Jay Putnam – Director, Investor Relations
David G. Hanna - Chairman of the Board & Chief Executive Officer
J. Paul Whitehead, III - Chief Financial Officer
CompuCredit Corporation (CCRT) Q3 2008 Earnings Call November 5, 2008 5:00 PM ET
Welcome to the third quarter 2008 CompuCredit earnings conference call. At this time all participants are in a listen only mode. (Operator Instructions) As a reminder this conference is being recorded for replay purposes. I would now like to the turn the presentation over to your host for today’s call, Mr. Jay Putnam, Director of Investor Relations.
Thanks for joining us for CompuCredit Corporation’s third quarter 2008 earnings call. Before we get started I’d like to remind you that some of our comments today will be forward-looking statements.
These forward-looking statements include all statements of our plans, beliefs or expectations of future results or developments such as the performance of our credit card receivables including receivables levels, net interest margin, other income ratio and charge-offs, acquisitions of portfolios from third parties, our plans to repurchase securities, growth and downsizing expectations for our business segments, expected timing and levels of expense reductions, our prospects generally, our marketing plan, plans for our micro-loans businesses, our liquidity levels and capital raising plans and general economic conditions.
For information regarding some of the more important factors that may cause actual results to differ materially from those reflected in the forward-looking statements that we make today you should read the Forward-Looking Information section and the Risk Factors in our Form 10-Q for the quarter ended September 30th, 2008.
Thanks again for your interest in CompuCredit. Please feel free to contact me if you ever have any questions you would like to discuss. You may also access our website to obtain a hard copy of the press release and our financial statements, to view our risk factors or to look into an archived version of this call. I’ll now turn it over to David Hanna, Chairman and CEO, of CompuCredit for his remarks.
David G. Hanna
I’ll take a few minutes to review our third quarter results and update everyone on recent developments within our company. J. Paul Whitehead, our CFO, also is here to discuss our financial results in greater detail. Today we reported a GAAP net loss of $32.3 million or $0.69 per share and a managed net loss of $33.7 million or $0.72 per share.
These results include a pre-tax non-cash impairment charge of $29.2 million we took during the quarter to write off goodwill within our auto finance segment. This goodwill write off reflects our third quarter refinancing of debt within that segment at pricing and advance rates that do not allow for returns sufficient enough for us to want to invest the capital necessary to achieve our acquisition date growth and profitability expectations.
While we’d obviously like to be growing our auto finance segment and our other businesses the continued dislocation of credit and capital markets prohibits it. Until we see improvements in the liquidity markets which we don’t expect anytime soon we’ll continue to operate very conservatively. By that I mean continuing to cut costs, reducing credit card marketing efforts and taking account management actions aimed at freeing up cash for our use in both deleveraging our business and taking advantage of any extraordinary distressed asset opportunities in the marketplace.
Some of our deleveraging is being imposed upon us by lenders who have reduced their advance rates upon our facility renewals which we saw not only in our September auto finance segment renewals as I already noted but also in a September renewal of one of our lower tier originated credit card receivables securitization facilities. Key to our success in this environment is meeting any lender imposed deleveraging requirements and balancing the cash necessary to meet those requirements against out desires to take advantage of extraordinary investment opportunities.
At current market prices among the more attractive investment opportunities that we see are repurchases of our convertible debt and stock. In the face of significant economic uncertainty and rising unemployment levels we believe our highest risk adjusted returns may be achieved by simply deleveraging our business through acquiring our convertible senior notes for a fraction of PAR value and by acquiring our stock at a fraction of its book value.
As we seek to balance our goal of taking advantage of extraordinary investment opportunities in currently dislocated markets against ensuring that we have sufficient liquidity to meet lender imposed deleveraging we note that when we amended our lower tier credit card receivables securitization facility in September we were able to obtain an extension of that facility and lock in pricing and advance rate levels through October, 2010.
Accordingly we expect to be able to operate under the terms and existing advance rates of all of our financing and securitization facilities without the need for renewals or extension of any material facilities until September, 2009 which is when our auto finance segment facilities come up for renewal. After that our earliest material credit care facility renewal date if January of 2010.
These factors lead to us to the expectations of being able to use the cash flows that we can generate over the next several months for extraordinary investment opportunities rather than for meeting lender imposed deleveraging requirements. We know we have to be conservative and have to be prepared for the unexpected. Beyond the debt and stock repurchase investment opportunities that I previously mentioned are potential opportunities for us to participate in distressed asset transactions.
There has been significant dislocation and devaluation of financial assets in the marketplace and we believe there are literally billions of dollars of credit card assets held by financial institutions that fall right within our wheelhouse. We have a particular expertise in working with the financially underserved or subprime consumer and believe the intellectual property that we have in this area will allow us to participate either in low capital intensive ways merely as a servicer for example or as both a servicer and a financial partner or investor.
For example particularly in instances where portfolio sellers who already have balance sheet exposure may be willing to finance the sale of their distressed assets. Although credit currently is severely constrained in the markets generally and for subprime lenders like CompuCredit specifically we believe our business model is one that ultimately will attract the funding that we desire for future organic growth although we do not know when this will occur or the sources from which our future funding will come.
We are not optimistic that we will be able to obtain growth capital from the more traditional securitization markets but with the ever improving competitive landscape as many lenders in our space have pulled out permanently from our markets there will be opportunities for attractive returns and we all know that wherever there are attractive returns there are investors who seek to put their capital to work earning them.
While the entire investment market has been somewhat frozen during these unprecedented times we believe over the coming months available capital will be seeking attractive areas to invest. We continue to monitor our credit trends very closely and delinquencies have been in line with our expectations. Sixty plus day delinquent receivables were 13.1% of our portfolio at September 30, 2008 which is a very acceptable number for us.
This is up from 12.6% at the end of last quarter but lower than at the end of last year’s third quarter when it was 14.6%. Though we have seen some reduction in payment rates that we believe is in part attributable to recently elevated gasoline prices we believe that the recent decline in gas prices is a very favorable development for our customers and their ability to make timely payments.
On the other hand the prospect for higher unemployment levels for our customer base is a potential negative factor for our future payment, delinquency and charge off rates. Our adjusted charge off rate fell 500 basis points from 19.2% last quarter to 14.2% in the third quarter. As we have talked about at great length in our last couple of conference calls our charge off rates in the first and second quarters of this year were significantly impacted by our marketing pull back immediately after the close of record growth in originations in the second and third quarters of last year.
As expected a significant number of credit card accounts added in 2007 reached their peak vintage charge off levels in the first and second quarters of this year. With this marketing volume based volatility behind us we have seen charge off and delinquency statistics normalize and return to more traditional seasonal patterns and levels.
Let me now quickly touch on our regulatory situation within our credit cards business. As you know we are involved in litigation with the FTC and the FDIC regarding some of our prior marketing programs. As we have stated many times in the past we believe that our marketing materials fully complied with all applicable laws. However we were and are prepared to settle the dispute in order to get a costly legal situation behind us.
At the same time if necessary we are prepared to continue vigorously contesting assertions made by the FTC and the FDIC. Turning to our other segments our Jefferson Capital charge off debt buying subsidiary posted a $717,000 pre-tax loss in the third quarter which is significantly lower than this segment’s $9 million pre-tax profit posted in last year’s third quarter. You may recall that Jefferson Capital has a long-term forward flow arrangement with Encore Capital.
Citing allegations made by the FTC Encore has refused since July of this year to purchase charged off receivables under this agreement and to provide leads for Jefferson Capital’s balance transfer and Chapter 13 bankruptcy programs under the agreement. We are in the process of arbitrating these disputes with Encore and these disputes have caused Jefferson Capital to experience significantly adverse operating results over the past few quarters.
We also expect Jefferson Capital’s future operating results to continue to suffer until these matters are favorably resolved. There are two main contributors to Jefferson Capital’s diminished performance based on the Encore disputes. First, as we explained in last quarter’s call Encore agreed to pay a fixed price for our charge offs under its forward flow contract with Jefferson Capital.
Given that we negotiated the arrangement in 2005 when charge offs were in low supply this agreed to fixed price is appreciably higher than the pricing in today’s markets. Second, Jefferson Capital uses a cost recovery method of accounting to recognize income, a method that the FTC required it to adopt and under which it must book collections expenses and commissions currently while deferring all revenue recognition on each portfolio purchase until it has fully recovered its basis or purchase price in each purchase.
Until the Encore dispute arose this year Jefferson Capital sold charge offs to Encore almost simultaneously with their acquisitions rather than retaining them on its balance sheet. Because of the nearly simultaneous nature of these transactions the segment had not previously experienced any substantial mismatch between the timing of its collection expense and the correction of revenues under its cost recovery method of accounting.
With Jefferson Capital now being forced to retain all of its purchases and either collect them or sell them to others Jefferson Capital is experiencing severe mismatches between its accelerated expense recognition and its deferred revenue recognition. Although Jefferson Capital has experienced continued growth and profitability under its Chapter 13 bankruptcy and balance transfer programs the success of these programs is masked by the cost recovery method expense and revenue mismatches associated with the charge off receivables that we must now purchase and hold given Encore’s refusal to purchase them.
Through arbitration proceedings we hope to be able to compel Encore to perform under the forward flow contract and to be able to recover damages from Encore for its prior failures to meet its purchase obligations under the contract. Moving to our retail micro-loan segment our storefronts experienced a $33,000 pre-tax GAAP loss from continued operations for the third quarter.
Back in the fourth quarter of last year we announced our decision to pursue a sale of our retail micro-lending operations in six states. Through a series of staged sales to third parties and store closings through the end of the third quarter we have now exited all of the operations that we desired to exit within those six states and we now operate 354 storefronts within 10 states and the UK.
Our third quarter results in this segment were disrupted by an event in our largest state, Ohio, where we currently have 90 locations. Ohio enacted legislation restricting cash advance lending models in the second quarter of 2008 causing us to significantly pull back our lending activities in that state. However with the comfort of our August receipt of regulatory approvals for our alternative lending products in Ohio we returned to marketing cash advance loans to new and inactive customers in the latter half of the third quarter.
We now are seeing a gradual return to the volumes necessary in Ohio to generate profits in that state and despite yesterday’s vote not to overturn legislation adverse to the economics of traditional micro-loan cash advance products we expect to recover from the brief interruption in our Ohio activities through our approved alternative lending arrangements.
We also expect to pick up in consumer demand for micro-loans generally in the fourth quarter now that the adverse affects of tax stimulus payments on demand have subsided and as more consumers may have needs for short-term loans in the current economic environment. Moreover we have launched an Internet lead generation program that has shown early signs of increasing foot traffic within our stores.
Finally the fourth quarter is typically strong given the seasonal effects and should help us build momentum for this business to increase in revenues and profitability in 2009. But for the $29.2 million goodwill charge that I previously discussed our auto finance segment would have experienced a modest pre-tax loss of only $1.3 million in the third quarter.
We have been improving our auto platform over the last tree years and believe it could be very profitable with scale. Unfortunately given the challenges in the capital markets we are prohibited from growing it even though competition has dried up and we are commanding our highest yields to date in this segment. Absent attractive funding we expect our auto finance receivables to decline in the next few quarters.
Nevertheless we view our auto platforms a fairly low cost option to take advantage of high return opportunities in this space when funding again becomes available. Turning now to our final segment or our other segment is comprised of our UK based online micro-loans provider called [monthly end] money, or MEM. This segment posted a $1.2 million pre-tax GAAP profit from continuing operations and grew its to net loans to $15 million.
The business remains attractive to us in the current environment as it features small loan sizes and quick repayments so it is not as capital intensive as credit card or auto lending. We expect continued modest loan and profitability growth from this segment over the next few quarters. To summarize the themes we would want you to take away from our call today we are working hard to strengthen our liquidity position and preserve to the greatest extent possible in this unprecedented economic environment the book value of over $14 per share that we have built over the last 12 years.
Notwithstanding the adverse affects of the current capital markets on our advance rates and the potential for further credit tightening by our lenders and investors of the coming quarters we believe we are positioning ourselves to take advantage of the extraordinary investment opportunities that we believe exist in today’s dislocated markets whether in the form of opportunities to profitably deleverage by repurchasing our discounted convertible bonds or opportunities to repurchase our stock at a significant discount to book value or opportunities to participate in the economics of distressed financial assets available in the marketplace.
Thanks again for joining us this afternoon and for your interest in CompuCredit. I’ll now turn the call over to J. Paul for further details on our financial performance.
J. Paul Whitehead
To recap our results we reported a GAAP loss from continuing operations of $31 million for the quarter or $.066 per share compared to last year’s third quarter loss from continuing operations of $48 million or $0.99 per share. We also reported a managed loss from continuing operations of $32.8 million or $0.70 per share compared to managed net income of $50.1 million or $1.02 per share in the third quarter of last year.
Both our GAAP and managed numbers for the third quarter are net of a $29.2 million pre-tax goodwill write off in our auto finance segment which had an after-tax effect of $0.38 per share for GAAP and $0.40 per share for managed the slight difference being attributable to different effective tax rates under the two systems.
Our adjusted net charge off rate was 14.2% in the third quarter down 500 basis points from the 19.2% we reported in the second quarter of this year and up from the 10% we reported in the third quarter of last year. David mentioned the improvement in our quarter-over-quarter charge off rate due to the record level of credit card accounts we added in mid-2007 that reached peak charge off vintage levels during the first half of this year.
I might also add that the increase in our third quarter adjusted charge off ratio versus the third quarter of last year principally reflects an atypical depression of last year’s third quarter ratio due to the discounted purchase of our UK credit card portfolio acquisition in the second quarter of last year and due to the denominator effect in last year’s third quarter of our booking the record $1.5 million credit card accounts added in the second and third quarters of last year.
The balances of these accounts would have been current in last year’s third quarter thereby significantly increasing the adjusted charge off ratio of managed receivables denominator with little or no affect on charge offs in the numerator of the ratio. As we move forward with our currently planned efforts to generate cash through account management actions and by curtailing credit card marketing we will see a gradual contraction of our managed receivables levels for the foreseeable future and more normalized delinquency charge off and other ratios.
The marketing volume based volatility that significantly affected our various ratios over the past several quarters is substantially behind us and unless and until we acquire discounted portfolios or resume marketing at significant levels our various ratios should be more predictable and less volatile from quarter to quarter. Reflecting this phenomenon we expect our fourth quarter charge off ratios to be similar to our third quarter ratios.
Perhaps surprisingly to some of this environment at the vintage level we are not seeing significant degradation of performance. We have seen some reduction in payment rates, modestly higher roll rates for late stage delinquencies and trending increases in bankruptcies over the past several quarters but our early stage delinquency rates and roll rates are relatively stable perhaps reflecting the beneficial effects of the recent fall in gasoline prices.
Our 60 plus day delinquency rate was 13.1% at quarter end up just 50 basis points from the enc of the second quarter and tracking within expectations when accounting for seasonal affects. Our net interest margin climbed to 15.1% for the third quarter compared to 12.9% in the second quarter and 18.7% in the third quarter of last year. Similarly our other income ratio was 11.3% in the third quarter up significantly from last quarter’s 6.1% rate but lower than last year’s third quarter ratio of 16.7%.
The gain in the other income ratio over this year’s second quarter is even more pronounced when considering that this year’s second quarter ratio included the affects of a $28.4 million pre-tax gain we recognized in that quarter on repurchases of our convertible bonds. Lower interest and fee charge offs were the major drivers of the improvement in our net interest margin and our other income ratio between the second and third quarter.
We do not anticipate of these ratios to last year’s level however as last year’s ratios all benefited from significant late fee, over limit and other fee assessments on a portfolio which is rapidly growing at record growth rates and which at the time had not reached charge off stages. Turning to our expenses our third quarter operating ratio was 16.4% which included the $29.2 million goodwill impairment charge within our auto finance segment.
Without that impairment charge our operating ratio would have been 13.1% a reduction over both last quarter’s 13.9% operating ratio and last year’s third quarter ratio of 13.3%. We have been working diligently and will continue to do so in aligning our cost structure with expectations of contractions in the level of our managed receivables for the foreseeable future.
As long as the capital markets and specifically securitization markets remain effectively closed to growth financing under attractive terms and pricing we will continue to analyze and implement additional cost cutting initiatives. While we do have a certain level of fixed costs needed to run our operations a large portion of our operating costs are variable with the amount of assets we service and acquisition opportunities we pursue.
We have discussed various managed income and expenses that are largely the same within both GAAP and managed earnings measurement systems. Overall we saw GAAP and managed results more aligned in the third quarter than in the past several periods. As in portfolio acquisitions and significant marketing levels and fluctuations in those levels and with anticipated gradual contractions in our managed receivables levels not only would we expect less volatility in our various managed receivables ratios as I previously noted but we should also expect less volatility in our GAAP results and less material deviations between our GAAP and managed results.
Such was the case in the third quarter. Our various fair value determinations under GAAP generally should be easier and less variable in a more stable liquidating portfolio environment and credit quality being equal we would expect to experience modest levels of quarterly loan loss reserve release under GAAP that will not affect our managed results.
Summarizing again for your liquidity position we expect our cash position and our anticipated cash flows generated from the business should allow us to continue to meet all of our obligations and provide us with some dry capital for opportunities such as the ones we previously discussed. Notwithstanding the changes in terms and reductions in advance rates we were very pleased to have renewed our two auto finance segment debt facilities for another year and to have extended our key lower tier credit card securitization facilities until October, 2010.
These September renewals were important to us in that we now expect to be able to operate with stability in our advance rates under all of our material debt and securitization facilities for the next year. Reiterating what David said about our liquidity plan we continue to take account management actions within our receivables portfolios in an effort to generate positive cash flows that we can use either to deleverage our balance sheet ideally in a very profitable way by repurchasing our heavily discounted convertible bonds or to reinvest in share repurchases at significant discounts to book value or in extraordinary opportunities to take advantage of market dislocations in the pricing of distressed portfolios.
Although managing to generate positive cash flows represents short-term earnings sacrifices this is the only prudent course of action in the current environment and we remain focused on preserving as much as we can of the $14.82 book value per share that we have worked so hard to create over the years.
We believe the long-term future for CompuCredit is a positive one and we are doing everything that we can to position ourselves to take advantage of all of the opportunities that are certain to arise both during and after this cycle. I invite you to review our Form 10-Q that we filed this afternoon.
It provides much greater insight into the performance trends of our receivables and a more in depth discussion of our results. I’ll close now by thanking you all for your interest in CompuCredit and for your participation in our call today.
Thank you for your participation. This concludes the third quarter 2008 CompuCredit earnings conference. You may now disconnect.
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