction in the year was well received and oversubscribed in September, allowing the transaction to be up sized. Additionally we executed our second deal of the year from our Chrysler Capital prime retail platform, CCAR, a $1 billion securitization. We also received $1.5 billion of additional liquidity from private term amortizing facilities from warehouses. Aggregate loan sales for the quarter totaled $2.4 billion including $1 billion sold in our CCAR securitization, with the remainder driven by our flow agreements and Citizens Bank. We also sold $18 million in dealer loans to an affiliate. Loan sales were up 39% from last quarter's $1.8 billion as we continue to focus on balance sheet management and growth in our serviced for others portfolio. The portfolio of loans and leases serviced for others totaled $10.2 billion at quarter end, up from $8 billion at the end of the second quarter. This portfolio has also more than doubled since the end of 2013. Investment gains for the quarter which are primarily comprised of gains on sale total $38 million, up from $22 million in the second quarter as this quarter included a CCAR securitization. Servicing fee income totaled $21 million for the quarter, down from $22 million in the second quarter. Excluding a one-time positive adjustment during the second quarter of about $3 million, servicing income also increased. Finally, our effective tax rate decreased to 32.1% this quarter from 36.8% last quarter due to several factors including a release of reserves for uncertain tax positions. We expect this rate to revert to previous levels moving forward. Before we begin Q&A, I would like to turn the call back over to Tom. Tom?

[Thomas Dundon:]

So in summary, looking back over the third quarter. We were able to originate attractive assets, produce strong net income. Core net income for the first nine months of the year totaled $595 million. Originations were up over the last quarter and for the nine months ended September 30 originations totaled $21.4 billion. We continue to achieve robust profitability despite competition, used-car pricing declines and recent regulatory developments. In response to these evolving industry dynamics, we continue to develop our business model remaining focused on our efficient core, nonprime platform. We also remain excited about our relationship with Chrysler, the growth of our serviced for others portfolio and our unsecured lending platform. We are determined to make the best use of our capital, allocating resources towards the greatest ROA opportunities while generating recurring fee income via our serviced for others portfolio. With that, I would like to open up for questions. Operator?

[Operator:]

(Operator Instructions) Your first question comes from the line of Mark DeVries at Barclays.

[Mark DeVries:]

I am trying to understand what's causing the reserve levels to continue to increase sequentially, particularly in an environment where it looks like clearly you are concerned about recoveries. Delinquencies are fairly stable year-over-year. And by my calculation it looks like, just on a sequential quarter basis assuming kind of a 17 months coverage, like the implied charge-offs in your reserve levels went from about 8.2% to 8.7%. Can you just help me better understand, and I understand there is a little bit of seasonality to that, but why we continue to see that the reserve levels are going up and the implied charge-offs going up same time.

[Thomas Dundon:]

Sure. Look, we have been doing this for a while and when you get a book this size with different channels, we have lots of loans coming from lots of different places and they perform -- there is nuances to all of them. And I think just as an overall philosophy, more information makes us more confident and the Chrysler relationship is less than two years old and those loans are a bigger portion of our portfolio. And as we continue to sort of dig in and understand what makes that book of business perform the way it does along with the fact that we think competition and the access to liquidity created some difficult market conditions for us, I think we just want to watch. And so our judgment is, you hold the provision while you watch and you analyze. And over time, if the trends that we are seeing were to continue then I think what you are saying could be true, but I don't know that we are hundred percent convinced of what the outcome is for the loans we have in the portfolio today. So I think we're feeling pretty good about it but at the same time we are going into a tough part of the year. Used-car prices are down. We have had a lot of changes in the regulatory environment and we feel really, really good about the way we are integrating those into our business. But there are just a lot of, a lot of variables and this feels like the most prudent way to approach the information we have today.

[Mark DeVries:]

Okay. And just to follow up on the consumer business. One of the things that's been a little surprising is, I think if we just look at the loss adjusted margin there, charge-offs almost equal. The yield, I think you guys are excited about the business to talk to 3% to 4% ROE business there. Can you help us kind of understand the disconnect between those types of returns you expect there and what we are seeing right now in the current quarter with kind of the very limited loss adjusted margin?

[Thomas Dundon:]

Sure. It's just fee income. So we will think about how we show that because the margins are in line with our expectations. So it's interest income plus fee income will give you the margin that we have guided to and we expect and that you are referencing. So for this quarter about half of the fees commissions in other line is from the unsecured business and that's not included in the yield. If it were, the yield for that business would be in the low 30s for the quarter. So we still think it's a very profitable and lucrative business.

[Operator:]

Your next question is from the line of Cheryl Pate at Morgan Stanley.

[Cheryl Pate:]

Just wanted to follow up on the provisioning question. I was just wondering if you could break it down for us in terms of how much of the reserve build was related to retaining more autos, more of the lower credit quality autos versus seasonality in the consumer business versus any additional reserve on your existing book.

[Thomas Dundon:]

Yes. It's hard to be -- I don't think the unsecured consumer book is a big driver of variability because those margins with the way we have some of our -- the majority of our arrangements set up, the ROA is fairly predictable and consistent. In terms of holding more subprime assets, and obviously a subprime asset holds a bigger provision upfront and then you earn more interest income over time. And the amount of provisions that we are holding, because we are taking a conservative view of the future, can only be known when the future actually happens. So it would be hard to quantify each of those things. I would say that the trends, and I think on the last question it was pointed out that our delinquency trends look okay and therefore if that were to continue then you would expect to see loss trends improve or at least stabilize. And the way we traditionally price loans is we look at history and make sure we have enough margin to justify putting our capital out. And whenever the loss rates stabilize as opposed to increase, you should ultimately see provision to stabilize or decrease. It's just a cycle and we don't perfectly know when that happens. But it feels like we are closer to that point today than we were early this year.

[Cheryl Pate:]

Okay. And just a second from me. Just on the efficiency ratio. It continues to, I think, to come in better than we expect. And previously you had guided to full year efficiency in the range of 2013 levels. Is that still the case or how have found places for better efficiencies to offset some of the regulatory costs and we could see levels below 2013?

[Thomas Dundon:]

Yes. I think there is probably two ways to look at it. One, a lot of -- as we have, I think, matured in our understanding of regulatory expectations, there were many pieces of improving our risk management, our model validation, our compliance and our governance that we have been able to integrate in our business and find actual improvements and risk controls that maybe we did in a different way. So the increase in those costs probably weren't as we bad as that could have been. That you could have feared they were when you didn’t quite understand expectations. And then there is a trade-off. We can spend more money in collections and get lower losses. That doesn't necessarily mean that will all flow the bottom line and given how litigious and how much scrutiny there is around how you treat customers. We always have and continue to take the -- to be under the opinion that a dollar of an expense and a dollar of loss are the same thing and we will lean towards lower expenses and less activity as it relates to collecting our customers when we believe that it's a zero sum outcome. And that’s part of how you can get some lower expenses. Where losses feel a little higher, we could trade those dollars out, but we don’t think that’s the right decision especially in this environment. And historically we have tended to believe that you should be strategic in how you collect your book and hammering phone calls and the type of, sort of abuses that maybe the subprime industry has been known for. We take the opposite approach with less calls but more strategic and a smarter approach. And therefore that’s a place where we can get, continue to see efficiency as we get better at that.

[Jason Kulas:]

We do expect the efficiency ratio to get to where it was last year and really through that and higher than that over time as the serviced for others business grows. But for all the reasons Tom said, this year we won't see the level of last year.

[Operator:]

The next question is from the line of Rick Shane at JP Morgan.

[Rick Shane:]

Thanks guys for taking my question. I think you could pick up on a theme here in terms of allowance and provision. I want to explore sort of where we were last quarter and some of the metrics that you provided on a more detailed basis and maybe we can get those this quarter. The comment was made last quarter that the allowance to loss ratio outlook was stable. It increased. It sounds like a little of that or some of that is attributable to mix shift. To help us understand that, last quarter you actually provided by product the coverage ratios for retail installment for the purchase portfolios, for dealer financing and for the unsecured. Can you do that again? That would be really helpful. And actually that Slide 21 last quarter had a lot of good data on it but if you could just give us the ratios now that would be helpful.

[Jason Kulas:]

Yes. Sure. We will share this information because there is a lot of detail in it. But I think you are right on, the comment you made about just the general change in allowance to loans ratio being partially driven by mix shift. If you are going to narrow down to two things, it's a combination of the way our model factors in seasonality and the 17 month provision look combined with mix on one side. And then the other side is the unsecured business as it's been shared and we have added provisions there. So it's both and it's probably equal parts, those two things. But we would be happy to share that information.

[Rick Shane:]

Terrific. And then just to follow up on that in terms of the 17 month. I took away last quarter that over time that 17 months forward look was going to compress modestly. Is that still the intention so the people think about this in the right way, we certainly I think had drawn some wrong conclusions. How should we be thinking about that going forward?

[Thomas Dundon:]

I think as we see, as we look backward and see where we think we come to an inflection point where we don’t think losses could increase. The problem with the way provision model work is you are looking backwards. So you have to take history and compare your outcome for the same type credits compared to what you think the best and worst case scenario have been. And as we move towards an area where credit is performing in a way that capital will not be as attracted to our space and losses get to a point where historically we think that’s as high as they go, then you think about month's coverage in a different way than when you are at historically low losses. Capitals attracted to your competitors come in, driven price down, drive losses up. So I think there is -- the best thing about this business is we have got a two year average life asset and we react daily in how we underwrite and price these assets. And we feel confident that we look at the return on asset assuming that things when they are really really good, they are going to get worse. And then whey they are really really bad they are going to stay about at historically high places. So if the world -- in a scenario where loss rates were to stabilize and then with the things we do to tweak credit in a stable environment, you would expect to see some improvement, and that’s kind of what we are paid to do, then you could envision provision as months coverage coming down as you believe some of the volatility is taken out of the market. And I think that’s just a philosophy of how we go about the business.

[Rick Shane:]

And I apologize to my peers who are listening this call, I am actually going to try to drill in this just a little bit deeper. But is that -- to say that this will be an evolution not over quarters but over years as that portfolio, as the vintage is really shifting you move away from those '09, '012 vintages with very low loss rates and potentially high coverage ratios, or high months coverage ratios, to a more normal mix and it really could take 18 more months?

[Thomas Dundon:]

This is -- I am not -- please don’t take this in, I am not being smart about this all, it's just that we can't really predict the future or how competitors are going to act. What we think we are seeing is more rational behavior in the market. All the attention on the securitization market I think is going to lead people to be more careful in deploying capital in this space and recognizing that the servicer and the originator matter. And as investors we are -- the rating agencies and investors were willing to back lenders that maybe didn’t have the ability to deal as well with higher loss rates in a more volatile environment. And if we were to continue to see the trends we see now, then it could happen faster. And if it were to take longer, it could take longer. But it feels like the loss rates this year, based on competition, deteriorated in last couple of years quickly to a historically high place and now seemed to have settled down. And every month we feel better about that position but there is no way to really know. So I wouldn’t want to give you time other than, I think we could originate assets to the risk-adjusted margins that we have always thought we needed and that hasn’t changed. It got a little tougher there for a little while and we gave up some volume and now we are starting to gain some of that share back and we like the prices. But what it means for the back book as it rolls off, those loans are already booked and the price is the price and we can't do anything about it and it feels like we are adequately reserved for the back book. And the price that we reserve for on a new loan, is going to be based on history. And if history gets better, those numbers will come down.

[Operator:]

And your next question is from the line of Moshe Orenbuch with Credit Suisse.

[Moshe Orenbuch:]

I am just wondering if you can kind of just help us understand maybe the trajectory of the [loss rates] (ph) in the auto business over the next couple of quarters. Your thoughts given that there has been a fair amount of volatility, maybe a little more than normal, and yet you are talking about kind of the newer assets being booked being kind of a better quality than you had seen in the quarters [past] (ph)?

[Thomas Dundon:]

Sure. So we are indifferent about loss rates. There is not a better or lower quality car loan. It is simply the loan that we get the reserve of the yield for the risk. And we think the loans we are booking today, we are able to price for the risk. So that fact that a certain credit customer today is going to have losses that are some multiple higher than it would have had in 2009 or 2011, doesn’t make it a worse loan. It just means you got to understand the right price and the right structure that this market can support. And I think the way we would look at it is, when there is very low competition, things perform better. When there is too much competition, things perform worse relative to your expectations. And we cone again seem to be in an environment that we understand pretty well. The rate of change over the last six years where you went to no liquidity in the market to liquidity flooding the market and new entrants that maybe didn't -- they had built their models off of a time when there was no liquidity and therefore might have got fooled a little in terms of credit risk. And now it feels like everybody has got data that you can rely on and if you can execute your plan, you can make a reasonable return on originations today. It's easier to originate when no one else has liquidity than you do, but it's not actually a real long-term business strategy for us. So we think we perform really well when there is a little more volatility and a little more competition. And I think we have gotten through the majority of that and now things seem to be a little more normalized although at a higher loss level. Performance is more in line in our recent vintages with our expectations.

[Jason Kulas:]

So as we look into the fourth quarter, we will see seasonally higher losses. And as we look into next year, we will continue to see an uptick in losses but just at a more controlled measured rate. And so we do expect to see that lift. And I think the point we are trying to make here is that if that results -- if the combination of that and the mix of what we have on the books results in higher provisions, it's something we will have priced for and something and something we will be comfortable with. We did see -- and there is an impact, I want to make sure it's clear. We did see a shift in this quarter too because we saw, what we ended up doing is retaining more lease and selling more near prime auto. And so the result on the allowance to loans ratio which doesn’t include lease, is at the mix of what we are provisioning for was lower in the credit spectrum. Still a place we are very comfortable but resulted in a higher ratio of coverage. So, again, hopefully you are getting the point that we are sort of agnostic to the level of that reserve because whatever it is it's right for what we have originated.

[Moshe Orenbuch:]

Right. I have got that. Just to follow up what you said about going into 2015. Is it fair to assume though that the kind of normal seasonal patterns would be maintained in terms of first half versus the second half? Even though, obviously the higher levels a year ago.

[Thomas Dundon:]

Yes. I think seasonality has never changed ever.

[Operator:]

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

[Eric Beardsley:]

Could you tell us what the provision dollar amount was for unsecured loans in the quarter?

[Jason Kulas:]

Yes, it was -- of the $770 million total provision, unsecured was $167 million.

[Eric Beardsley:]

Thank you. You also mentioned, lower recovery assumption versus the current actual experience. Did you change the recovery rate in the quarter and if so what's your assumption now?

[Jason Kulas:]

We did change it. It's still on that mid-40s range we talked about previously for provisioning purposes.

[Eric Beardsley:]

Okay, got it. And then just lastly, what would it take for you to actually release reserves in a given quarter. I mean could we see seasonality of provisions such that you have these reserves in these quarters for your methodology dictates higher because you are capturing two-third quarters and on the fourth quarter we actually get a release. Or is this something where we should expect the dollar amount to be stable and growing over time.

[Thomas Dundon:]

I think we would just have to watch each month and see what the losses in the delinquency and the yields do. So we try not to get too far out there. And as a general rule, we tend to want to be 100% sure before we go the other way on provision, especially when we are maintaining our earnings target and the yields are stable. So it would be hard to guide to that. I think everybody is, in the first year is figuring out sort of where we lean in terms of how we look at provisions. But part of it is, this has been a year where because of the increased competition there has been loss pressures at loss rates go higher. I don’t think any of it's unexpected but no one really knows where these things level out and you don’t really know how competition is going to react or what's going to happen in the economy. But I think we will study the book, we will study our ability to price. We will look at the market and probably always be leaning a little more conservative. But it definitely possible that we get to a point where we feel like we are on the other side of where we have been the last couple of years. We expect that to happen someday but it's not based on anything other than history and looking at some information. We are not a hundred percent sure about anything other than what we have just put out today.

[Operator:]

Your next question is from the line of Donald Fandetti at Citi Corp.

[Donald Fandetti:]

Just a question around the Chrysler agreement. The penetration rate obviously, looks like it's going to come in below the agreed upon levels. Can you just remind us about what the locations of that might be for the next 12 or 24 months, let's say there is a scenario where there is no relief for the parent company on CCAR. I mean is that something that we should be watching?

[Thomas Dundon:]

I don’t think it has anything to do with CCAR. But I think the Chrysler agreement, it's pretty clear that our penetration were targeted to other captives and that the relationship between Chrysler and us would have to be reflective of the relationship between OEMs and captives even though we are technically not a captive. And I think at this moment, the amount of subvention that we have access to is not very similar to some of the other OEM captives and therefore these penetration rates for the contract would not be something we would held to. So I don’t think there is any problem if we have the same subvention available to us that other captive do. Those penetration rates that we have agreed to, we feel very confident that we would hit them. And that’s just a business decision each OEM makes. And so if other OEMs were to put less subvention in the market then the amount of business captive we would get goes down. But we targeted our penetration rates to being treated like other captives. And I think at this moment, we haven't quite got there with Chrysler yet but we are making progress. They have been great partners. Their cars are improving. Their market share is improving. And we are just trying to support them where it's helpful and then over time we think they will continue to see the value in what we do and maybe increase the amount of subvention which will get our capture rates up and our penetration up.

[Donald Fandetti:]

Okay. Because I thought the next target was around 44%, so are you saying you think you could hit that level or...?

[Thomas Dundon:]

Yes. I think as a simple example, if you see like a 72-months, zero percent interest and you are buying a vehicle, today to get zero percent for 72-months on a lot of the product we offer, you would have to give up a large rebate. Where for a lot of the other captive finance companies, the amount of rebate you would have to trade to get that zero percent interest is smaller. And so consumers are rational and when they do their analysis in buying a car, they tend to take the right offer. And we don’t always have a sub-vented offer as competitive as what some others have. And that changes the penetration rates quite a bit. So depending on what happens with the amount of subvention -- and we go through it today. We have some times where Chrysler supports us in a way that creates really higher capture on certain vehicles because the offer is an offer that is favorable to the customer to take the financing offer relative to the rebate and we see penetration rates that are really high. And when there is no subvention, you are kind of fighting with the market, we will get penetration rates like what you are seeing. I think overall we are pretty happy with where we are given the level of support. And Chrysler has to do what's best for them. And as we mature and we understand that segment of the market better and they understand where we can help and what we can do together, it feels like we are moving in the right direction. But the actually penetration rates for the contract are tied to us being treated like other captives and I think today it's clear that we are not. That we are not quite there.

[Operator:]

Your next question is from the line of John Hecht at Jefferies.

[John Hecht:]

Just looking for a little bit more commentary in the competitive market. Is sound like, you guys discussed maybe it's tightening up, I guess in the competitive market. Are you able to increase pricing to the extent you are expecting losses to rise?

[Thomas Dundon:]

Yes. I would say margins are on the lower end of where we are not -- we would not be willing to do a deal. Which is part of the reason our penetration rates, for example for Chrysler, are down from their peak because there are just some trades we won't make. What we have see is it's coming back our way a little bit. So we are able to do a little more than maybe we could in the middle of the year because the competition had, I think it took a little longer for some of the newer entrants or smaller players to realize sort of the environment that we are in and we probably move a little quicker. Maybe not quicker than everybody but just in general it seems like we tend to lose share earlier when losses go up and maybe take it back earlier when we think they are stabilizing. We think losses are at a point now that you can price for but you have to be really good at this and really efficient. And if you are not efficient, which, that’s probably our biggest advantage, and you are not good at the credit risk side, this is a really tough environment for those competitors. Two years ago I think anybody could do it and now I would say, it's harder. But at the price that we are doing loans today, I think there are many people that couldn’t make any kind of return based just on cost structure and their analytics and their depth. So it feels pretty good right now but you can't do as many loans as you could do in other environments because there is just some credit that we can't price for.

[John Hecht:]

Okay. That’s helpful. And just to kind of go back to some of the questions about allowances. Just I am curious, can you tell us, maybe say a year ago, what your [accumulated] (ph) loss expectations were, say in maybe the '13 vintages? And has that [accumulated] (ph) loss expectation shifted in the past six months.

[Thomas Dundon:]

It's hard to do vintages because obviously we go kind of loan by loan and the actual vintages will shift. I would say in '13 we were buying more, we were probably more aggressive then we are today in terms of structure and price, because we think -- as we have mentioned, as you have come away from the '9, '10, '11 vintages and start having the loss rates go back up to kind of the higher end of the historical vintages, that it would be hard to call vintages because if you tighten credit a little bit in the face of rising competition, you are kind of offsetting two variables there. But in general, it feels like we are now seeing our vintages on a score by score basis stabilize. So we are not seeing significant deterioration like we felt on that '9, '10, '11 to today. Loan for loan, score for score, the loans perform worse today than they did then. But I would say over the last year, we started to see some stabilization.

[Operator:]

Your next question is from the line of J.R. Bizzell at Stephens Inc.

[J.R. Bizzell:]

Thanks guys for taking my questions. I know most of them have been asked but, I wanted to dig in a little more deeply, fairly meaningful uptick there on the 31 to 60 day delinquencies. Just wondering if you could kind of point to what you are attributing that to? I am guessing a little bit to do with portfolio mix.

[Thomas Dundon:]

Look, portfolio is a tough delinquency measure to talk about because, as you just said, mix changes. And as that older stuff rolls off, it had lower delinquencies and the newer stuff has higher delinquencies. But once again I think the loans we are originating are giving us the performance we are expecting and the yield we are expecting. So it's less I think about the delinquency and loss then it is about the net margin for us. And so because the loans are short and they turn where we are constantly readjusting our price, everyday, everyday, everday and there is less price adjustments today and less volatility today then maybe there was in the last year. And we hope that continues because it gets a little easier when things aren't changing as fast.

[J.R. Bizzell:]

Great. Thanks. And switching gears here. Your servicing portfolio continues to show nice expansion and progression. I am wondering if you could kind of update us around, how you all are thinking about growth rates as we move forward in this portfolio and kind of your thoughts on where we are at in the progression stage as opposed to kind of what you were thinking before.

[Thomas Dundon:]

Sure. So without getting into actual specifics I will say as a philosophy most of the prime, almost all the prime we are going to do is for Chrysler. And as a general rule, we believe that we should use our infrastructure and our efficiency to give the best deal we can to their customers so they can sell as many cars as possible. And because our servicing platform is efficient, we can do more volume and keep servicing fee income without regard as much to what margin we would like to have. So we look at that business more as we have to price at market to support our partner. Because we are not holding capital, it's more about volume, how much volume can you take, because our servicing platforms infinitely scalable we think. So it's a little different decision than should you do a subprime loan where your decisions, is can you make the proper return on equity and do you have enough spread for the volatility that’s inherent in subprime. On a prime loan that you are just going to service, that question is, what does it take to get that loan because we think that’s all about volume and scale.

[Operator:]

Your next is from the line of Charles Nabhan at Wells Fargo.

[Charles Nabhan:]

I wanted to ask about credit within the unsecured consumer loan book. Now given the trajectory of growth within that book and the difference in credit profile relative to the retail book which you indicated in Slide 20. Should we anticipate a similar pattern, seasonal pattern for losses in provision levels going into 2015?

[Thomas Dundon:]

For losses, yes. Provision levels, once again it's harder to know till it happens but...

[Jason Kulas:]

Although in that business it's a 12 month provision which takes some of the impact out. You sure have seasonal impact but not the double seasonal impact.

[Charles Nabhan:]

Okay. And as a follow-up, we have seen modest widening in spreads over the past couple of months along with some rate volatility. And I was wondering if you could talk about the impact, if any, that’s had on the market and perhaps specifically on funding cost.

[Thomas Dundon:]

Sure. I mean funding costs went up for a little while there. We think they go up less for us then they do for maybe the less established smaller competitor. But we are pricing to a return so funding or credit losses go up and our price goes up. And so we probably would prefer funding to be harder to get and more expensive for industry. We think part of the reason we have seen the deterioration in the loss rates the last couple of years is directly attributed to easy access to liquidity. But for us, we will always pass -- we will always pass on that cost up or down. So if our funding cost goes down then our cost to the end customer goes down and hopefully you get more loan. And then if it goes up, you pass it on and eventually the market will do that to and it shouldn’t have a big impact. But I really think the more volatile the capital markets, the higher the loss rates, the tougher it is for capital be attracted to this space and we do really well in those environments. The toughest environment for us when there is plenty of access and lots of capital and people think no one is ever going to take a loss. And the fact that this business is, the losses are inevitable, it's how you manage it and price it.

[Charles Nabhan:]

Okay. So in other words, it's fair to say that you ability to price, to pass on that pricing in a volatile environment is enhanced given some of the declines in competition that results from that volatility.

[Thomas Dundon:]

Yes. I think that's a much quicker, better way to say it then what I said.

[Operator:]

Our last question comes from David Ho at Deutsche Bank.

[David Ho:]

Thanks for the squeezing me in. Just one last question on the severity assumptions that maybe you guys are baking into your models. What kind of decline in used-car pricing vis-à-vis the market expectations are you kind of implying going forward and has that increased versus maybe a few months ago?

[Thomas Dundon:]

I would say the market is moving towards where we always sort of expected to be. And you could look at our take on used-car prices similar to our take on losses, is we try to look at history and look at sort of a higher and lower bound of loss rates and used-car prices and we tend to underwrite to those. And so when recoveries are higher, the difference between what we are projecting and where we are actually getting will be bigger. And as loss rates come down, the difference between where we project and where they are will be smaller. And I mean it's just sort of common sense, right. Things tend to end up close to their averages over time and we don't get too excited when they are really good, we don't get too excited when they are really bad. We actually think lower used-car prices is good for the market because the subprime customer, as cars have become -- this is little bit of a tangent -- but as cars have become safer and the cars have become better emissions and better gas mileage, they have become more expensive. Wage growth clearly has not moved up along with the cost of a car and therefore the used car is a substitute for many consumers to be able to afford reliable, safe transportation. And when that used-car is more expensive, it prices a lot of people out of the market or stresses their budget. And so used-cars coming down, bad for recoveries, great for originations. Used cars being high, great for recoveries bad for originations. So I think we have said this lots of times, we think because of the short nature of these assets, we are perfectly hedged in a lot of ways and we won't tend to maybe analyze it as closely mostly all do in terms of what's good or bad because it's all got pros and cons and our job is to deal with those changes in the environment to make good risk return decisions. And I keep trying to put out the point that that's what we think we do really well. But in terms of exactly what's going to happen tomorrow, probably we are less likely to have a strong take on that then we are what's going to happen over long periods of time.

[David Ho:]

Okay. That's helpful. And one more question on the lower gas prices. Based on your mix, and impact there?

[Thomas Dundon:]

Well, I think if customers have more dollars, it should be good. It's early to tell but I can't see much downside to low gas prices for us. As the lease book starts to mature, clearly there could be difference in recovery rates based on where gas prices are. But I would say, we wouldn’t spent a lot of time trying to figure out gas prices. We think it's just one off the issues within our business, wages, employment, gas prices, cost of funds, used-car prices competition. It's one of things in there that we that we just have to deal with but I wouldn’t expect to see major changes. We would have to be really really careful thinking. I remember back, I think it was '08, there was some period of time where there was huge volatility in gas prices and cars became super expensive and you couldn’t give a Suburban or a truck away and six months later that shifted. So we are not, we are probably not going to be in the business of worrying about that a whole lot. On the margin, lower gas prices are good for subprime customers though.

[Operator:]

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

[Thomas Dundon:]

Great. Thanks for joining the call today and for your interest in SCUSA. Our investor relations teams will be available for follow up questions and we look forward to speaking with you again next quarter. Thanks a lot.

[Operator:]

And this concludes today's conference call. You may now disconnect at this time.