Advanta Corp. Q2 2008 Earnings Call Transcript

Advanta Corp. (ADVNB)

Q2 2008 Earnings Call

July 29, 2008 9:00 am ET

Executives

Amy Holderer - VP, IR

Dennis Alter - Chairman and CEO

Bill Rosoff - President

Phil Browne - CFO

Analysts

Sameer Gokhale - KBW

Chris Brendler - Stifel Nicholas

Scott Valentin - Friedman, Billings, Ramsey

Lenny Brecken - Brecken Capital

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Advanta’s Second Quarter 2008 Earnings Call. We’ll note that today’s call is being recorded. At this time, for opening remarks and introductions I would like to turn the conference to Miss. Amy Holderer. Please go ahead.

Amy Holderer

Thank you. Good morning, and welcome to our conference call. Joining me today are Dennis Alter, Chairman and CEO; Bill Rosoff, President; and Phil Browne, CFO. During our call this morning, we will share comments regarding our second quarter 2008 performance, and will then -- we’ll then take questions from the analysts and institutional investors. (Operator Instructions).

Our discussion today 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. In addition, 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.

Now I will turn the call over to Dennis.

Dennis Alter

Good morning. Thanks for joining us. Earlier today, we reported that we earned $0.10 per combined diluted share in the second quarter. This includes an $0.18 per share after-tax gain on the sale of a portion of our MasterCard shares, which was partially offset by $0.06 per share after-tax charge to increase credit reserve -- reserves for owned receivables. These earnings are obviously not what we would like. The economy continues to challenge small-business owners and their ability to pay their bills.

For the quarter our managed annualized net credit loss rate rose to 8.38%, and managed 30 day plus and 90 day plus delinquency rates increased at quarter-end to 5.67% and 2.81% respectively. We take no comfort from it, but our losses and delinquencies are below the average of other small-business issuers on a lagged basis.

We’d mentioned on the last call that our losses and delinquencies had risen faster than the average rate of other small-business issuers in surveys in which we participate. On further analysis though, it only appeared that way on a coincident basis. After additional evaluation, lag-based rates, which eliminate the effect of different receivable growth rates show that our losses and delinquencies have traded -- have trended, I’m sorry, at about the same rate as the averages. More importantly, though, as we’ve discussed, we’re responsible for Advanta not the industry, and we’re doing everything we can to mitigate the losses and delinquencies. It would be very difficult for us to give that more attention than we are at all levels of the Company.

I can also add a little more color on some of our delinquency measures, although it’s important not to read too much into them given the volatility of the economy. The 30 day plus delinquency dollars and rates in our mature vintages are the same or lower this quarter compared to last quarter where they had been rising. At the same time, we like the industry as a whole, are seeing more delinquencies from relatively newer customers than has been the case over the past several years.

We had also mentioned on the last call and at an investor conference in June that after months of a rising trend early delinquencies of 1 to 29 days past due, had improved modestly in March and April beyond nominal -- normal seasonality. There was further improvement again in May. And although June was not as low as May, it was also better than we’ve been seeing in the latter part of ‘07 and early ‘08 and was in line with March and April. I don’t believe this is a harbinger of anything. These are just our facts.

Turning to other areas, our managed receivables declined slightly from last quarter end to about $6.1 billion from 6.3 billion. This flows principally from reducing our direct mail volume in the second quarter, as we anticipated, resulting in fewer customers. For the quarter, our new customers totaled a little over 26,000.

Purchase volume grew to about 3.1 billion, which is an increase from about 8% from last quarter. In particular, customers increased their spending for gasoline and retail store purchases by about 20%. This includes more transactions and higher transaction amounts. On the other hand, other transaction volumes declined with balance transfers being the primary driver. This decrease in balance transfers is mainly the result of fewer new customers.

More broadly, we believe that what’s important now is to focus and be rigorous through this very difficult environment and to take actions that will serve us well today and into the future. We’re committed to doing that, and that’s what we’re doing.

Now Phil will update you on the details of our financials. Phil?

Phil Browne

Thanks, Dennis. Consistent with our last quarter’s comments, our MasterCard Class B shares provided additional income this quarter as we further increased our credit reserves and at a time when we wanted to foster initiatives for the future. During the quarter, we sold 46,000 of B shares with a gain of $14.2 million. At the end of the quarter, we owned 27,000 shares of MasterCard and about 500,000 Class B Visa shares all of which are carried at zero book value.

We also increased our allowance for credit losses on principal receivables by $4.5 million. At June 30, our allowance for receivable losses was 9.9% of owned receivables. Our managed net interest yield continued to grow in the second quarter as expected. The net yield widened to 9.34% which is 130 basis points above the first quarter. A little over half of this increase can be attributed to growth in interest income yield and we also benefited from lower securitization cost of funds. We expect to see additional growth in net yield during the second half of 2008.

Overall revenue from transaction volume was up slightly in the second quarter versus the first. This is consistent with Dennis’s earlier comments regarding transaction volumes. To help you with your analysis of our Company, we’ve enhanced our transaction volume reporting in our statistical supplement and you can now see specific volumes for each transaction type.

Moving on to operating expenses; our business cards expenses were higher in the second quarter compared to last quarter. This is consistent with the directional comments we made on our first quarter call as well as Dennis’s earlier comments today regarding our initiatives to manage risk exposures today and thus position ourselves for the future. Our operating expense ratio was 5.24% compared to 4.72% in the first quarter.

On the liquidity front, we increased our cash and liquid investments at quarter-end to $1.8 billion. In addition to this, we had $450 million of AAA capacity and start our securitization structure. During the quarter, the size of our reported AAA capacity was impacted by several activities including the maturity of a $20 million subordinated Class B tranche. However, this does not affect our liquidity or real AAA capacity because we’ve the ability to issue and hold the new $20 million subordinated Class B security. This would put us in essentially the same AAA capacity position we were in before the Class B maturity.

Over the past few months, we’ve received questions about the possibility of a cash trapping event in our Advanta series. Our current excess spread level as of June month end was at a three-month average of 4.88% versus an initial trigger of 4.5%. Our current estimates suggest that our excess spread maybe tighter than we had expected it to be for July and August, but we think that most likely, we’ll be above the 4.5% average in these months and then improve.

If however, we were to trip below this 4.5% trigger, we’d be required to accumulate an additional $50 million, plus or minus of cash in our cash collateral accounts and we would expect to come back to us at a later date. Keep in mind, that $50 million represents only 3% of our cash and liquid investments. The additional cash collateral would be funded by the trust’s excess spread.

Next, I’d like to turn the call over to Bill.

Bill Rosoff

Thanks, Phil. To sum up, we obviously continue to be in a difficult environment. And we are doing everything we can to minimize the effects of the economy and to put ourselves in a strong position for the future. We expect to be profitable for the full year and to pay our quarterly dividends at its present level for the year as we’ve said before. We are also continuing to have discussions with the Board about the possibility of a stock buy back. Now let’s get to your questions.

Amy Holderer

During the question-and-answer session, the operator will be closing the line after you ask the question, if you had more than one question, please state all your questions first and then management will response. After management’s response, if you have additional questions or follow-ups, please signal the operator so that you can re-enter the queue. Operator, will you please remind the participants how to signal if they have a question.

Question-and-Answer Session

Operator

(Operator Instructions). And from KBW, we’ll go to Sameer Gokhale.

Sameer Gokhale - KBW

Hi. Thank you. Three questions. The first one was, on the net interest margin the sequential increase I think you’ve given some explanation for the -- for half of the growth, but I noticed that the Company had a higher liquidity portfolio as well, I think at the end of this quarter compared to last quarter, so that should have put downward pressure on the NIMs. I’m wondering if there was anything else that was flowing through there that might have resulted in the benefit of the net interest margin during the quarter.

The second question I had was, as it relates to maybe some changes in FAS 140, and maybe having to bring the receivables on balance sheet. How does that affect you as a Company from a capital perspective? I would love to get your thoughts there? And then, lastly, on the residual interest, I know, you were up by $4 million and I was wondering what specifically you changed? It seems like the charge-off assumption only went up. So was it the yield assumption that you also increased resulting in the increase in the residual interest? Thank you.

Phil Browne

Good morning, Sameer. It’s Phil. How are you? First of all, I’ll just take these in order. The net interest margin sequentially was up about 130 basis points, and we called out that some of that benefit was for cost of funds and the rest was on the yield side. The liquidity portfolio certainly has a dampening impact, but we have the run-off of prior balance transfer promotional pricing on the portfolio that we’ve talked about for a number of years having an impact on the net interest margin and just pricing for the risk of the portfolio appropriately impacting in a positive way the net interest margin. So there are the principal moving parts there, and it’s consistent with the moving parts we’ve talked about before, your point on liquidity position being well taken and appropriate.

On FAS 140, we’re keeping very close to what’s going on there. As you know, there isn’t an exposure draft outstanding yet. We’re going to have to take a look at what ultimately the accounting rules come out to, what proposed changes, what actually happens, and then there is other moving parts. What will capital requirements at the banks do? You may know that we’re not really subject to risk-based capital or other capital ratios at the parent company, so there are a lot of moving parts including how it would impact reserves. So I think we’ll have to wait and see more there what’s going to happen, but I wouldn’t say there is any definite impact on capital structure at this point based on what we know.

On the residual interests, you mentioned the loss estimate being up, that’s on page three of the Statistical Supplement, for other folks to note. The other principal moving parts are net interest margin and the direction that that’s going. There is other moving parts, but the net interest margin expectation versus the losses are the principal items that gave rise to the change in the IO valuation that you mentioned.

Operator

And our next question will come from Chris Brendler of Stifel Nicolaus.

Chris Brendler - Stifel Nicholas

Hi thanks. Good morning. Can you give us a little detail behind your forecast that the trust will not trap cash? I guess the hardest one for us to predict is the yield. Is some of that top line success you reported on a GAAP basis this quarter going to start showing up more in the trust or do you expect losses to actually trend down in the trust? Is that the reason for your expectations there? And then on delinquency movements, just give us a little more detail on the trends you noted in the quarter?

It’s difficult for me to see much positive in the trust, or these results, it seems like things are still moving incrementally higher, and I guess if you could just give us a little more detail on where you see any signs of optimism from a credit perspective? And if you see -- if you saw any of the deterioration that some of your competitors have noted in late-stage roll rates. And then finally, can you remind us how you treat accruing fees, finance charges on delinquent accounts? How aggressive are you in suppressing revenues when accounts go delinquent, to the extent that they ultimately charge-off and you don’t want to have to back those revenues out? Any color you can give us on that and how it trended in the quarter in terms of suppressing uncollectible fees and finance charges? Thanks.

Dennis Alter

I’ll start with a couple of those items. On the trust question, it’s really I take it as a variety of the answer that we just gave to Sameer on the IO, which really went to, what are the expectations that gave rise to an increase in the IO valuation, and that’s referring back to earlier in the year. But it’s really the net moving parts of expectations in net interest margin versus losses. Keep in mind that the trust statistics are on a cash basis, they generally move consistent with the accrual expectations, but there is a little bit of timing issues and that is why the trust statistics are done on a three-month average basis.

As far as the delinquent interest in fees, we reserve in a very tight manner, very statistical manner for delinquent interest in fees, we can point out some disclosures for you in the 10-Qs to get a little more detail on that. But we have had a consistent reserving process for delinquency interest and fees on both securitized and owned loans for quite a number of years now, and I think are pretty tight on that. Obviously as 90-day rates, 30-day rates, dollar amounts of delinquencies increase, as we’re billing interest and fees on those, those accounts, we’re reserving for that. So that’s the net impact that you have within a quarter.

Bill Rosoff

On the third point about a little more flavor on the delinquencies and whether there is any cause for optimism in that, as Dennis said, we’re not suggesting at all it’s a predictor of anything, or any of the other delinquency information that Dennis referred to.

In terms of the facts, as I think Dennis mentioned, the mature vintages are -- delinquencies are at or below the prior quarter and the newer vintages as with others, you’re seeing more early delinquencies than you normally would have. So in any given quarter how that combines is sort of a detailed forecast of what’s new and what’s old and how that interrelates and how much of each of those. But I think the main message is obviously on a mature vintages if that continued that would be a good thing, but we’re not predicting that that means next quarter things will be at X or Y at all.

Operator

And from Friedman, Billings, Ramsey we’ll go to Scott Valentin.

Scott Valentin - Friedman, Billings, Ramsey

Hi, good morning. Two questions. First, just another regulatory issue, I guess the Fed’s proposal and maybe the commentary there regarding teaser rates and their recommendation on payment allocation. How would that impact your current offer, which I think is a one-year, 0% teaser balance transfer offer? And the second question would be on the dividend as if the holding company and the bank, the ability to transfer funds from the bank to holding company, do you perceive any problems there in light of maybe the credit quality issues and the trusts?

Bill Rosoff

Hi. This is Bill. When the proposed regulations -- the proposed regulations are proposed to be effective at the end of ‘09. They’re waiting for comments. If they were broadly applicable, the -- and didn’t change, the entire industry I think is likely to change in terms of the pricing and the effective, the payment allocation. It’s not an Advanta issue. And as we’ve said before, I think, we are -- using those rules, we were applying those rules to us and everybody else we would be in the same position as everybody else. And you could argue with advantaged or the same, but we don’t see it as a negative as long as it’s ubiquitously applied, which is -- and we don’t see any it would be applied, in any way that would be adverse relative, us relative to other people.

When the dividend, we’re not allowed to comment, it’s a crime to comment on information from regulators, no matter how positive it is or anything else. We think, we have very good relations with the regulators, and we don’t anticipate any kind of restrictive issues. And you’ll see in the quarter report, when it comes out, that the Bank has been paying dividends, just authorized a dividend which will be paid, so, and we’ve made the comments we have about our expectations on the apparent dividend.

Operator

And next we’ll go to Lenny Brecken with Brecken Capital.

Lenny Brecken - Brecken Capital

Hey, guys. I know it’s probably a difficult decision to actually outsource some of the back-end of the business. Can you just describe what finally -- why do you finally decided to go ahead through that? And when we -- whether it be, I think you said on ‘10 actually, to see the recognized benefit of that, but whether we’ll see any benefit in the second half of ‘08 into ‘09?

Dennis Alter

I think what convinced us to go ahead is where we have proven out the thesis for doing the pilots in the first place. And we spent a year or more in pilot and that is -- the two advantages of it are, great cost savings and to some extent importing practices of others and expertise in certain areas that can -- which can benefit us. The benefit, we don’t expect to benefit in ‘08 or early ‘09. We have put out and Phil would have it in his fingertips more the cost savings we project, I think by the end on an annualized basis by the end of ‘09. But I think it will flow to the bottom line 2010 and thereafter. As we’ve said in our disclosures and it is already -- sizeable rate, I think it’s at the annual rate of $15 million a year.

Phil Browne

Yes, that’s correct.

Operator

(Operator Instructions) And we’ll go back to Scott Valentin.

Scott Valentin - Friedman, Billings, Ramsey

Thanks for taking the follow-up question. Just wanted to get, possibly, more color on the margin. You mentioned you expected to continue going higher in the back half of the year. Is that dependent upon any type of underlying trend in rates or is that just the natural repricing? Maybe if you could provide more color on a relative basis. Do you expect the margin to increase at the same pace you saw this quarter or will it slow down or increase? Thank you.

Phil Browne

Hi, Scott. This is Phil. I don’t want to get into particulars given that we don’t have a lot of forward-looking disclosures out there on a relative pacing. But the increase that we’re considering in net interest margin, is it really dependent on a rate directional change on, it’s really the natural consequences of the roll-off of promotional balances on the higher acquisitions that we had in ‘07 continuing, which has been benefiting our net interest margin, as well as pricing appropriately for the risk.

Let me just make one clarifying point on another matter, if I could, going back to an earlier question. We had a question regarding the valuation adjustment of $4 million and I mentioned that was earlier, just to be clear for everybody that was a first quarter item. We do not have a valuation adjustment upward or downward for the second quarter in our residual assets. I just wanted to make that clear given the context of that question and answer.

Operator

And we’ll take a follow up question from Lenny Brecken.

Lenny Brecken - Brecken Capital

Hi, guys. If we go through the current environment, how do you, in the second half into ‘09, grow your business? I mean, how do you see -- I’m not asking you to actually make a forecast, but the consensus assumption is that GDP will bounce around -- at around a 1% rate if that -- through probably at least the first half of ‘09. So how do you maintain profitability or go back to profitability, I should say, and grow your business in that kind of environment? Thanks.

Dennis Alter

Lenny, this is Dennis, a couple of things; one, right now the focus of everyone in senior management and many others throughout the company is not growth per se, but curing the book and working the current customers we have and, consequently, acquisitions, new customers will be down. I don’t recall if we gave an estimate, but we did, we put on 26,000 customers this quarter, which, if you compare it with other quarters in previous years, is lower. In terms of the broader economy and how we will grow the business when the time comes to begin to shift our attention, which, it isn’t now, that’s for sure.

There are -- as we’ve said before, being as small as we are, for us to find some hundreds of thousands of good customers in a given year, is just fine for us, and we can grow, and we can be profitable and build shareholder value. We don’t need to turn over 5, 10 million customers, just from attrition every year.

So, while we’re small and there are some disadvantages of that in some other activities, and we’ve been speaking to them with some of the offshoring comments, where some of the back office activities will be offshored and we can use someone else’s scale at a -- cost comparable to those of our competitors. We believe our marketing and our analytic groups and others in the company will be just fine and have been just fine in being able to source new customers at the appropriate time, but right now it’s all hands on deck for credit delinquency and losses.

Operator

And we’ll take a follow-up question from Sameer.

Sameer Gokhale - KBW

Okay, thank you. I was wondering, if you could just share any statistics with us today which would perhaps show how for a given FICO band, how your cards are performing from a credit standpoint relative to say a control group of just, FICO without any incremental underwriting, I know you use information in addition to FICO to underwrite your accounts, but I want to get a sense for, if you look at your super-prime customers, where are the charge-off rates coming in relative to just if some one would make a card offer solely on FICO, what that delta is? If you could share some statistics, that would be interesting and useful. Thank you.

Phil Browne

Sameer, I don’t want to disappoint you, but I don’t think we’re going to be able to in a statistical way help you. That just, well, we have -- we, as well as I think many others in the industry think that various analytic scoring beyond FICO are a vast improvement on FICO itself. And we’ve talked about that and we certainly do.

And maybe if we had somebody in our analytic group on the phone, they could give more detail on that. I think on the other hand, at a given FICO band and with the customers we have, the best source of comparison of us with others, is the statistics which we have referenced of how our losses are going compared to others. And it’s what Dennis reviewed and what we’ve reviewed last time.

Operator

And we’ll go back to Chris Brendler.

Chris Brendler - Stifel Nicholas

Just one quick follow-up, do you have handy, the maturity schedule for the securitizations over the next four quarters and whether or not you think you can access the securitization market currently.

Phil Browne

Hi, Chris; it’s Phil. The securitization maturities, we have about another $250 million of AAA capacity through the end of this year. And then in the first half of next year about on 950 million of AAA maturities, the 250 was the maturity also. And I think we have a C tranche in ‘08 of about $100 million.

I think the key from our liquidly perspective is on that we positioned ourselves so that we don’t need to access the securitization market. Those numbers of maturities, I mentioned, should be put in the context of the $1.8 billion of cash and short-term investments that we had at the end of the quarter, we’re in very good shape.

We’re not requiring access to the securitization market. Having said that, if we wanted to, and we don’t want to chase price and that’s why we’re trying to draw a strict distinction here, but could we have access to the market if we wanted to, go to the prices of the market wants, yes, we could.

Operator

And Lenny Brecken, please go ahead.

Lenny Brecken - Brecken Capital

Just one follow-up question. The intensity at which you are outsourcing your back office, how long have you been trialing with them?

Dennis Alter

Almost a year, and we’ve been -- we first started doing site tours and interviewing potential third parties in India and elsewhere two summers ago. So we’ve been at it for two years, made the decision and began the pilots a year ago, and pulled the trigger in the last couple of months.

Lenny Brecken - Brecken Capital

Okay. So it’s not reflective of some kind of change in the business that you see in the near-term?

Dennis Alter

Two years ago we began.

Lenny Brecken - Brecken Capital

Okay.

Dennis Alter

(inaudible) I argue, we should have moved faster, but it’s not a short-term decision nor was it a short-term process to evaluate the decision.

Lenny Brecken - Brecken Capital

Okay, one follow-up. In terms of the improvement, albeit slightly in the near-term delinquencies, how much of that do you think is tied to the tax rebates and whether that’s sort of, budget wise cycle through now and in August and September will drop back a bit?

Dennis Alter

Our impression is not at all. But again, we’re not saying it’s predictive, but whatever it is there, we saw little evidence, and notwithstanding trying to use the tax rebates as a tool in collections, we saw little evidence of that being productive at all.

Operator

And, Miss. Holderer, there are no further questions at this time. (Operator Instructions)

Amy Holderer

While we wait to see if there’s any additional questions, let me just remind you that a recording of today’s call will be available for the next 90 days at our website advanta.com, or at investorcalendar.com. In addition, after 12 o’clock today, you can access a recording by phone for the next week by calling 888-203-1112 and referring to pass code 8417100.

Operator

And we’ll hear from Lenny, again.

Lenny Brecken - Brecken Capital

I’m sorry, I forgot to ask it. The operating expenses were up quite a bit sequentially, can you just describe, that was a seasonality involved there or something else?

Phil Browne

The principle items on increase in operating expenses that we referred to were cost, really associated with managing the risks that Dennis made a couple comments about. And also some, positioning ourselves appropriately for the future as we’ve referred to on a prior call and this call, so that when the environment gets better we’ll be ready to go from a growth-mode perspective.

Operator

And Miss. Holderer, there are no further questions at this time.

Amy Holderer

Okay, thank you. So let me close the call with a final reminder that I can be reached at 215-444-5335. Thank you for joining us today.

Operator

Ladies and gentlemen, that does conclude today’s conference. We thank you for your participation. Have a great rest of your day.

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