Investors Spooked by SCUSA’s Loss Provision Increase

Santander Consumer USA is plowing through a rough patch on Wall Street as analysts and investors react to news that loss provisions unexpectedly went up in the third quarter.

Analysts who spoke to Auto Finance News say they’d been expecting Santander Consumer USA credit to stabilize and, more importantly, for loss provisions to stay flat from 2Q or even decline.

Instead, SCUSA said during its 3Q earnings presentation that credit would continue to deteriorate YoY and provisions had gone up.

Specifically, the provision for loan losses increased to $770 million, up from $598 million in the third quarter of 2013 and up from $589 million in Q2.

SCUSA President and CFO Jason Kulas told analysts during the company earnings call that much of the allowance to loans ratio increase is related to the credit profile of retained loans. He said in 3Q, SCUSA sold $1 billion in higher credit profile assets through its Chrysler Capital securitization platform.

He said as they sold the higher credit profile loans, the mix of lower credit profile loans remaining on the balance sheet required more upfront provision.

Later that day, analysts were downgrading the company’s stock.  Bank of America/Merrill Lynch downgraded the company to “neutral” from “buy” setting a price target of $19, down from the previous mark of $24. BOA/Merrill said poor credit results are cutting into earnings.

Wells Fargo downgraded the company to “market perform” from “outperform” and set a valuation range of $17 to $19 down from $21 to $23.

By the time trading ended Wednesday, the stock price had tumbled to $16.85 a share.  That’s down from the $24 that 75 million shares sold for during the company’s IPO back in January raising $1.8 billion for the company. But in just nine months, that stock’s total value had fallen around $560 million.

“The big question that most analyst came away with is what SCUSA communicated last quarter,” Compass Point analyst Jason Stewart told AFN on Wednesday. “They had told the Street back then that they thought provision levels would decline, that the reserve was pretty conservative. So everyone took that and said, when we come up with earnings estimates, we’ll assume a more normal level of provision activity.” It its report released Wednesday, Compass Point reiterated its Neutral rating but reduced its price target to $20, down from $23.

In the Compass Point report, Stewart wrote that the targeted reserve coverage ratio is 15 months, although, current reserve coverage is 17 months.  He also wrote that SCUSA continues to execute on its strategy to retain only high margin paper, but, the economics on SCUSA’s retained loans do not appear to have reached a bottom.

“We’re getting pretty close to that bottom, “said Kulas.

He said Q4 is usually a weaker credit quarter so there’s probably still not a lot of good news to come out this year.

“But, when you get to 2015 verses 2014, you’ll see moderately higher delinquencies and probably moderately higher losses, but, I don’t think you’re going to continue to project sequential increases in provision or losses,” he said.

But, over the near term, Compass Point writes that it expects the shift in SCUSA’s retained loan mix toward lower Fico bands and lower recovery assumptions will drive a continued reserve build.  Compass Point says it has increased its expectation for the 2015 allowance to loans ratio to from 11% to 13%.

So for now, Compass Point says it remains neutral “as consumer protection and CCAR related regulatory headwinds add a layer of uncertainty to the SCUSA story,” in addition to uncertainty surrounding future loss rates for SCUSA’s evolving portfolio mix.

Nonetheless, SCUSA did robust originations this past quarter. Total Q3 originations were $7.4 billion, up from $6.5 billion the same time last year. Finance receivables, loans and leases, net, increased 3 percent to $27.3 billion at September 30, 2014, up from $26.5 billion from the previous quarter.