Santander Consumer USA Holdings' (SC) CEO Jason Kulas on Q4 2015 Results - Earnings Call Transcript

| About: Santander Consumer (SC)

Executives

Kristina Carbonneau - Manager, Investor Relations

Jason Kulas - Chief Executive Officer, Director

Jennifer Davis - Deputy Chief Financial Officer

Analysts

Matthew Howlett - UBS

J.R. Bizzell - Stephens, Inc.

Vincent Caintic - Macquarie

John Hecht - Jefferies

Cheryl Pate - Morgan Stanley

Charles Nabon - Wells Fargo

David Ho - Deutsche Bank

Jason Arnold - RBC Capital Markets

Mark DeVries - Barclays

David Scharf - JMP

Eric Beardsley - Goldman Sachs

Operator

Good morning and welcome to the Santander Consumer USA Holdings fourth quarter 2015 earnings conference call. At this time, all participants are in a listen-only mode. Following today's presentation, the floor will be opened for your questions. [Operator Instructions].

It is now my pleasure to introduce your host, Kristina Carbonneau from the SC Investor Relations Team. Kristina, the floor is yours.

Kristina Carbonneau

Good morning and thank you for joining the call. On the call today we have Jason Kulas, Chief Executive Officer and Jennifer Davis, Deputy Chief Financial Officer. We also want to welcome our new CFO, Izzy Dawood.

Before we begin, as you are aware, certain statements made today such as projections for SC's future performance are forward-looking statements. Actual results may be materially different from those projected. SC has no obligation to update the information presented on this call. For further information concerning factors that could cause these results to differ, please refer to our public SEC filings.

Also on today's call, our speakers may reference certain non-GAAP financial measures that we believe will provide useful information for investors. A reconciliation of those measures to U.S. GAAP is included in the earnings release issued today, January 27, 2016. 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 website.

Now, I will turn the call over to Jason Kulas. Jason?

Jason Kulas

Thank you and good morning, everyone. Today I will discuss our full year highlights and key strategic priorities. I will then turn the discussion over to Jennifer for a detailed review of the quarter's results and then open-up the call for questions.

Turning to slide five. Our strategy continues to produce strong results. Total net income for the year was a record $866 million, up 13% versus reported 2014 net income and up 3% versus 2014 core net income. Full year auto originations grew 6% versus prior year to $28 billion and $17 billion of these originations were generated from our growing Chrysler Capital platform. Total auto asset sales for the year were more than $9 billion, up 31% from 2014, driven by strong market demand for our assets.

Excluding lower of cost or market or LOCM adjustments related to certain asset sales, credit performance in the auto book for 2015 remained relatively stable versus the prior year as we remain selective in the loans we bring on to our platform. The adjusted full year net charge-off ratio for retail installment contracts increased marginally to 7% versus 6.9% in 2014 on a lower credit quality and higher-margin book of business. While there continues to be overall credit concerns, current industry dynamics demonstrate strong auto sales and continue to quote on recovery values for used vehicles.

Auto industry ABS net loss rates remain stable, but delinquency rates are at slightly elevated levels relative to several years ago. We continue to monitor the performance of our portfolio and are committed to disciplined underwriting practices as the industry and economy shift. We are committed to continuing to deliver value through our focused business model including expanding the reach of our vehicle finance business and creating opportunities for our service for others platform while also diversifying our funding sources and growing capital.

Moving to slide nine. Chrysler Capital remains a focal point of our strategy and this year we have made significant progress in realizing the full value of this relationship. During the fourth quarter we partnered with Fiat Chrysler or FCA to rollout two new pilot programs, including a rewards program to improve dealer relations and an additional subvention program. The Chrysler Capital penetration rate for December 2015 was 29%, up from 27% in December 2014.

Turning to slide 10. I will break down our $28 billion in auto originations, including $11 billion from our core nonprime platform. We also originated more than $11 billion in Chrysler Capital loans with an approximately even share between prime and nonprime originations, as well as more than $5 billion in Chrysler Capital leases. We look forward to continuing to build our relationship with FCA and are pleased with the results we have seen.

As shown on slide 11, we remain determined to deliver value through our service for others platform, another pillar of our strategy which increased 47% versus the prior year to $15 billion. Servicing fee income totaled $131 million this year, up 81% versus prior year. Over time, we believe this scalable and capital efficient strategy will be an even more meaningful contributor to returns. We will continue to optimize the mix of assets we keep on our books versus those we sell and service for others.

As you can see on slide 12, in 2015 we took further steps to improve our liquidity position. Through the relaunch of the DRIVE platform in March, we were able to continue to expand our investor base. We now have 122 distinct investors participating in three ABS platforms and we received $11 billion in liquidity this year through these platforms. We currently have 14 third-party funding relationships with more than $18 billion in committed funding. We also now have the ability to fund up to $1 billion through our first lease residual financing facility. We were also able to sell approximately $7.5 billion in assets through our committed flow programs and other unique loan and lease sales. We continue to have a strong capital base with a common equity Tier 1 ratio for the quarter of 11.2%.

I would like to turn now to Jennifer for a review of our financial results. Jennifer?

Jennifer Davis

Thank you Jason and good morning everyone. We will begin on slide 15 to walk through this quarter's results. Net income for the fourth quarter was $68 million or $0.19 per diluted share. Pretax net income of $109 million was down $300 million from fourth quarter This decrease had two primary drivers, $149 million in fourth quarter 2014 credit loss provision model impact that do recur in the current quarter and $109 million in balance driven lower of cost or market adjustments on our personal lending portfolio which we had classified as held for sale as of September 30, 2015. We will provide further details on these drivers in the following slides.

Our core business remains strong and continues to perform. As highlighted by net finance and other interest income increasing 17% to $1.3 billion this quarter, up from $1.1 billion during the same period last year driven by 15% growth in the average portfolio. Also, the expense ratio for the quarter was 1.8%, down from 2.2% during the same quarter last year as operating expenses increased one 4% to $239 million from $230 million during the same period last year. Our expense ratio was low in the quarter due to some one-time benefits from the legal reserves and compensation, but we expect our 2016 expense ratio to be in line with full year 2015.

On slide 16, we walk through the drivers in the provision increase from fourth quarter 2014 to fourth quarter 2015. We had two significant model impacts providing a benefit of $149 million in the fourth quarter of 2014, an $88 million impact from the forward-looking seasonality that was in our model at the time that was removed as of third quarter 2015 due to model [indiscernible] and a $61 million impact from the decrease in months coverage which was announced in the prior year period. We have no modeling impact to our provision in the current quarter. Fourth quarter 2014 also was benefited by $58 million due to substantial outperformance in net charge-offs compared to our pricing expectations.

These drivers were partially offset the impact of the reclassification of personal loans held for sale as of September 30, 2015. Prior year fourth quarter provision included $134 million related to this portfolio. In current year fourth quarter, all changes in value of the personal lending portfolio including those driven by customer deposits are recorded in net investment gains and losses and there no credit our provisioning on assets as they are no longer classified as held for investing.

After normalizing for these factors, the remaining provision increase is $167 million, of which $126 million is due to net growth in mix of the auto portfolio. This is $41 million impact from the change in expected credit performance, factoring all expected deterioration of the forecast period [indiscernible] in the provision, principally driven by an increase in subprime origination in early 2015. We do not expect our loans to loss ratio of 12.2% to change significantly in 2016.

Delinquencies for the quarter totaled 4.4%, up from 4.2% in the prior year period. The net charge-off ratios for the retail installment contracts this quarter totaled 9.6%, up from 8.1% in the prior year period and up from an adjusted 7.9% in third quarter 2015. The timing of the latest CCART sales drove some of this quarter's increase.

The other P&L line that was a significant between year-over-year was net investment gains/losses which we detail on slide 17. The reclassification of personal loans to held for sale caused us slightly negative this quarter of $232 million in lower of cost or market adjustments were classified in this line. $123 million of LOCM adjustments are attributable to normal customer default activity, which would have been characterized as charge-offs and impacted provision and the portfolio had remained held for investment. The remaining $109 million is primarily due to seasonally higher balances on our revolving portfolio which we held at the same percentage mark as in prior quarter. Balances on this portfolio and customer defaults generally declined throughout the first half of the year. So we expect smaller LOCM adjustments over the next couple of quarters.

During the quarter, we originated $6.2 billion in loans and leases including approximately $2.9 billion in Chrysler Capital retail loans, $1.7 billion of which were prime and the remaining $1.2 billion nonprime. We also originated $1 billion in Chrysler Capital leases. This quarter, asset sales totaled $1.9 billion, up from $1.2 billion during the same period last year, driven by this quarter's CCART transaction. We continue to focus on growth in our capital efficient servicing business. As a result of the continued demand for our assets, our service for others portfolio increased to $15 billion at quarter end, up 45% from $10.3 billion at the end of the fourth quarter 2014. Servicing fee income more than doubled to $42 million for the quarter, up from $19 million in the fourth quarter 2014.

Turning now to liquidity on slide 20. We continue to demonstrate our ability to place assets across a broad investor base, evidencing consistent and diversified access to liquidity during the fourth quarter via the execution of $1.9 billion in securitization including SSDART and CCART, $1.1 billion in sales through our Flow program and $1 billion of advance on new and existing private term amortizing facilities.

We recently priced our first securitization of the year under the DRIVE platform, continuing to demonstrate our ability to access market liquidity, even in volatile market conditions. Looking ahead in 2016, we will continue to focus on ABS as a stable funding source. So we plan for a robust issuance calendar as we have had in the past. Also, as previously announced, we plan to assess the senior unsecured market in 2016, which will increase available liquidity, strengthen our balance sheet and diversify funding mix. We are continually monitoring the market and planning accordingly.

Before we begin Q&A, I would like to turn the call back over to Jason. Jason?

Jason Kulas

Thanks Jennifer. As Jennifer mentioned, when analyzing the quarterly results on a year-over-year basis, there many intricacies which do not make the quarters comparable.

When we evaluate the earnings for this quarter, $109 million of personal lending LOCM adjustments are not related to the fundamentals of our business and do not accurately reflect the earnings power of the company. In addition, historically the fourth quarter tends to be a smaller contributor to full year results. This is particularly true going forward when taking into account recent provision model changes, which will no longer benefit the fourth quarter.

Focusing on the full year results. Net income is up. We continue to demonstrate conservative originations growth and the 2015 adjusted net charge-off ratio in the auto book increased only 10 basis points from 2014.

Moving to slide 22. We show that over time vintage profitability varies. Importantly, all loan vintages have been profitable, including during the most recent downturn due to the selectivity of the loans we choose to originate and the efficiency of our operations. Our newer vintages continue to follow a similar trend. Also, the recent quarterly vintages evidenced no meaningful deviation at this time. We will continue to monitor these trends closely as we leverage more data to make rational credit decisions on every loan we originate.

Slide 23 outlines many of the notable accomplishments during 2015. Regarding leadership, I want to formally welcome Izzy Dawood, our newly appointed Chief Financial Officer, to the team. I also want to thank Jennifer Davis on a job well done as interim CFO since last July. She will continue to play an integral role as Deputy CFO. During the year, we also made significant additions to our Board, appointing eight new directors and adding an independent Board Chair.

Regarding strategic developments, we were able to build upon several processes that have enhanced our Chrysler Capital platform, including origination platform enhancements, further development of our lease end of term process and continual refinement of our dealer performance management process. To better serve our customers, enhanced vendor management oversight and diversifying and derisk our business, we focused on expanding our servicing capabilities with new facilities in Arizona and Puerto Rico. We further enhanced our leading technology platform by increasing the automation of our quality assurance functions and we now score 100% of our customer calls for quality assurance as we strive to create a better overall customer experience.

Finally moving into 2016. To further leverage our scalable servicing business, we are taking a more proactive approach to expanding our service for others platform by educating the market about our industry-leading suite of service offerings. In the first quarter of 2016, we expect business trends to follow normal seasonal patterns. First quarter typically experiences strong originations and favorable credit performance due to tax season, both impacting provision. Expenses will continue to be in line with or slightly lower than the growth of managed assets.

For the personal lending portfolio sale, we continue to go through the diligence process and we expect more moderate impacts as we move forward. Specifically, lower of cost or market adjustments will likely be less severe than Q4 2015 as the fourth quarter was driven by seasonal peaks and balances and customer defaults. And finally, I want to thank all of our employees, dealers and customers for a successful 2015.

With that, I would like to open the call for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Matthew Howlett with UBS.

Matthew Howlett

Thanks, Jason, for taking my call. Just any further information you can provide on the LOCM adjustments. You said really not anything more material going forward. Is that going to be a function of performance, which is seasonal? And do you think possibly spreads are going to tie to the asset backed market and the stuff, will get the stuff off your books? I guess a little bit more on the timing and what you think the volatility is going to be on that line item here in 2016?

Jason Kulas

Sure. So the way to look at that is, if you look at one of the big drivers for the increase in the LOCM adjustments in Q4 was the seasonal increase in balances. And so really, that's driven by the net increase or decrease in the balances and through a holiday season the revolving balances went up as expected. The reverse is true as we enter the first half of 2016. And so we should see that go back the other way. So from a timing perspective, you will see a portion of that go away in the first part of the year.

Matthew Howlett

Will that just mean a reversal?

Jennifer Davis

Yes. A reversal of the balance driven piece of the LOCM adjustment. The other piece is the customer default, which are no longer being considered charge-offs that would flow through provision, are also in the LOCM adjustment line in net investment losses, those will continue to obviously be a positive number or negative impact to earnings, but they will be smaller because fourth quarter is also a highest loss quarter.

Matthew Howlett

Right. Got you tax refund season. And then just what is the best thing can you tell you us on timing? Will we have to go another year with these adjustments? When are you taking it off your books? Is that a function of the securitization market?

Jason Kulas

Well, we are still working through the process. And we don't have any updates on the process at this time. But we still continue to go through it and through the course of year we will make sure we keep everyone updated.

Matthew Howlett

Great. Thanks Jason.

Jason Kulas

Sure.

Operator

We will go to our next questioner, J.R. Bizzell with Stephens, Inc.

J.R. Bizzell

Yes. Thanks. Good morning. And thanks for taking my questions. Jason last quarter you spoke to you all were reviewing some of the competitive pressures that you will start to see and some of the capture rate. Just wondering if you can give us an update, what you saw compared to what you told the last quarter and as it progressed through 4Q and maybe your expectations for 2016 on competition and capture rate?

Jason Kulas

Absolutely. Happy to do that. So if you look at and what we referenced last quarter, is a trend that we were seeing since really sometime in the spring, a steady gradual decline in our overall market share. And what that was a symptom of is just obviously everyday we are cautious about credit regardless of at what one point we think we are in the cycle. And sometimes those cautious conservative decisions on credit that we try to approach with balance end up giving us more or less share depending on what the rest of the market is doing. So it's a sign to us that competition is picking up when we start to lose share. So that continued through the fourth quarter.

What's really interesting, though, is another observation we make about the overall competitive landscape. If you take the top 20 lenders in the market, as a group the top 20 lenders lost share the fourth quarter and rally if you look at them all individually, there are only a few that didn't lose share. And we obviously lost some share in the fourth quarter. But if you compare that to the smallest players in the industry, the smallest players actually picked up share. So there is this interesting dynamic going on where the people with the most history and the most data have held the line on credit and structure and lost a little bit of share and the smaller competitors at the very low end, from a size perspective in the industry, appear to be picking up some share.

That's not a trend because it's only happened over the last quarter or so as far as the smaller players, but it's something we want to watch because the move is pretty significant relative to where they were entering the quarter. And just a sign, I think again, of some the increasing competition. So that leads us obviously to watch things very closely. I think the good news is, right now we are not seeing that reflected in a big way in the performance that we are seeing. And what I am referencing is performance relative to our expectations because mix and timing of CCART and those kind of things drives headline losses and those kinds of things. So what we are seeing relative to our expectations, it's pretty close. But we are seeing that it's challenging and challenging times are when we typically differentiate ourselves and we expect that to be no different this time.

J.R. Bizzell

And building on that, it sounds like the ABS market while seeing some uptick on coupon rates, the ABS market is still there and available and it a sound like these smaller players are potentially leveraging that opportunity. Just wondering your overall thesis on the market, what you all saw in this previous quarter and kind of your expectations in the spreads and coupons on a going forward basis?

Jason Kulas

What we are seeing is that there is a lot of demand and so you are right. Many different types of issuers have been able access to the markets fairly successfully. And what we have seen as far as changes is that and I mentioned this last quarter, there has been a little bit of an increase in the spreads for the executions but the demand is still there. And that continues into early 2016 with the transaction that we priced recently. Although, we are seeing that the market continues to have its challenges. And so I think what you are using reflected in the market right now is concern about where we are on the credit cycle, concern about some of the volatility that they are seeing in the credit markets.

And our perspective on that is that we have a significant following in the credit markets because we have such a long history of performance through cycles. We tend to be in a position as liquidity goes way that we remain fairly strong on a relative basis. And so I think we will benefit from that. But at the same time, what we will continue to do, is if we see certain tranches that we think are to dislocated for where we think the overall market should be, then we can make decisions. We got excess liquidity from different sources to make decisions that make sense for the business. So we think that that flexibility, the excess liquidity and capital we have and our ongoing very deep access to the markets will continue to be a really good liquidity story for us.

The thing I will say on liquidity is that we manage very carefully the maturities and the maturities of our credit facilities with our bank partners and how that process works. And so we don't find ourselves in a situation where something happens and immediately lose access a lot of credit. So I think we benefit from that as well. We focus a lot on staggering maturities, making sure the relationships are deep and strong. And that's paid off for us in the past and will continue to.

J.R. Bizzell

Thanks for taking my question.

Jason Kulas

Thanks.

Operator

We will got next to Vincent Caintic with Macquarie.

Vincent Caintic

Hi. Good morning. Thanks so much, guys. Just another question on the personal loan security lending book. If we were to try to just pull out the impacts of that business from your results, so we pull out the net interest income and all that, could you give us a sense of how much, say, other impacts there were to the income statement?

Jennifer Davis

Sure. So we tell on slide 18 how much net interest income the personal lending line contributed. So it sounds like we got that. And the LOCM adjustment is obviously the $232 million going through net investment losses. Another piece is that it continues to be true about or more than half of the fee income line in other income is driven by personal lending and then there is a small amount of operating expenses mostly related to our servicing expenses. Our entire personal lending portfolio is serviced by others. So those are kind of the pieces to get to the bottom line on that portfolio.

Vincent Caintic

Okay. Got it. And then on the LOCM adjustments again, could you remind us the way the seasonality works for the charge-offs of the personal lending book?

Jennifer Davis

Sure. In general, I guess the simplest way to say is that the fourth quarter is going to be the highest there and in fact historically, as we said on the Investor Day drives, on GAAP loss for the quarter on that line of business even though overall on annual basis that portfolio does continue to be profitable for us.

Vincent Caintic

Okay. Got it. Thank you.

Operator

We will go next to John Hecht with Jefferies.

John Hecht

Yes, morning. Thanks very much. Just focusing a little bit of credit. I know you are able to show us some exhibits that show the credit trends are fairly stable over the year, but when you just look at the auto book, you had charge-offs that went off from 8.1% to 9.5% year-over-year. And then it looks like just given the numbers you have given us in the personal loan book, you had charge-offs move from $86 million to $123 million year-over-year. So there some migration there. I am just wondering how you guys assess this? You have done a mix shift in the auto book. You have some seasoning of the portfolio. There has been modifications to recovery rates in the market. I am just wondering if you can kind of speak as to what you see to be going on at the consumer level? And is this just sort of again a changing of business? Or is there any stress you are assessing at the borrower level?

Jason Kulas

So I will start with this and I am sure Jennifer will add in too. There are several factors here. I think if you look at what's going on the overall markets, a lot of that does not translate directly at this point to the consumer. Unemployment is still a really good story. Gas prices are at seven year lows. So in many respects, the consumer is still really strong, Having said that, we are seeing, there is an element of the performance that we are seeing that is related to a little bit of degradation in the portfolio. And so what I would say it, it is a mix of several different things.

The first is yes, there is a mix component to the losses because we did in early 2015 have some opportunity to book some additional subprime business. It took the profile of the company to a place that was more subprime than it's been recent quarters and there is a slide in the presentation that walks through that. But if we went further back in time really back to 2007 or 2008, so not too far buy back, we had substantially deeper subprime back then. So not anywhere near where we used to be, but still a little bit of an opportunity. And so as those losses roll through, we feel like we have got structures and prices that justify those losses but they are rolling through and that increases losses.

The second thing is, as Jennifer mentioned, you have to look at the timing of any CCART deals we have done, because effectively what happens is, you are taking off the very top portion of the assets held on our books and what's left has a higher loan loss profile. And then finally, we do have, we called out a portion of our provisioning that was related to looking forward on the same book and taking a little bit more negative view. From a percentage perspective, it's low. It is something we watch closely but I think another point Jennifer made is very important to remember and that adjustment reflects now our view going forward on the entire portfolio and everything we expect going forward based on what we see today in the current trends.

We will continue to watch that closely but I think it's a mix of different things, some of which are easily explained by mix and timing of CCART and then a small portion of which is the degradation of performance. If we look by vintage, I think the story is still what we have been saying. In general, if you look at the vintages they are in line with what we have expected. We do have a vintage here and there that has some lift above the expected loss line, but all-in we are really seeing stability just sort of signs of things we want to make sure we watch closely.

Jennifer Davis

So I will add a color on the CCART sale timing. So if you look at 2015, we did our last CCART deal of the year in the fourth quarter instead of third quarter compared to last year. And that does drive the increase in charge-off ratios in Q3 to be a little better when the CCART sales in the fourth quarter. Also the negative impact from the change in expected performance, the $41 million that's in our fourth quarter results, that's a pretty normal change.

If you look back over the last four quarters, there were two quarters where our [indiscernible] levels are better from beginning of quarter to end and then two quarters into the fourth quarter where it got a little worse than it was in the second quarter and the fourth quarter. And both cases, it was around $40 million in the direction of pretty small fluctuation on our $30 billion book.

And then I think you asked about personal lending net charge-offs going up year-over-year. The charge-off rate did tick up a little bit on that portfolio. That portfolio is settling into being a more mature portfolio now that we are about two-and-a-half years into it. And so that was nothing that was surprising or concerning to us and we it looked more seasonal and based on age of the portfolio.

John Hecht

Okay. That's very helpful color. I appreciate that. And second quick question is, just going back to the recent securitization, I think you guys just completed. Can you give us a sense just to gauge what's going on in the market? What was, maybe like all-in cost of financing or all-in spreads of this specific securitization versus the same platform the last time you did the securitization on the same platform?

Jason Kulas

So we are haven't yet disclosed the all-in cost of the transaction, but just a little bit of color. So I think it's indicative of what's going on in the market in general. So we saw a little bit of spread widening. We also saw that in the very deepest tranche of the deal, the spreads widened to a point where we thought it was more beneficial for the company to retain and finance that tranche through other internal mechanisms we have. And so we sold portion of that tranche but we retained a large portion of it. But again as I mentioned earlier on liquidity, we really do that as a strength of the platform that we have the ability to do that and only take terms on these deals that we think makes sense and reflect the true market conditions.

John Hecht

Great. Thanks very much.

Jason Kulas

Sure.

Operator

We will go next to Cheryl Pate with Morgan Stanley.

Cheryl Pate

Hi. Good morning. I just wanted to follow up on some of the credit questions that have come through already. I guess when we think about the deterioration, partially mix shift driven and that looks like a five percentage point change in the sub-5.40% book, how should we think about that relative to the risk adjusted margin ROA that you are getting on that business? And I ask that specifically when we look at the average APR on the retained portfolio looks like it came down fourth quarter versus third quarter. So can you just speak to the dynamics on what you are getting in terms of pricing relative to expected loss in the portfolio?

Jason Kulas

Sure. So we are still pricing to pretax ROAs that are consistent with what we have said in the past in that 3.5% to 4% pretax ROA range. If you look at some of the incremental deeper subprime originations from early in 2015, if you drill down on those vintages, what you see is, there are a couple of different ways to get the right price. And if you get it through yields, you can also get it through structure. And in those specific transactions what we have seen is, we did get additional yields clearly for deeper originations on those vintages, but we also had structures that were more conservative and LTVs, for example loan-to-values, that reflected the additional risk in those assets.

Again we have a lot of experience booking deeper subprime assets because through 2007, it was 100% of what we did and so we have got a lot of data there and know how to structure those deal and we feel very comfortable with the structures we have got. But again, I would say we have got some incremental yield, but we also got incremental structure and the combination of those two things is what makes us positive about the experience we have those assets. But again we are all-in still targeting net 3.5% to 4% ROA range and feel comfortable that as we keep originating we are factoring units we have in the market that the data we have to ensure that that continues to be okay.

Cheryl Pate

And just a follow up. I guess when we think about looking at your history through the prior cycle and sort of where losses peaked out at, how should we think about the composition of the portfolio today relative to if we look back to the 2008 or 2009 period?

Jason Kulas

Well, the composition of the portfolio is higher tier in general than it was back then. So back then the average cycle of the business was in the low-500s, today it's closer to the high-500s, or 600 or so. And so there has been a pretty significant shift in that market. Their dynamics in different times are going to be different. So what we don't know is the timing of drops and recovery rates and those kinds of things. And so that's the reason why and we talked about this in previous calls as well, that's the reason why we take the view we take on recovery rates. We provision for recovery rates that are different than the current environment and we feel like that gives us a fairly significant cushion for things being different to where than they are today. And we will continue to take that approach to the businesses.

Cheryl Pate

Okay. Just one for me. When I look at delinquency rates, we are kind of running pretty flat year-over-year. How should we be thinking about that in relation to the uptick in charge-off?

Jason Kulas

Well, so all those equal, delinquency should be a leading indicator. A 60-plus delinquency should be a leading indicator for where you expect losses to go. So stability there should be a good sign. I would say, it doesn't necessarily mean that the nominal headline losses are going to be flat because one of the things we commented on is going forward as we look at the 2016 other than replacing the personal lending assets we don't expect a lot of net growth in the portfolio and because of that what we will see is some aging in the portfolio and we expect the results to be that losses will tick up based on aging, not based on some significant decline in performance. Now we could see further declines in performance. And obviously we will report on that as we see it. But the view we have right now factors in everything we see with what's happened so far into the future.

Cheryl Pate

All right. Thanks very much.

Operator

We will go next to Charles Nabon with Wells Fargo.

Charles Nabon

Good morning and thanks for taking my questions. I wanted to get away from credit for a bit and ask about expenses. Leave expenses declined about 9% quarter-over-quarter when maybe you had guided to higher expenses in the fourth quarter in October. So I wanted to just get a sense for what changed relative to your expectations? Is there is anything nonrecurring in that number for the fourth quarter and how we should think about that going forward, given some of the initiatives you laid out on the servicing side, cost initiatives on the servicing side that you laid out at the Analyst Day?

Jennifer Davis

Sure. So keeping in mind that in the third quarter we had a nonrecurring charge related to the departure of Tom Dundon, our CEO. So that would magnify the drop from Q3 to Q4. And then in Q4, we did have been individually small nonrecurring credits into our expenses which would be the truing things up for year-end where we get a compensation and then also some legal reserve releases that drove the number down a little bit. We still think we are efficient in our expenses. We expect to remain so moving into 2016. Right now we are projecting that our expense ratio for the year will be about flat although we do have some new initiatives such as opening the new servicing centers, but we are looking to evaluate any opportunity to be efficient and as our servicing book remains growing and is a success but those opportunities continue to be flat year-over-year.

Charles Nabon

Okay. And as a follow-up, could you comment on what you are seeing on the lease side of the business in terms of residual values? And maybe comment on your outlook for 2016? As well as what kind of yields you are seeing in the fourth quarter and what your expectations are going forward?

Jason Kulas

In the lease business, we had a really positive experience with that so far. The lease residual value component of part has performed in line with our expectations to slightly better. I think that's attributable to the quality of the vehicles that are the underlying assets. We think FCA has done a great job of putting great product out there. And so I think we have really benefited from that. We like the arrangement we have lease, because we think it aligns interest in a way that is not unprecedented but fairly unique because we share loss. We share loss performance relative to expectations only.

So what that means is, we are coming to the table as manufacturer and finance company to make sure we put strong structures in place that makes sense. And so from our perspective, we feel like we have properly compensated for the lease exposure we have taken and the residual experience so far has been good. And we can say that with some meaning behind it because as you know, we are approaching our three year end of the launch of Chrysler Capital and we are starting to see a lot of leases come to end of term and roll off and we are seeing what the actual residual experience is. And so far it's been really good.

Charles Nabon

Okay. Thanks guys.

Jason Kulas

Sure. One additional comment I want to make on expenses, just to highlight, is we talked in the past about the difference between efficiency ratio and expense ratio and the reason we highlight expense ratio is because it reflects the true direction of expenses for the business as we grow the service for others platform. So we do expect efficiency ratio to continue to go up because we are consciously taking assets off the balance sheet through this more capital efficient structure and growing the service for others business. So it's the reason why we -- so efficiency ratio is still there. And we think relative to the industry, it's still a very positive story. But the reason we tracked the expense ratio is because we think it's better captured where we are trying to take business from a managed assets perspective. And that goes just back to what Jennifer said on the year-over-year flat look we have on that.

Charles Nabon

Okay. Thank you.

Operator

We will go next to David Ho with Deutsche Bank.

David Ho

Good morning. Thanks for taking my question. I had a question on your outlook on the penetration rate. We think Chrysler was around the 20. Do you think the new initiatives in place at the end of the year will help you achieve that earlier then you expected? And what are the put and takes in terms of the outlook for 2016?

Jason Kulas

That's the goal. And you can see, the early returns on some of the changes we have made are very positive because while we are up December-over-December, we are up even more September-to-December. And so I think that the things we have done recently have really paid some dividends and we would hope that continues into 2016. But what I can say is, we don't really know exactly what the competitive dynamics for the market will be, the rate environment, those kinds of things. But we can say that we are working very closely with FCA to get to exactly the point you mentioned. And I think it's important that we are seeing, from my comments earlier, about losing share because we fairly steadily lost share over the course of the back half of 2015. But the reason we have done that while increasing our penetration was Chrysler, as obviously that's a very special arrangement where we are in partnership with a manufacturer and subvention is involved and those kinds of things. So those two stories do go hand in hand, even though they appear to be going in different directions.

David Ho

Got it. And just one more on credit. You mentioned a more negative forward look. What really changed there in terms of that forward look? And does it relate to competition or some of the macro factors, lower recovery rates on used cars? Or is it more as embedded in the customer profile of your credit?

Jason Kulas

No. And I think customer profile is baked in already in our forward look. So really what changed is some of the other factors that you mentioned. So if you look on the margin, we have seen that that maybe competition has impacted performance because it tends to do that. As competition increases, performances is impacted. We have seen a little bit of just overall weakness, right. And so you know, I think that's just reflected in the losses. But I want to highlight $41 million is a meaningful number just on its face, but as a percentage of our portfolio, it's fairly low. And it also is something that is a number that reflects not just what we have today where we expect today or the next quarter, it reflects for the entire projected of our provisioning.

And so if you spread it out over that time, it starts to look like a smaller number. But having said that, again, it doesn't guarantee we won't have further adjustments in future quarters. I think Jennifer provided some really good perspective on that. If you look over the past five or six quarters, you have seen that those adjustments have been both positive and negative. And so we want to be careful to say that we think that number would be the beginning of a trend. What it really just reflects is what we think today based on all the information we have. And we will take that same view in the quarter based on what we learn over the next few months.

David Ho

So it's really more just a 12-months look and obviously taking account of all the other factors. Have you factored in what your view of ongoing low energy prices? Any concentration in geography that may have been hit harder with the weakness in the energy complex offset by the obviously better income available to service debt?

Jason Kulas

Yes. We actually do a lot of analytical work on that topic. And I mentioned earlier, the positive aspect of the low oil prices translating into low gas prices and that being a good thing for the consumer. But clearly, if we have exposure to MSAs in the U.S. where the business side of the oil and gas business is impacted and employment gets impacted that could impact performance. So we watch it very closely.

One of things we have seen is that if you look at Texas and California where we got a large portion of our business and there are also significant oil and gas businesses, what we have really seen is, if you are not seeing it in the majority of the MSAs in these areas you are not seeing this impact on employment. So it's something we continue to watch very closely but even if you take Houston, for example, which could be a hotbed of this activity, we have got a lot of exposure in Houston, what you are seeing is they did have an increase in unemployment, but it's still below the national average.

So in general, the story on unemployment is still really positive for us and even in areas where we have seen upticks in unemployment rates, it's a very small percentage of our overall portfolio. But it's something that we have our analytics and decision planning teams very focused on doing active analysis of. The good news at this point really, we are really just not seeing it. We are not seeing it reflected in performance and unemployment rates.

David Ho

Okay. Great. That's helpful.

Operator

And we will go next to Jason Arnold with RBC Capital Markets.

Jason Arnold

Hi. Good morning. Thanks for the auto credit comments there. Any additional color you can give on an absolute levels of charge-off on auto prospectively? Should we think about levels coming here? I know there is some seasonality involved but sticking around current levels. And then how should we also think about your months of reserves you are going to sustain going forward?

Jennifer Davis

Sure. So looking forward, we think, like you said, there is seasonality in there, but our charge-off levels maybe a little bit higher in 2016 but compensated for by the higher net interest income. So in other words, fully driven by mix as we have continued to move a little bit down market and expect to be so just in our net Chrysler [ph] portfolio as we continue to sell off the most prime loans through the programs and then continuing the CCART securitization. And then as far as the allowance ratio, we think that will stay in effect through low to maybe mid 12% range between quarter or year end. So no significant movement in that ratio as well.

Jason Arnold

Thank you. And one quick follow-up on the expenses. Can you give us the dollar value of those one-time contributors that you pointed out on expenses?

Jennifer Davis

Well, we had several, that were just individually small that added up enough to move the expense ratio down by 220 basis points.

Jason Kulas

I think the important point on expenses is, as we can compare full year to full year and take the noise out of individual quarters, we may have one-time benefits. We don't expect, from an expense ratio standpoint, any expansion there. We also don't expect a big drop in that ratio. So that flat look year-over-year is what we are expecting and modeling.

Jason Arnold

Okay. And then just maybe, I am sorry, one more quick one on the Mannheim index used prices, maybe some updated thoughts on that front as well, please?

Jason Kulas

So at SC, we saw a little bit of a drop through the course of 2015 and we expect that to continue at a measured rate as we go through 2016. And right now, we would say that primarily driven by just supply/demand factors. The increases in auto sales, increase in fleet purchases, increases in leasing, across the board bring more cars to auction when there is more supply clearly that's going to impact price. So those are factors that we think lead to a gradual decline and not any significant surprise drop in the recovery rates. I think that's consistent with what the industry sources are saying as well. So that's what we have factored in from an operational standpoint. From a risk standpoint as far as how we provision for the business, as I mentioned earlier, we haven't changed our view on that low to mid 40s rate and that's significantly below where they are today. So we have got some protection from a large drop, but we think it's gradual.

Jason Arnold

Okay. Great. Thank you very much for the color.

Jason Kulas

Sure.

Operator

We will go next to Mark DeVries with Barclays.

Mark DeVries

Yes, thanks. Jason, I think you eluded to the fact that you feel you are getting the right pricing and structure to justify the risk from going more deep subprime. But frankly, I kind of struggle to see that when I look at slide 22 and the profitability by vintage. As we look at like 2014, for example, we are just trending in line with 2007, your worst book and even 2015 where 2Q really is kind of inflected negatively. What am I missing here as I look at the profitability and concerns that you are just not getting compensated for the risk right now?

Jason Kulas

Well, yes and it's difficult to see because, well, there are a couple of dynamics. The first is, if you look at the early in 2015, we booked some incremental deeper subprime business. But as the course of 2015 went on, our capture in that business went down through the combination of the market reacting to that and also us continuing to treat our credit approach to business, as we have always done on a very regular basis, sometimes daily. So based on what we see in the market.

If you look at the chart on slide 22, one of the things that you see, for example, is that Q2 2015 vintage sort of taking that dip down in profitability. And the reason for that is, those deeper subprime originations has steeper loss curves earlier. So that's what you see reflected there. We still think the lifetime income on those portfolio is still very positive. And the reason we are confident in that is what I mentioned earlier when we really drill down into the vintages that are specifically related to those incremental subprime originations, what we see is year-over-year those same originations have higher yields and more conservative structures highlight one of the values. And we know that that results in the performance we are expecting to see.

Now clearly, there could be external factors going forward that influence that, but we also price and structure these loans that are under stress even if they are impacted they are not impact to a degree that they would move too far away. So I agree with you, it's difficult to see in the portfolio numbers and even the vintage numbers by the way we are measuring it, but as we break it out by credit, we are pretty comfortable with what we are seeing. And again, we mentioned earlier, it's a challenging environment, right. So we are seeing that we are seeing a performance that we saw in 2008, 2009, 2010 when there was less competition, but we are seeing performance that allows us to make what we think are very acceptable returns in a challenging environment.

Mark DeVries

Okay. Got it. And could you quantify for us what the charge-offs came in at on your balance sheet loans that are not in your public securitizations? Because when we average the public trust and compare that to the blended, it seems like the private loans must have come in kind of north of 10% charge-offs?

Jennifer Davis

Yes. Well, as far as quantification, you are right directionally that our total on the portfolio is always going to be higher than what's out there for public consumption from our SDARTs because there is some loans that stay on our books for a reason. They are not securitization eligible and those obviously tend to be higher charge-off. So the delta --

Jason Kulas

Not CCART eligible. The securitization eligibles are not CCART eligible.

Jennifer Davis

Right. So the delta tends to fluctuate depending on several factors including as we are building to our next CCART which happens approximately every six months that the denominator is going to fluctuate as far as credit quality and so there is always going to be that difference on book charge-offs being higher.

Mark DeVries

Okay. Thank you.

Operator

We will go next to David Scharf with JMP.

David Scharf

Hi. Good morning. Maybe I will start with just a very high-level guidance question. You had remarked back in November at your Investor Day that based on everything you knew at the time, we ought to be factoring in GAAP EPS in 2016 below GAAP EPS in 2015. It looks like particularly with the LOCM adjustments, you finished the year at $2.41. Directionally, is that still how we ought to be thinking about the overall earnings outlook this year?

Jennifer Davis

Yes. We are still thinking that 2016 is going to be lower than 2015. So one thing we talked about at Investor Day, I would like to reiterate, is our liquidity cost are going out for a couple of reasons, one being additional cost of contingency funding from our parent that's coming this year and then the unsecured issuance obviously would be a good thing for us. It will diversify our funding mix, expand our base there. But it will come in additional incremental cost.

David Scharf

Got it. And once again, just to clarify, that's in relation to that GAAP figure you posted, the $2.41?

Jennifer Davis

Yes. That's in relation to the $2.41.

David Scharf

Got it. Secondly on the recovery side, a couple of questions. One is related to the sale of the charge-offs, the flow arrangements which seem to have eased up in second half of the year relative to the first half. Is there any color you can shed on that in how we ought to be thinking about the timing of what's still in the pipeline?

Jason Kulas

Yes. Sure. So I think what you saw, as you saw a flurry of activity on that as we had a backlog of those types of asset. Going forward, the sales will be spread out a little bit more in smaller amounts. We will continue to take the opportunity to find places in the market where those could be maybe more efficiently handled. And we continue to believe that that will be an opportunity for the company. But you shouldn't expect to see the same volumes you have seen in the past.

David Scharf

Okay. Got it. And lastly, just a little bit help on the allowance. Obviously, the walk up slide is helpful to get us to the 12.2% at year-end. As we think about the combination of mix and seasonality is 12.2%, should we be thinking of that as sort of a low watermark to start the year marching up higher by Q4? I thought I heard comments about it being roughly flat but then I heard a comment that it was going to be low to mid-12%s. Maybe just a little more color on the thinking there.

Jennifer Davis

Yes. I think it will be relatively flat but with some movement depending on where we are in the year and that's probably indicated that it could touch the mid-12% at some point. But overall staying pretty flat from here.

David Scharf

Got it. And then one last question, once again on the recovery side. Related to the Mannheim trends and your expectations of sort a low to mid-40s, is there any way of getting a sense for how vehicle recovery values overall have been trending for the type of vehicles your subprime borrower actually buys as opposed to the aggregated Mannheim trends?

Jason Kulas

Well, I think there is enough data out there on what Manheim publishes and then what our trends have been. So I think it triangulates to that. It does shift slightly from time-to-time, but I think there is enough information out there to get an indication of what that relationship might be. But I would say is, yes, did see as -- so we saw a drop in recovery in 2015 and we do expect some measured drop going forward. But it's not necessarily that we think in the near term, it's going to the low to mid-40s. We think it could get there at some point and that's the way we provision, but we are not calling that for the next few months.

David Scharf

Got it. Okay. Thank you very much.

Operator

And we will go next to Eric Beardsley with Goldman Sachs.

Eric Beardsley

Hi. Thank you. Just to touch upon a couple earlier topics more specifically, at the Investor Day you gave us EPS excluding the held for sale consumers loans. Could you share that with us for the fourth quarter?

Jennifer Davis

We are not disclosing that precisely for the fourth quarter, but it would have been a little higher, because consistent with earlier years on a GAAP basis the personal lending portfolio did lose money just for the quarter. That was exacerbated by the fact that we are now taking LOCM adjustments on it rather than normal provisioning which makes the GAAP results a little worse compared to what they would have been in a healthier investment scenario.

Eric Beardsley

Got it. And then secondly, back to the questions about getting enough yield to offset the higher losses. Just first, if we were to look at the year-over-year increase, the 150 basis points in charge-offs, is that a relationship on a year-over-year basis that we should expect to continue? And if so, is there some catch up on the yields which individually acquired retail auto only increase 40 basis points year over year? Basically in other words, are you saying a step up on your charge-offs faster because of the mix than will actually come through on the yield side?

Jason Kulas

Well, I would say a couple of things about that. The first is, we can get pricing through either yield or structure and we tend to get it through both. And so we do feel comfortable with where we are on the all-in return on the assets we have. But I think we even make sure that we keep the increase in perspective that we talk about through, like you have to make sure that everybody is focused on the fact that because we are not growing the portfolio, we are going to see some aging. And so when we see increases in losses related to aging, those aren't increases in losses that we have to find some way to make up for the yield.

They are increase in losses that we expected. It just wouldn't have been shown in that way if the portfolio were growing. So the portfolio measure of loss hides some of those kinds of things sometimes in a way that's unintended. So that's what we really expect out of these higher losses. We haven't projected or disclosed exactly where we think the losses go or where they peak, but we are trying to give all the guidance we can on directionally why it's happening and that it's in line, generally with what our expectations are, which we think is really the key credit point.

Eric Beardsley

Got it. But I guess if we were to look at this optically, if you have 150 basis point higher charge-offs, only 40 basis points higher yield, that structure that you are getting, that will come through the charge-offs. Is it right to think then, that ROAs are down 100 basis points year over year?

Jason Kulas

No. I think some of the provision you see are timing and again some of it is related to the aging of portfolio. For us, when we are pricing new loans and when we price the loans that are already on the books, we were looking for those same levels of return that we have always talked about. We want to manage the business to that 3.5% to 4% pretax ROA range and we think that what we have over time through cycles and timing and those kinds of things gives us that result.

Eric Beardsley

Okay. Thank you.

Operator

And that will conclude our question-and-answer session at this time. I will now turn the call over to Jason Kulas for final comments.

Eric Beardsley

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

Operator

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

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