Advanta Corp., Q4 2008 Earnings Call Transcript

Advanta Corp. (ADVNB)

Q4 2008 Earnings Call

January 29, 2009, 9:00 am ET

Executives

Amy Holderer - VP, IR

Dennis Alter - Chairman and CEO

Phil Browne - CFO

Bill Rosoff - President

Analysts

Christopher Brendler - Stifel Nicolaus

Michael Cowen - Herald Hath Capital

Doug Campbell - Spirit Capital

Sameer Gokhale - KBW

Michael Stern - Stonehill

Presentation

Operator

Good day and welcome to the Advanta 2008 Fourth Quarter Earnings Call. Today's conference is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Ms. Amy Holderer. Please go ahead Ma'am.

Amy Holderer

Thank you. Good morning everyone and welcome to our call. Joining me today are Dennis Alter, Chairman and CEO; Bill Rosoff, President; and Phil Browne, CFO. During our call this morning Dennis, Bill and Phil will first share comments regarding our fourth quarter and full-year results and will then move into our question-and-answer session. (Operator Instructions).

I would like to remind you that some of our comments today are forward-looking and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that forward-looking statements involve risks and uncertainties which may affect the Company's business and prospects, including economic, environmental, competitive, governmental, technological, social, political, and other factors discussed in the Company's press releases, as well as in the Company's 10-K, 10-Q and other documents filed with the Securities and Exchange Commission.

In addition, our discussion will include the use of managed receivable data and other non-GAAP financial measures. Our press releases and statistical supplements are available at our website, advanta.com, in the 'Corporate Info' section. These documents provide a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures and a description of why we believe the non-GAAP financial measures are useful to investors.

Now I will turn the call over to Dennis.

Dennis Alter

Good morning. Thanks for joining us. As we all know these were exceptionally difficult times for both users of credit and those who grant it with no short-term end in sight. Fourth quarter earnings reports across the financial sector have been very poor and our operating results are as well.

We believe we helped position our selves to these times in two or three crucial areas. Through this last year of challenging economic events, we've increased our cash and liquid investments to $2.6 billion at year end or 53% of owned and securitized receivables. And we have very strong capital levels.

We added one half of the $1 billion of deposits in fourth quarter and our main operating subsidiary, Advanta Bank Corp.'s total risk base and Tier 1 capital ratios, increased to 38.4% and 35.4% respectively.

Contrary to some outside speculation, we do not foresee our cash being drained away by early amortization of our securitized master trust. This is because of the facts and the structure of the trust, as Phil will discuss later.

And we are taking other very significant steps which I'll outline in a minute, to further respond to the deteriorating financial and economic landscape.

First, the specifics of the operating results. In the fourth quarter we had a net loss of about $47 million or $1.16 per diluted share for Class A and Class B shares combined. For the full year our net loss was $1.08 per share.

Our managed net credit losses increased to 12% this quarter and our 30 day plus and 90 day plus managed delinquency rates increased to 9.5% and 4.2% respectively.

We believe deterioration tends to cluster in bad months. This is typical in the fourth quarter. Although our credit performance measures have been greatly influenced by the recession our trends are also impacted by two other significant factors. These include the seasoning of large recently originated vintages and the impact of declining managed receivables that create a lower base on which to calculate the percentages or the dominator effect.

I encourage you to take a look at our lagged credit metric as well as the coincidence rates to get an additional view of our loss and delinquency performance. Our managed receivables continued to decline as we have intentionally been acquiring fewer new customers each quarter.

As a result of this coupled with lower customer spending and higher charge-offs and payments, the overall managed receivable balance was $5 billion at year-end, down about 20% from the year earlier.

In addition, to maintaining our high levels of cash and capital, we are taking two more steps to help our business. First, our Board of Directors has approved a reduction in our dividend rate for both Class A and Class B shares. These new rates will apply to our next dividend declaration.

The Class A quarterly dividend rate has been reduced from.17.71 cents1 to $0.02, and the Class B dividend rate has been reduced from $21.25 to $2.05. These reductions will further preserve capital and cash.

And second, we will be reducing our operating expenses in a very substantial way. We are restructuring the organization to be more efficient and reducing staffing levels beyond those previously announced that were related to our offshore initiative.

As a result of this, we expect to have about 300 fewer Advanta employees and therefore will be staffed at a level more commensurate with our anticipated portfolio size and the scale of our business activities we anticipate in '09. In '09 we will be slowing our acquisition marketing efforts and focusing on building value from our existing customer base, particularly our higher value customers.

We expect '09 operating expenses to be roughly 20% to 25% lower than those reported in '08. We believe these actions are appropriate in these difficult times, and we will implement them swiftly.

Now I would like to turn this call over to Phil. Phil?

Phil Browne

Thanks Dennis. There are four areas I would like to focus on this morning. These include business card yields, balance sheet charges and reserve build, our Master Trust performance and consolidated capital and liquidity.

Our managed net yield extended nicely again for the six consecutive quarter to 12.45%, consistent with what we discussed last quarter, we have increased the average rate of interest that we charge our customers in response to the worsening risk profile of many customers in our portfolio. And as a result our yield has widened.

If it was not for the additional cost of higher liquidity in the quarter, we would have seen even more expansion in our net yield. As you read in our press release this morning, we had sizable charges related to our retained interest and securitization and growth in our allowance for loan loss reserves.

Consistent with the environment and widening of market credit spreads, we recorded a $36.4 million write-down on our retained interest and securitizations. About two-thirds of this related to increasing the discounts on the subordinated trust assets that we own in our cash collateral accounts or outstanding securitization.

The other portion of the write-down related to lower net cash flows projected due primarily to credit trends. The estimated fair value for retained interest in securitizations of $126 million at quarter end is net of the total discount of about $60 million.

We also took in $11.4 million charge in the quarter to increase our allowance for credit losses on principle receivables. At the end of the year, our allowance for receivable losses totaled to $102.7 million and was 20.3% of owned receivables.

Moving onto our Master Trust, over the past three months, although we have had increased charge-offs and delinquencies, we also had increasing revenues and lower borrowing rates. As a result, our three months average excess spread has increased from last quarter to 5.7%.

During the course of 2008, we said that we didn’t expect the net cash trapping credits in 2008 and we didn’t. Cash trapping would occur if the three months average excess spread in the trust dropped below 4.5%.

As you know, we are not giving forward-looking guidance for 2009. However, there is a possibility of cash trapping although the effect on our liquidity would be small.

Let me explain. If we trapped cash, the balance in the trust cash collateral account will need to increase by some percentage of the dollar value of outstanding bonds in the trust. This would be funded with future excess spread dollars which would otherwise come back to us. So, for example, if the three months average excess spread falls between 4% and 4.5%, we have to increase our cash collateral account by an additional 1% of outstanding bonds or in the $40 million range. If instead, our three month average excess spread would fall to between 2% and 3%. We have increased our cash collateral account by 3%, we are in the $120 million range.

These dollar amount are a small percentage when compared to our available liquidity. The amount of trapped cash would then decline as the amount of outstanding bonds decline. These funds would also be released in the trust excess spread levels improve in future period, restoring the trapped cash fill up.

The securitization trust also calls for early amortization of the trust bond, if the three months average excess spread drops below zero. As Dennis referenced, there has been some outside speculation recently about this possibility.

Last week, we filed an 8-K where we said the early amortization for our Master Trust is avoidable and we don’t expect it to occur. Here is why we believe this. We have tools available to increase revenues such as customer balance reprising, spent stimulation programs and the increased opportunities.

We also have tools to enable us to shift the timing of cash flows that would come from action such as changing the timing of collection settlement offers.

In addition to these positive items, we also have securitization structuring alternatives available. For example, we could establish a yield supplement account using parent cash. We could sell it at discount, or contribute cash receipts from our receivables to the trust. These items would add more cash flow to the trust. This type of structuring is very powerful.

Finally, we are also under no obligation to fund any receivables on our balance sheet and we are free to do so for the accounts we choose and to the degree we choose.

On the liquidity front, I think the fourth quarter is in excellent demonstration of our capabilities to maintain and enhance our strong liquidity position. Our cash and liquid investment at quarter end was as we said $2.6 billion. This is up about $800 million since last quarter with as Dennis indicated roughly $500 million being fueled by an increase in deposits.

Although, carrying this level of liquidity come to the price we believe the security and flexibility provides in this economy is worth of cost. We also continue to maintain high level to capital. At a consolidated level equity and sub debt for trust preferred securities together were 12.2% of managed receivable.

Again as Dennis mentioned the Advanta Bank Corp. total risk-based capital and Tier 1 capital levels are exceptionally high and increased from last quarter also.

Now I would like to turn the call over to Phil.

Phil Browne

Thanks Bill. Tough times call for being prepared and taking tough actions. We are prepared to help. We are taking more tough actions now to strengthen ourselves even further. We foresee short-term unpleasantness for long-term opportunity.

Now let's get to your questions.

Amy Holderer

(Operator Instructions). We would like you to ask only one question at the time and limit the length of it to be we sure to be responsive to whats on your mind. If after management's response you have additional questions or follow-ups, please re-enter the queue. Operator, we will take the first question now.

Question-and-Answer Session

Operator

Definitely Ma'am. (Operator Instructions). We will take our first question from Chris Brendler from Stifel Nicolaus.

Christopher Brendler - Stifel Nicolaus

Hi, good morning. I'm sorry I joined late. I missed most of your part of your margins. I just wanted to see if you haven't addressed it, anything you can say about the trust, how do you expect to try to improve the performance of the trust as you head into the higher losses? Typically you could address the strategies that might be used to protect yourself from the drop in LIBOR of your account or price offer as well as any strategies related to selling discounted receivable’s in the trust if that’s an option for you. Thanks

Dennis Alter

Chris, I'm sorry that you missed the call, but we really already addressed, all those items point-by-point in the call. So, you can listen in certainly as usual you know Amy and I will be available after the call. But we really addressed all those items in our prepared remarks.

Operator

Our next question will come from Michael Cowen with Herald Hath Capital.

Michael Cowen - Herald Hath Capital

Hi, I was wondering if you could address some of the commentary you had with your regulators and how they are feeling about your capital position, your sort of business plan for the next year. I guess, that would be the matter that would of most concern to investors?

Phil Browne

It is, Phil. Unfortunately, it’s a crime for us to discuss with you what the regulators discuss with us. But I would say that we feel very good in all those regards.

Operator

(Operator Instructions) We'll move on to Doug Campbell with Spirit Capital.

Doug Campbell - Spirit Capital

Thanks very much. These are tough times as you've point out, and with your prime position for long term opportunity, could you talk a little bit about what you think the role would be over time of a small very specialize financial intermediary such as Advanta. And do you see potential niches opening up that you could exploit once this more difficult time begins abate or will things be sort of business as usual among the various players in this space.

Dennis Alter

Doug, this is Dennis. I think there is opportunity. And if we look to the recent past the years '01, '02, '03 through '06 and into '07 we were a much smaller company than we are now even though we are small compared to most against whom we compete. But we had receivables of 1, 2 3, $4 billion and were profitable and had a robust business and a growing business and while we grew into those levels and now we’re perhaps shrinking into those levels. There is still a business to be had. Not everyone gets all of the business, our largest competitors themselves are in turmoil, the Citi's and the BofA’s. Perhaps they loose focus a bit. So I believe there is always room for smaller players, being agile and moving around the larger competitors. And we’ll be a smaller level of receivables in customers. We have before and we were profitable before and we look forward to that again.

Operator

And we’ll take our next question from Brandon Schehe with KBW.

Sameer Gokhale - KBW

Hi, is there actually Sameer Gokhale. Phil, you talked about structuring alternatives in your trust to help avode early amortization and I don’t think I caught all of that discussion, I think you talked about some sort of yield supplements. If you wouldn't mind just explaining that I didn't catch exactly how you're going to transfer cash in to the trust to boost the yield and then also how much of, based on your current cash balance, how much of a benefit to the excess spread, could you have from those structuring alternatives. Is it 3, 4, 500 basis points, any sense about that? Thank you.

Phil Browne

The two items I mentioned were a yield supplement count. It's a mechanic that is recognized in the industry. In fact many many years ago we used it in the consumer card business here. And the other was selling it at discount or contributing receipts from our parent funded receivable portfolio that’s about $100 million or so. So both of those items are very sizable and as I mentioned provide a real lot of support to the trust that would be order of magnitude very large. It is somewhat mechanical if you want to get into the particulars of the mechanics, yes we could do that on a separate call but that's in essence what they are. As I mentioned I think, structures that people who are in any industry would be familiar with.

Operator

(Operator Instructions) Let's take a follow-up from Michael Cowen with Herald Hath Capital.

Michael Cowen - Herald Hath Capital

Hi, what is the size of your Visa and MasterCard holding at this point?

Phil Browne

We have no further MasterCard on shares, we have about 500,000 of Visa shares.

Operator

(Operator Instructions) And we will take the next question from Brandon Schehe with KBW.

Sameer Gokhale - KBW

Yeah, hi this is Sameer Gokhale again. Phil, can you just go over how much cash the company currently has at the,parent. And remind us again what you have in terms of debt maturities on your notes coming up for the next 12 months and then the following year, thank you.

Phil Browne

We're put out a full-on parent company balance sheet in the 10-K's as we do once a year, you'll see the cash balance in that balance sheet. It will be about what it was last year which was in the $150 million range give or take. So that's were we are. On the note maturities, I don’t have that front of mind, it is a retail book that has everything from small portion of balances on demand to at origination 1 to 10 year, 1 to 10 year regional term. So it later out, turns over like a typical retail portfolio or almost like a CD portfolio.

Obviously this is uninsured turns over. And again we can get into the Q and last year's K and I think back into the particulars of your question but a decent amount is in the next 12 months, which again is typical of the retailers type liability portfolio.

Operator

And we do have one question left in the queue, I’m sorry we have a few other. Doug Campbell from Spirit Capital.

Doug Campbell - Spirit Capital

Thanks. You mentioned you are scaling back your customer acquisition activities in order to focus efforts on more high value existing customers. Can you characterize how much you know about these customers, what proportion in general are in the high value category, and what kind of a base that would represent going forward if you were to over sometime reduce the business to those customers, and beyond that of course even well run small businesses are subject to attrition for all sorts of reasons.

Bill Rosoff

This is, Bill. We have a sizable group of customers who have very little attrition or have a lot of transactions and are very profitable. With those characteristics and a lot of others that are very profitable.

And I think Dennis's in his remark referred to trying to build more with them as well as other profitable customers. And we think it would be sizable and highly profitable. And it's definitely worth focusing.

Operator

And our next question comes from Michael Stern with Stonehill.

Michael Stern - Stonehill

Hi, guys, a couple of quick questions. First, with respect to the term asset lending facilities that Fed has talked about, and I think not yet fully implemented. It seems like the AAA securities that you guys issue out of your trust would be prime candidates for that, I wonder if you could talk about that a little bit. How you think it might work for you. If it might work for you, and what barriers, if any specific to Advana will be to accessing it?

Second, it just looks like there was a shift from the cash being largely held, or the excess liquidity being marginally held in Fed Funds to being largely held in deposits, so I wonder if you could talk about that a little bit.

And then finally on the yield management things, you talked about, Phil, just wanted to make sure I understood correctly that the cash or receivables from that would have to come out of on balance sheet receivables held at the holding company and not on balance sheet receivables or cash in the bank? Thanks.

Phil Browne

Yeah, I'll try to respond to this but that’s why we ask you one question at a time, none of us don't know how to take short hand here. We are looking at all the proposals that are out there and they are flying around all the time that provide, may provide flexibility assistance if you will for the banking sector from funding perspectives.

Right now our attitude has very much been don’t depend on anything except our own balance sheet which is why we had and have had throughout the year as this environment continued to be weak, increased our cash position and our deposits, because that’s something we can point to and clearly rely on.

But we'll continue studying other options as they developed. I think on your second question, it went to on the structural items we talked about for the trust and receivables, the receipts on the receivables or the contributions on those receipts that are selling at a discount would be from the parent company. That was correct. I apologize if there was another question but that’s what I got..

Operator

And we have no further questions at this time.

Amy Holderer

Why don't we just wait for a minute, and while we are doing that I'll remind you that a recording of today's call will be available on the Internet beginning this morning around 11 o'clock Eastern Time at our website advanta.com or investorcalendar.com.

If there is any other questions we'll take them otherwise we'll wrap up.

Operator

(Operator Instructions). We’ll take a follow-up from Michael Stern from Stonehill.

Michael Stern - Stonehill

I had the advantage of having them written down in front of me.

Phil Browne

No problem.

Michael Stern - Stonehill

Just the last one, it looks like the excess liquidity moved from Fed Funds sold to deposits, the big numbers and also somewhat with securities and just could you talk about, what the components to that were and what the decision making around that was? And if there are concentrations, I guess, as well with deposits?

Dennis Alter

The only concentration we really had things lie is with the Federal Reserve Bank. We aren leaving more of our money, overnight, deposited with the Federal Reserve. Depending on the small basis points shifts, we try to take advantage of it we moved a little bit more in treasuries. So, very risk averse, varied liquid portfolio with the principle shifts that we had from the prior quarters as per your question was.

Operator

And Miss. Holderer, we have no further questions at this time.

Amy Holderer

Okay, well, I would like to thank everyone for participating in today’s conference call. And if you have any further questions, I can be reached at 215-444-5335. Have a good day.

Operator

Ladies and gentlemen that does conclude today's conference. Thank you for your participation and have a wonderful day.

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