SANTANDER CONSUMER USA HOLDINGS INC. Background and Overview
Santander Consumer USA Holdings Inc. was formed in 2013 as a corporation in the state ofDelaware and is the holding company forSantander Consumer USA Inc. , a full-service, technology-driven consumer finance company focused on vehicle finance and third-party servicing. The Company is majority-owned (as ofFebruary 20, 2020 , approximately 72.4%) by SHUSA, a wholly-owned subsidiary of Santander. The Company is managed through a single reporting segment, Consumer Finance, which includes its vehicle financial products and services, including retail installment contracts, vehicle leases, and Dealer Loans, as well as financial products and services related to recreational and marine vehicles, and other consumer finance products. CCAP continues to be a focal point of the Company's strategy. OnJune 28, 2019 , the Company entered into an Amendment to the Chrysler Agreement withFCA , which modified the Chrysler Agreement to, among other things, adjust certain performance metrics, exclusivity commitments and payment provisions. The Amendment also established an operating framework that is mutually beneficial for both parties for the remainder of the contract. The Company's average penetration rate under the Chrysler Agreement for the year endedDecember 31, 2019 was 34%, an increase from 30% for the same period in 2018. 39 -------------------------------------------------------------------------------- The Company has dedicated financing facilities in place for its CCAP business and has worked strategically and collaboratively withFCA to continue to strengthen its relationship and create value within the CCAP program. During the year endedDecember 31, 2019 , the Company originated$12.8 billion in CCAP loans which represented 56% of total retail installment contract originations (unpaid principal balance), as well as$8.5 billion in CCAP leases. Additionally, substantially all of the leases originated by the Company during the year endedDecember 31, 2019 were under the Chrysler Agreement. Since itsMay 2013 launch, CCAP has originated more than$65.9 billion in retail loans (excluding SBNA originations program) and purchased$41.9 billion in leases. Economic and Business Environment
Unemployment rates continue to be at low levels of 3.5% as reported by the
Despite this stability, consumer debt levels continued to rise, specifically auto debt. As consumers assume higher debt levels, the Company may experience an increase in delinquencies and credit losses. Additionally, the Company is exposed to geographic customer concentration risk, which could have an adverse effect on the Company's business, financial position, results of operations or cash flow. Refer to Note 2 - "Finance Receivables" to these accompanying consolidated financial statements for the details on the Company's retail installment contracts by state concentration.
How the Company Assesses its Business Performance
Net income, and the associated return on assets and equity, are the primary metrics by which the Company judges the performance of its business. Accordingly, the Company closely monitors the primary drivers of net income:
•Net financing income - The Company tracks the spread between the interest and finance charge income earned on assets and the interest expense incurred on liabilities, and continually monitors the components of its yield and cost of funds. The Company's effective interest rate on borrowing is driven by various items including, but not limited to, credit quality of the collateral assigned, used/unused portion of facilities, and reference rate for the credit spread. These drivers, as well as external rate trends, including the swap curve, spot and forward rates are monitored. •Net credit losses - The Company performs net credit loss analysis at the vintage level for retail installment contracts, loans and leases, and at the pool level for purchased portfolios - credit impaired, enabling it to pinpoint drivers of any unusual or unexpected trends. The Company also monitors its recovery rates as well as industry-wide rates. Additionally, because delinquencies are an early indicator of future net credit losses, the Company analyzes delinquency trends, adjusting for seasonality, to determine if the Company's loans are performing in line with original estimations. The net credit loss analysis does not include considerations of the Company's estimated allowance for credit losses. •Other income - The Company's flow agreements have resulted in a large portfolio of assets serviced for others. These assets provide a steady stream of servicing income and may provide a gain or loss on sale. The Company monitors the size of the portfolio and average servicing fee rate and gain. Additionally, due to the classification of the Company's personal lending portfolio as held for sale upon the decision to exit the personal lending line of business, adjustments to record this portfolio at the lower of cost or market are included in investment gains (losses), net, which is a component of other income (losses). •Operating expenses - The Company assesses its operational efficiency using the cost-to-managed assets ratio. The Company performs extensive analysis to determine whether observed fluctuations in operating expense levels indicate a trend or are the nonrecurring impact of large projects. The operating expense analysis also includes a loan- and portfolio-level review of origination and servicing costs to assist the Company in assessing profitability by pool and vintage. Because volume and portfolio size determine the magnitude of the impact of each of the above factors on the Company's earnings, the Company also closely monitors origination and sales volume along with APR and discounts (including subvention and net of dealer participation). Recent Developments and Other Factors AffectingThe Company's Results of Operations Changes to Board of Directors & Management Team 40 --------------------------------------------------------------------------------Jose Doncel submitted his resignation from the Board, effective as ofDecember 18, 2019 . Also, onDecember 18, 2019 , the Board appointedHomaira Akbari as a member of the Board, effective as ofJanuary 1, 2020 . Effective as ofDecember 2, 2019 , the Board appointedMahesh Aditya , as President and CEO of the Company.Mr. Aditya replacedScott Powell , who resigned as President and CEO and as a director of the Company, effective as ofDecember 2, 2019 . Effective as ofSeptember 16, 2019 , the Board appointedFahmi Karam as CFO of the Company.Mr. Karam replacedJuan Carlos Alvarez de Soto , who departed from the Company to become CFO of SHUSA.
The Board appointed
Tender Offer OnJanuary 30, 2020 , the Company commenced a modified Dutch Auction tender offer to purchase up to$1 billion of shares of its common stock, at a range of between$23 and$26 per share, or such lesser number of shares of its common stock as are properly tendered and not properly withdrawn by the seller, in cash. The tender offer expires onFebruary 27, 2020 .
Volume
The Company's originations of loans and leases, including revolving loans,
average APR, and dealer discount (net of dealer participation) for the year
ended
For the Year Ended December 31,
2019 2018 2017
Retained Originations (Dollar amounts in thousands)
Retail installment contracts $ 15,835,618 $ 15,379,778 $ 11,634,395
Average APR 16.3 % 17.3 % 16.4 %
Average FICO® (a) 598 595 602
Discount (0.5) % 0.2 % 0.7 %
Personal loans (b) $
1,467,452
29.8 % 29.6 % 25.7 %
Leased vehicles $
8,520,489
Finance lease $
17,589
$
25,841,148
Sold Originations (c) Retail installment contracts $ -$ 1,820,085 $ 2,550,065 Average APR - % 7.3 % 6.2 % Average FICO® (d) - 727 727 Total Originations Sold $
-
Total SC Originations 25,841,148 28,434,750 21,658,652
Total originations (excluding SBNA Originations Program) (e)
$
25,841,148
(a)Unpaid principal balance excluded from the weighted average FICO score is$1.8 billion ,$1.9 billion and$1.5 billion as the borrowers on these loans did not have FICO scores at origination and$582 million ,$76 million and$164 million of commercial loans for the years ended 2019, 2018 and 2017, respectively. (b) Included in the total origination volume is$270 million ,$304 million and$264 million for the years ended 2019, 2018 and 2017, respectively, related to newly opened accounts. (c) There were no sales in 2019. 41 -------------------------------------------------------------------------------- (d) Unpaid principal balance excluded from the weighted average FICO score is zero,$143 million and$318 million as the borrowers on these loans did not have FICO scores at origination and zero,$76 million and$102 million of commercial loans for the years ended 2019, 2018 and 2017, respectively. (e) Total originations excludes finance receivables (UPB) of$1.1 billion , zero and zero purchased from third party lenders during the years endedDecember 31, 2019 , 2018 and 2017, respectively. Total auto originations (excluding SBNA Origination Program) decreased$2.6 billion , or 9.6%, from the year endedDecember 31, 2018 to the year endedDecember 31, 2019 , since the Company has initiated the SBNA originations program as described below. The company's initiatives to improve our pricing as well as dealer and customer experience has increased our competitive position in the market. The Company continues to focus on optimizing the loan quality of its portfolio with an appropriate balance of volume and risk. CCAP volume and penetration rates are influenced by strategies implemented byFCA and the Company, including product mix and incentives.
SBNA Originations Program
Beginning in 2018, the Company agreed to provide SBNA with origination support services in connection with the processing, underwriting and purchase of retail auto loans, primarily fromFCA dealers. In addition, the Company agreed to perform the servicing for any loans originated on SBNA's behalf. During the year endedDecember 31, 2019 and 2018 the Company facilitated the purchase of$7.0 billion and$1.9 billion of retail installment contacts, respectively. The Company's originations of retail installment contracts and leases by vehicle type during the years endedDecember 31, 2019 , 2018 and 2017 were as follows: For the Year Ended December 31, 2019 2018 2017 (Dollar amounts in thousands) Retail installment contracts Car$ 5,644,541
35.6 %
%
Truck and utility 9,546,642
60.3 % 10,062,285 58.5 % 7,168,113 50.5
%
Van and other (a) 644,435 4.1 % 846,541 4.9 % 1,292,125 9.1 %
$ 15,835,618 100.0 % $ 17,199,863 100 % $ 14,184,460 100 %
Leased vehicles
Car $ 410,194 4.8 % $ 822,102 8.4 % 1,017,410 17.0 %
Truck and utility 7,831,086 91.9 % 8,532,819 87.6 % 4,582,753 76.5
%
Van and other (a) 279,209 3.3 % 387,502 4.0 % 387,485 6.5 %
$ 8,520,489 100.0 % $ 9,742,423 100.0 % $ 5,987,648 100.0 %
Total originations by vehicle type
Car $ 6,054,735 24.9 %
%
Truck and utility 17,377,728
71.3 % 18,595,104 69.0 % 11,750,866 58.3
%
Van and other (a) 923,644 3.8 % 1,234,043 4.6 % 1,679,610 8.3 %
$ 24,356,107 100.0 % $ 26,942,286 100.0 % $ 20,172,108 100.0 %
(a) Other primarily consists of commercial vehicles.
The Company's asset sales for the years ended December 31, 2019 , 2018 and 2017
were as follows:
For the Year Ended December 31,
2019 2018 2017
(Dollar amounts in thousands)
Retail installment contracts $ - $ 2,905,922 $ 2,979,033
Average APR - % 7.2 % 6.2 %
Average FICO® - 726 721
42-------------------------------------------------------------------------------- There were no asset sales during the year 2019. The Company's portfolio of retail installment contracts held for investment and leases by vehicle type as ofDecember 31, 2019 and 2018 are as follows: December 31, 2019 December 31, 2018 (Dollar amounts in thousands) Retail installment contracts Car$ 12,286,182 39.9 %$ 13,011,925 45.7 % Truck and utility 17,238,406 56.0 % 14,266,757 50.1 % Van and other (a) 1,251,450 4.1 % 1,184,554 4.2 %$ 30,776,038 100.0 %$ 28,463,236 100.0 % Leased vehicles Car$ 1,237,803 7.1 %$ 1,590,621 10.5 % Truck and utility 15,795,594 89.8 % 12,899,955 84.8 % Van and other (a) 529,385 3.1 % 728,737 4.7 %$ 17,562,782 100.0 %$ 15,219,313 100.0 % Total by vehicle type Car$ 13,523,985 28.0 %$ 14,602,546 33.4 % Truck and utility 33,034,000 68.3 % 27,166,712 62.2 % Van and other (a) 1,780,835 3.7 % 1,913,291 4.4 %$ 48,338,820 100.0 %$ 43,682,549 100.0 % (a) Other primarily consists of commercial vehicles. The unpaid principal balance, average APR, and remaining unaccreted net discount of the Company's held for investment portfolio as ofDecember 31, 2019 and 2018 are as follows: December 31, 2019 December 31, 2018 (Dollar amounts in thousands) Retail installment contracts (a)$ 30,776,038 $ 28,463,236 Average APR 16.1 % 16.7 % Discount 0.3 % 0.8 % Personal loans (b) $ - $ 2,637 Average APR - % 31.7 % Receivables from dealers $ 12,668 $ 14,710 Average APR 4.0 % 4.1 % Leased vehicles$ 17,562,782 $ 15,219,313 Finance leases $ 27,584 $ 19,344 (a) Of this balance as ofDecember 31, 2019 ,$13.5 billion ,$8.0 billion and$3.8 billion was originated in the years endedDecember 31, 2019 , 2018 and 2017 respectively. (b) The remaining balance of personal loans, held for investment, was charged off during the quarter endedJune 30, 2019 . The Company records interest income from retail installment contracts and receivables from dealers in accordance with the terms of the loans, generally discontinuing and reversing accrued income once a loan becomes more than 60 days past due, except in the case of revolving personal loans, for which the Company continues to accrue interest until charge-off, in the month in which the loan becomes 180 days past due, and receivables from dealers, for which the Company continues to accrue interest until the loan becomes more than 90 days past due. 43 -------------------------------------------------------------------------------- The Company generally does not acquire receivables from dealers and term personal loans at a discount. The Company amortizes discounts, subvention payments from manufacturers, and origination costs as adjustments to income from retail installment contracts using the effective yield method. The Company estimates future principal prepayments specific to pools of homogeneous loans which are based on the vintage, credit quality at origination and term of the loan. Prepayments in our portfolio are sensitive to credit quality, with higher credit quality loans generally experiencing higher voluntary prepayment rates than lower credit quality loans. The impact of defaults is not considered in the prepayment rate; the prepayment rate only considers voluntary prepayments. The resulting prepayment rate specific to each pool is based on historical experience, and is used as an input in the calculation of the constant effective yield. Our estimated weighted average prepayment rates ranged from 5.1% to 11.0% as ofDecember 31, 2019 , and 5.7% to 10.8% as ofDecember 31, 2018 . The Company amortizes the discount, if applicable, on revolving personal loans straight-line over the estimated period over which the receivables are expected to be outstanding. For retail installment contracts, personal loans, finance leases, and receivables from dealers, the Company also establishes a credit loss allowance for the estimated losses inherent in the portfolio. The Company estimates probable losses based on contractual delinquency status, historical loss experience, expected recovery rates from sale of repossessed collateral, bankruptcy trends, and general economic conditions such as unemployment rates. For loans within these portfolios that are classified as TDRs, impairment is measured based on the present value of expected future cash flows discounted at the original effective interest rate. For loans that are considered collateral-dependent, such as certain bankruptcy modifications, impairment is measured based on the fair value of the collateral, less its estimated cost to sell. The Company classifies most of its vehicle leases as operating leases. The Company records the net capitalized cost of each lease as an asset, which is depreciated straight-line over the contractual term of the lease to the expected residual value. The Company records lease payments due from customers as income until and unless a customer becomes more than 60 days delinquent, at which time the accrual of revenue is discontinued and reversed. The Company resumes and reinstates the accrual if a delinquent account subsequently becomes 60 days or less past due. The Company amortizes subvention payments from the manufacturer, down payments from the customer, and initial direct costs incurred in connection with originating the lease straight-line over the contractual term of the lease. Historically, the Company's primary means of acquiring retail installment contracts has been through individual acquisitions immediately after origination by a dealer. The Company also periodically purchases pools of receivables and had significant volumes of these purchases during the credit crisis. During the year endedDecember 31, 2019 , the Company purchased a pool of receivables from a third party lender for$1.09 billion , of which the Company elected the fair value option for$22 million deemed to be non-performing since it was determined that not all contractually required payments would be collected. The Company did not purchase any pools of non-performing loans during the years endedDecember 31, 2018 and 2017. In addition, during the years endedDecember 31, 2019 , 2018 and 2017 the Company did recognize certain retail installment contracts with an unpaid principal balance of$74,718 ,$213,973 and$290,613 respectively, held by non-consolidated securitization Trusts under optional clean-up calls. Following the initial recognition of these loans at fair value, the performing loans in the portfolio will be carried at amortized cost, net of allowance for credit losses. The Company elected the fair value option for all non-performing loans acquired (more than 60 days delinquent as of re-recognition date), for which it was probable that not all contractually required payments would be collected. For the Company's existing purchased receivables portfolios - credit impaired, which were acquired at a discount partially attributable to credit deterioration since origination, the Company estimates the expected yield on each portfolio at acquisition and record monthly accretion income based on this expectation. The Company periodically re-evaluates performance expectations and may increase the accretion rate if a pool is performing better than expected. If a pool is performing worse than expected, the Company is required to continue to record accretion income at the previously established rate and to record impairment to account for the worsening performance. 44 --------------------------------------------------------------------------------
Year Ended
For the Year Ended
December 31, Increase (Decrease)
2019 2018 Amount Percent
(Dollar amounts in thousands)
Income from retail installment contracts $ 4,683,083 $ 4,487,614 $ 195,469 4 %
Income from purchased receivables portfolios - credit impaired 4,007 8,569 (4,562) (53) % Income from receivables from dealers 240 458 (218) (48) % Income from personal loans 362,636 345,923 16,713 5
%
Total interest on finance receivables and loans$ 5,049,966 $ 4,842,564 $ 207,402 4 % Income from retail installment contracts increased$195 million , or 4%, from 2018 to 2019, primarily due to a 5.5% increase in average outstanding balance of company's portfolio and new originations in 2019 with higher loan APRs.
Income from purchased receivables - credit impaired portfolios decreased
For the Year Ended
December 31, Increase (Decrease)
2019 2018 Amount Percent
(Dollar amounts in thousands)
Leased vehicle income $ 2,764,258 $ 2,257,719 $ 506,539 22 %
Leased vehicle expense 1,862,121 1,535,756 326,365 21 %
Leased vehicle income, net $ 902,137 $ 721,963 $ 180,174 25 %
Leased vehicle income, net increased in 2019 as compared to 2018 due to an
increase in average outstanding balance of the portfolio by 26%. Through the
Chrysler Agreement, the Company receives manufacturer incentives on new leases
originated under the program in the form of lease subvention payments, which are
amortized over the term of the lease and reduce depreciation expense within
leased vehicle expense.
Interest Expense
For the Year Ended
December 31, Increase (Decrease)
2019 2018 Amount Percent
(Dollar amounts in thousands)
Interest expense on notes payable $ 1,356,245 $ 1,158,271 $ 197,974 17 %
Interest expense on derivatives (24,441) (46,511) 22,070 (47) % Total interest expense$ 1,331,804 $ 1,111,760 $ 220,044 20
%
Total Interest expense increased
For the Year Ended
December 31, Increase (Decrease)
2019 2018 Amount Percent
(Dollar amounts in thousands)
Provision for credit losses $ 2,093,749 $ 2,205,585 $ (111,836) (5) %
45-------------------------------------------------------------------------------- Provision for credit losses decreased$112 million , or 5%, from 2018 to 2019, primarily due to net charge off activity and portfolio composition. Our assets covered by allowance for credit losses have increased 8.2% from 2018 to 2019 but our total allowance ratio has decreased from 11.4% atDecember 31, 2018 to 9.9% atDecember 31, 2019 , driven by lower TDR balances and better recovery rates. Profit Sharing For the Year Ended December 31, Increase (Decrease) 2019 2018 Amount Percent (Dollar amounts in thousands) Profit sharing$ 52,731 $ 33,137 $ 19,594 59 % Profit sharing expense consists of revenue sharing related to the Chrysler Agreement and profit sharing on personal loans originated pursuant to the agreements with Bluestem. Profit sharing expense increased in 2019 compared to 2018, primarily due to increase in lease portfolio and an increase in profit sharing eligible portfolio due to amendment to the Chrysler Agreement withFCA . Other Income For the Year Ended December 31, Increase (Decrease) 2019 2018 Amount Percent (Dollar amounts in thousands) Investment losses, net$ (406,687) $ (401,638) $ (5,049) (1) % Servicing fee income 91,334 106,840 (15,506) (15) % Fees, commissions, and other 364,119 333,458 30,661 9 % Total other income$ 48,766 $ 38,660 $ 10,106 26 % Average serviced for others portfolio $
9,443,908
Investment losses, net, remained flat from 2018 to 2019.
Servicing fee income decreased$16 million in 2019, as compared to 2018, due to the lower average balances for serviced portfolio that had higher servicing fee rates. The Company records servicing fee income on loans that it services but does not own and does not report on its balance sheet. The serviced for others portfolio as ofDecember 31, 2019 and 2018 was as follows:December 31, 2019 2018 (Dollar amounts in thousands)
SBNA and Santander retail installment contracts
177 338
Total serviced for related parties 8,800,866 5,414,454 CCAP securitizations 259,197 611,050 Other third parties 1,353,524 2,959,929 Total serviced for third parties 1,612,721
3,570,979
Total serviced for others portfolio$ 10,413,587 $
8,985,433
Fees, commissions, and other, primarily includes late fees, miscellaneous, and
other income. This income increased in 2019 as compared 2018, primarily due to
the increase in referral fee income from SBNA related to origination support
services.
46
--------------------------------------------------------------------------------
Total Operating Expenses
For the Year Ended
December 31, Increase (Decrease)
2019 2018 Amount Percent
(Dollar amounts in thousands)
Compensation expense $ 510,743 $ 482,800 $ 27,943 6 %
Repossession expense 262,061 264,777 (2,716) (1) %
Other operating costs 437,747 346,095 91,652 26 %
Total operating expenses $ 1,210,551 $ 1,093,672 $ 116,879 11 %
Compensation expense increased during 2019 compared to 2018, primarily due to an
increase in average number of employees period over period.
Repossession expense remained flat from 2018 to 2019.
Other operating costs increased during 2019 compared to 2018, primarily due to
an increase in legal accruals in 2019.
Income Tax Expense
For the Year Ended
December 31, Increase (Decrease)
2019 2018 Amount Percent
(Dollar amounts in thousands)
Income tax expense $ 359,898 $ 276,342 $ 83,556 30 %
Income before income taxes 1,354,268 1,192,268 162,000 14 %
Effective tax rate 26.6 % 23.2 %
The effective tax rate increased from 23.2% in 2018 to 26.6% in 2019, primarily due to certain state return to provision true-ups and decrease in electric vehicle credits in 2019.
Other Comprehensive Income (Loss)
For the Year Ended
December 31, Increase (Decrease)
2019 2018 Amount Percent
(Dollar amounts in thousands)
Change in unrealized gains (losses) on cash flow hedges and available-for-sale securities, net of tax
$ (60,208) $ (16,896) $ (43,312) (256) % The change in unrealized gains (losses) for 2019 as compared to 2018 was primarily driven by interest income realized into the Statement of Income in 2019. In addition, as described in Note 8 "Derivative Financial Instruments", our cash flow hedge portfolio is in a net negative position because of the decreasing rate environment. For information regarding the Company's analysis for the year endedDecember 31, 2018 to year endedDecember 31, 2017 , refer to the Results of Operation detailed in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the 2018 Annual Report on Form 10-K. Credit Quality Loans and Other Finance Receivables Non-prime loans comprise 78% of the Company's portfolio as ofDecember 31, 2019 . The Company records an allowance for credit losses to cover the estimate of inherent losses on retail installment contracts and other loans and receivables held for investment. Refer to Note 2 - "Finance Receivables" to these accompanying consolidated financial statements for the details on the Company's held for investment portfolio of retail installment contracts, receivables from dealers and personal loans as ofDecember 31, 2019 and 2018. 47 -------------------------------------------------------------------------------- A summary of the credit risk profile of the Company's retail installment contracts held for investment, by FICO® score, number of trade lines, and length of credit history, each as determined at origination, as ofDecember 31, 2019 and 2018 was as follows (dollar amounts in billions, totals may not foot due to rounding): December 31, 2019Trade Lines 1 2 3 4+ Total FICO Months History $ % $ % $ % $ % $ % No-FICO (a) <36$2.8 97 %$0.1 3 %$0.0 - %$0.0 - %$2.9 9 % 36+ 0.3 38 % 0.2 25 % 0.1 13 % 0.2 25 % 0.8 3 % <540 <36 0.1 25 % 0.1 25 % 0.1 25 % 0.1 25 % 0.4 1 % 36+ 0.1 2 % 0.2 4 % 0.2 4 % 4.4 90 % 4.9 16 % 540-599 <36 0.3 43 % 0.2 29 % 0.1 14 % 0.1 14 % 0.7 2 % 36+ 0.2 2 % 0.3 3 % 0.3 3 % 8.3 91 % 9.1 30 % 600-639 <36 0.3 43 % 0.2 29 % 0.1 14 % 0.1 14 % 0.7 2 % 36+ 0.1 2 % 0.1 2 % 0.2 4 % 4.7 92 % 5.1 17 % >640 <36 0.5 45 % 0.1 9 % 0.1 9 % 0.4 36 % 1.1 4 % 36+ 0.1 2 % 0.1 2 % 0.1 2 % 4.7 94 % 5.0 16 % Total$4.8 16 %$1.6 5 %$1.3 4 %$23.0 75 %$30.8 100 % December 31, 2018Trade Lines 1 2 3 4+ Total FICO Months History $ % $ % $ % $ % $ % No-FICO (a) <36$ 2.5 96 %$ 0.1 4 % $ - - $ - -$ 2.6 9 % 36+ 0.4 40 % 0.2 20 % 0.1 10 % 0.3 30 % 1.0 4 % <540 <36 0.1 25 % 0.1 25 % 0.1 25 % 0.1 25 % 0.4 1 % 36+ 0.2 4 % 0.3 5 % 0.3 5 % 4.7 86 % 5.5 19 % 540-599 <36 0.3 37 % 0.2 25 % 0.1 13 % 0.2 25 % 0.8 3 % 36+ 0.2 2 % 0.2 2 % 0.3 4 % 7.7 92 % 8.4 30 % 600-639 <36 0.2 33 % 0.1 17 % 0.1 17 % 0.2 33 % 0.6 2 % 36+ 0.1 2 % 0.1 2 % 0.1 2 % 4.2 94 % 4.5 16 % >640 <36 0.3 43 % 0.2 29 % 0.1 14 % 0.1 14 % 0.7 2 % 36+ 0.1 2 % 0.1 2 % 0.1 2 % 3.7 94 % 4.0 14 % Total$ 4.4 15 %$ 1.6 6 %$ 1.3 5 %$ 21.2 74 %$ 28.5 100 % (a) Includes commercial loans Delinquencies
The Company considers an account delinquent when an obligor fails to pay substantially all (defined as 90%) of the scheduled payment by the due date.
In each case, the period of delinquency is based on the number of days payments are contractually past due. Delinquencies may vary from period to period based upon the average age or seasoning of the portfolio, seasonality within the calendar year, and economic factors. Historically, the Company's delinquencies have been highest in the period from November through January due to consumers' holiday spending. Refer to Note 4 - "Credit Loss Allowance and Credit Quality" to these accompanying consolidated financial statements for the details on the retail installment contracts held for investment that were placed on nonaccrual status, as ofDecember 31, 2019 and 2018. Credit Loss Experience The following is a summary of net losses and repossession activity on retail installment contracts held for investment for the year endedDecember 31, 2019 and 2018. 48 --------------------------------------------------------------------------------
For the Year Ended December 31,
2019 2018
(Dollar amounts in thousands)
Principal outstanding at year end $ 30,776,038 $ 28,463,236
Average principal outstanding during the period $ 29,248,201 $ 27,263,780
Number of receivables outstanding at year end 1,810,973 1,800,081
Average number of receivables outstanding during the period 1,814,454 1,762,594
Number of repossessions (a) 285,661 287,694
Number of repossessions as a percent of average number of receivables outstanding
15.7 % 16.3 %
Net losses $ 2,288,812 $ 2,313,286
Net losses as a percent of average principal amount outstanding 7.8 % 8.5 %
(a) Repossessions are net of redemptions. The number of repossessions includes
repossessions from the outstanding portfolio and from accounts already charged
off.
There were no charge-offs on the Company's receivables from dealers for the
years ended December 31, 2019 and 2018. Net charge-offs on the finance lease
receivables portfolio, totaled $769 and $1,642 for the years ended December 31,
2019 and 2018, respectively.
Deferrals and Troubled Debt Restructurings
In accordance with the Company's policies and guidelines, the Company may offer
extensions (deferrals) to consumers on its retail installment contracts, whereby
the consumer is allowed to move a maximum of three payments per event to the end
of the loan. The Company's policies and guidelines limit the frequency of each
new deferral that may be granted to one deferral every six months, regardless of
the length of any prior deferral. The maximum number of lifetime months extended
for all automobile retail installment contracts is eight, while some marine and
recreational vehicle contracts have a maximum of twelve months extended to
reflect their longer term. Additionally, the Company generally limits the
granting of deferrals on new accounts until a requisite number of payments has
been received. During the deferral period, the Company continues to accrue and
collect interest on the loan in accordance with the terms of the deferral
agreement.
At the time a deferral is granted, all delinquent amounts may be deferred or
paid. This may result in the classification of the loan as current and therefore
not considered a delinquent account. However, there are other instances when a
deferral is granted but the loan is not brought completely current, such as when
the account days past due is greater than the deferment period granted. Such
accounts are aged based on the timely payment of future installments in the same
manner as any other account. Historically, the majority of deferrals are
approved for borrowers who are either 31-60 or 61-90 days delinquent, and these
borrowers are typically reported as current after deferral. A customer is
limited to one deferral each six months, and if a customer receives two or more
deferrals over the life of the loan, the loan will advance to a TDR designation.
The following is a summary of deferrals on the Company's retail installment
contracts held for investment as of the dates indicated:
December 31, 2019 December 31, 2018
(Dollar amounts in thousands)
Never deferred $ 23,830,368 77.3 % $ 20,212,452 71.0 %
Deferred once 3,499,477 11.4 % 3,690,522 13.0 %
Deferred twice 1,463,503 4.8 % 1,952,894 6.9 %
Deferred 3 - 4 times 1,867,546 6.1 % 2,516,451 8.8 %
Deferred greater than 4 times 115,144 0.4 % 90,917 0.3 %
Total $ 30,776,038 $ 28,463,236
The Company evaluates the results of deferral strategies based upon the amount
of cash installments that are collected on accounts after they have been
deferred versus the extent to which the collateral underlying the deferred
accounts has depreciated over the same period of time. Based on this evaluation,
the Company believes that payment deferrals granted according to its policies
and guidelines are an effective portfolio management technique and result in
higher ultimate cash collections from the portfolio.
Changes in deferral levels do not have a direct impact on the ultimate amount of
consumer finance receivables charged off. However, the timing of a charge-off
may be affected if the previously deferred account ultimately results in a
charge-off. To the extent that deferrals impact the ultimate timing of when an
account is charged off, historical charge-off ratios, loss confirmation
49
--------------------------------------------------------------------------------periods, and cash flow forecasts for loans classified as TDRs used in the determination of the adequacy of the Company's allowance for credit losses are also impacted.
Increased use of deferrals may result in a lengthening of the loss confirmation period, which would increase expectations of credit losses inherent in the portfolio and therefore increase the allowance for credit losses and related provision for credit losses. Changes in the charge-off ratios and loss confirmation periods are considered in determining the appropriate level of allowance for credit losses and related provision for credit losses, including the allowance and provision for loans that are not classified as TDRs. For loans that are classified as TDRs, the Company generally compares the present value of expected cash flows to the outstanding recorded investment of TDRs to determine the amount of TDR impairment and related provision for credit losses that should be recorded. For loans that are considered collateral-dependent, such as certain bankruptcy modifications, impairment is measured based on the fair value of the collateral, less its estimated cost to sell. The Company also may agree, or be required by operation of law or by a bankruptcy court, to grant a modification involving one or a combination of the following: a reduction in interest rate, a reduction in loan principal balance, a temporary reduction of monthly payment, or an extension of the maturity date. The servicer of the Company's revolving personal loans also may grant modifications in the form of principal or interest rate reductions or payment plans. Similar to deferrals, the Company believes modifications are an effective portfolio management technique. Not all modifications are classified as TDRs as the loan may not meet the scope of the applicable guidance or the modification may have been granted for a reason other than the borrower's financial difficulties. A loan that has been classified as a TDR remains so until the loan is liquidated through payoff or charge-off. TDRs are generally placed on nonaccrual status when the account becomes past due more than 60 days. For loans on nonaccrual status, interest income is recognized on a cash basis and the accrual of interest is resumed and reinstated if a delinquent account subsequently becomes 60 days or less past due. TDR loans are generally measured based on the present value of expected cash flows. The recognition of interest income on TDR loans reflects management's best estimate of the amount that is reasonably assured of collection and is consistent with the estimate of future cash flows used in the impairment measurement. Any accrued but unpaid interest is fully reserved for through the recognition of additional impairment on the recorded investment, if not expected to be collected. The following is a summary of the principal balance as ofDecember 31, 2019 and 2018 of loans that have received these modifications and concessions; December 31, 2019 December 31, 2018 Retail Installment Contracts (Dollar amounts in thousands) Temporary reduction of monthly payment (a)$1,168,358 $ 2,137,334 Bankruptcy-related accounts 41,756 54,373 Extension of maturity date 35,238 25,644 Interest rate reduction 61,870 54,906 Max buy rate and fair lending (b) 6,069,509 4,685,522 Other (c) 240,553 137,958 Total modified loans$ 7,617,284 $ 7,095,737 (a) Reduces a customer's payment for a temporary time period (no more than six months) (b) Max buy rate modifications comprises of loans modified by the Company to adjust the interest rate quoted in a dealer-arranged financing. The Company reassesses the contracted APR when changes in the deal structure are made (e.g., higher down payment and lower vehicle price). If any of the changes result in a lower APR, the contracted rate is reduced. Substantially all deal structure changes occur within seven days of the date the contract is signed. These deal structure changes are made primarily to give the consumer the benefit of a lower rate due to an improved contracted deal structure compared to the deal structure that was approved during the underwriting process.Fair Lending modifications comprises of loans modified by the Company related to possible "disparate impact" credit discrimination in indirect vehicle finance. These modifications are not considered a TDR event because they do not relate to a concession provided to a customer experiencing financial difficulty. (c) Includes various other types of modifications and concessions, such as hardship modifications that are considered a TDR event. Refer to Note 4 - "Credit Loss Allowance and Credit Quality" to these accompanying consolidated financial statements for the details on the Company's recorded investment in TDRs and a summary of delinquent TDRs, as ofDecember 31, 2019 and 2018. 50 --------------------------------------------------------------------------------
The following table shows the components of the changes in the recorded
investment in retail installment contract TDRs (excluding collateral-dependent
bankruptcy TDRs) for the years ended
For the Year Ended December 31,
2019 2018
Balance - beginning of year $ 5,365,477 $ 6,328,159
New TDRs 1,275,300 2,210,872
Charge-offs (1,555,474) (2,022,130)
Paydowns (a) (1,256,801) (1,154,940)
Others 390 3,516
Balance - end of year $ 3,828,892 $ 5,365,477
(a) Includes net discount accreted in interest income for the period.
For loans not classified as TDRs, the Company generally estimates an appropriate
allowance for credit losses based on delinquency status, the Company's
historical loss experience, estimated values of underlying collateral, and
various economic factors. Once a loan has been classified as a TDR, it is
generally assessed for impairment based on the present value of expected future
cash flows discounted at the loan's original effective interest rate considering
all available evidence. For loans that are considered collateral-dependent, such
as certain bankruptcy modifications, impairment is measured based on the fair
value of the collateral, less its estimated cost to sell. Due to this key
distinction in allowance calculations, the coverage ratio is higher for TDRs in
comparison to non-TDRs.
The table below presents the Company's allowance ratio for TDR and non-TDR
retail installment contracts as of December 31, 2019 and 2018:
December 31, 2019 December 31, 2018
(Dollar amounts in thousands)
TDR - Unpaid principal balance $ 3,859,040 $ 5,378,603
TDR - Impairment 914,718 1,416,743
TDR - Allowance ratio 23.7 % 26.3 %
Non-TDR - Unpaid principal balance $ 26,895,551 $ 23,054,157
Non-TDR - Allowance 2,123,878 1,819,360
Non-TDR Allowance ratio 7.9 % 7.9 %
Total - Unpaid principal balance $ 30,754,591 $ 28,432,760
Total - Allowance 3,038,596 3,236,103
Total - Allowance ratio 9.9 % 11.4 %
The total allowance decreased from December 31, 2019 to December 31, 2018 ,
primarily driven by lower TDR balances and better recovery rates.
Liquidity Management, Funding and Capital Resources
Source of Funding
The Company requires a significant amount of liquidity to originate and acquire
loans and leases and to service debt. The Company funds its operations through
its lending relationships with 13 third-party banks, SHUSA and through
securitizations in the ABS market and flow agreements. The Company seeks to
issue debt that appropriately matches the cash flows of the assets that it
originates. The Company has more than $7.3 billion of stockholders' equity that
supports its access to the securitization markets, credit facilities, and flow
agreements.
During the year ended December 31, 2019 , the Company completed on-balance sheet
funding transactions totaling approximately $18.2 billion , including:
•securitizations on the Company's SDART platform for approximately $3.2 billion ;
•securitizations on the Company's DRIVE, deeper subprime platform, for
approximately $4.5 billion ;
•lease securitizations on our SRT platform for approximately $3.7 billion ;
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•lease securitization on our PSRT platform for approximately $1.2 billion ;
•private amortizing lease facilities for approximately $4.6 billion ;
•securitization on the Company's SREV platform for approximately $0.9 billion .
•issuance of retained bonds on the Company's SDART platform for approximately
$129.8 million ; and
•issuance of a retained bond on the Company's SRT platform for approximately
$60.4 million
Refer to Note 6 - "Debt" to these accompanying consolidated financial statements
for the details on the Company's total debt.
Credit Facilities
Third-party Revolving Credit Facilities
Warehouse Lines
The Company uses warehouse facilities to fund its originations. Each facility
specifies the required collateral characteristics, collateral concentrations,
credit enhancement, and advance rates. The Company's warehouse facilities
generally are backed by auto retail installment contracts or auto leases. These
facilities generally have one- or two-year commitments, staggered maturities and
floating interest rates. The Company maintains daily and long term funding
forecasts for originations, acquisitions, and other large outflows such as tax
payments to balance the desire to minimize funding costs with liquidity needs.
The Company's warehouse facilities generally have net spread, delinquency, and
net loss ratio limits. Generally, these limits are calculated based on the
portfolio collateralizing the respective line; however, for certain warehouse
facilities, delinquency and net loss ratios are calculated with respect to the
serviced portfolio as a whole. Failure to meet any of these covenants could
trigger increased overcollateralization requirements or, in the case of limits
calculated with respect to the specific portfolio underlying certain credit
lines, result in an event of default under these agreements. If an event of
default occurs under one of these agreements, the lenders could elect to declare
all amounts outstanding under the impacted agreement to be immediately due and
payable, enforce their interests against collateral pledged under the agreement,
restrict the Company's ability to obtain additional borrowings under the
agreement, and/or remove it as servicer. The Company has never had a warehouse
facility terminated due to failure to comply with any ratio or a failure to meet
any covenant. A default under one of these agreements can be enforced only with
respect to the impacted facility.
The Company has one credit facility with eight banks providing an aggregate
commitment of $5.0 billion for the exclusive use of providing short-term
liquidity needs to support Chrysler Finance lease financing. As of December 31,
2019 there was an outstanding balance of approximately $1.1 billion on this
facility in aggregate. The facility requires reduced Advance Rates in the event
of delinquency, credit loss, or residual loss ratios, as well as other metrics
exceeding specified thresholds.
The Company has seven credit facilities with eleven banks providing an aggregate
commitment of $6.5 billion for the exclusive use of providing short-term
liquidity needs to support Core and CCAP Loan financing. As of December 31,
2019 there was an outstanding balance of approximately $3.9 billion on these
facilities in aggregate. These facilities reduced Advance Rates in the event of
delinquency, credit loss, as well as various other metrics exceeding specific
thresholds.
Repurchase Agreements
The Company obtains financing through investment management or repurchase
agreements whereby the Company pledges retained subordinate bonds on its own
securitizations as collateral for repurchase agreements with various borrowers
and at renewable terms ranging up to one year. As of December 31, 2019 there was
an outstanding balance of $422 million under these repurchase agreements.
Lines of Credit with Santander and Related Subsidiaries Santander and certain of its subsidiaries, such as SHUSA, historically have provided, and continue to provide, the Company with significant funding support in the form of committed credit facilities. The Company's debt with these affiliated entities consisted of the following:
52
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As of
Average Maximum
Outstanding Outstanding
Counterparty Utilized Balance Committed Amount Balance Balance
Promissory Note SHUSA $ 250,000 $ 250,000 $ 250,000 $ 250,000
Promissory Note SHUSA 250,000 250,000 250,000 250,000
Promissory Note SHUSA 250,000 250,000 250,000 250,000
Promissory Note SHUSA 250,000 250,000 250,000 250,000
Promissory Note SHUSA 300,000 300,000 247,397 300,000
Promissory Note SHUSA 400,000 400,000 400,000 400,000
Promissory Note SHUSA 400,000 400,000 400,000 400,000
Promissory Note SHUSA 500,000 500,000 500,000 500,000
Promissory Note SHUSA 500,000 500,000 275,342 500,000
Promissory Note SHUSA 500,000 500,000 242,466 500,000
Promissory Note SHUSA 650,000 650,000 650,000 650,000
Promissory Note SHUSA 650,000 650,000 650,000 650,000
Promissory Note SHUSA 750,000 750,000 205,479 750,000
Line of Credit SHUSA - 500,000 94,603 435,000
Line of Credit SHUSA - 3,000,000 - -
$ 5,650,000 $ 9,150,000
SHUSA provides the Company with $3.5 billion of committed revolving credit that
can be drawn on an unsecured basis. SHUSA also provides the Company with $5.7
billion of term promissory notes with maturities ranging from May 2020 to July
2024 .
Secured Structured Financings
The Company's secured structured financings primarily consist of public,
SEC -registered securitizations. The Company also executes private
securitizations under Rule 144A of the Securities Act and privately issues
amortizing notes. The Company has on-balance sheet securitizations outstanding
in the market with a cumulative ABS balance of approximately $28 billion .
The Company obtains long-term funding for its receivables through securitization
in the ABS market. ABS provides an attractive source of funding due to the cost
efficiency of the market, a large and deep investor base, and tenors that
appropriately match the cash flows of the debt to the cash flows of the
underlying assets. The term structure of a securitization generally locks in
fixed rate funding for the life of the underlying fixed rate assets, and the
matching amortization of the assets and liabilities provides committed funding
for the collateralized loans throughout their terms. In certain cases, SC may
choose to issue floating rate securities based on market conditions.
The Company executes each securitization transaction by selling receivables to
securitization Trusts that issue ABS to investors. To attain specified credit
ratings for each class of bonds, these securitization transactions have credit
enhancement requirements in the form of subordination, restricted cash accounts,
excess cash flow, and overcollateralization, whereby more receivables are
transferred to the Trusts than the amount of ABS issued by the Trusts.
Excess cash flows result from the difference between the finance and interest
income received from the obligors on the receivables and the interest paid to
the ABS investors, net of credit losses and expenses. Initially, excess cash
flows generated by the Trusts are used to pay down outstanding debt in the
Trusts, increasing overcollateralization until a targeted percentage has been
reached. Once the targeted overcollateralization is reached it is maintained and
excess cash flows generated by the Trusts are released to the holder of the
residual (generally the Company) as distributions from the Trusts. The Company
also receives monthly servicing fees as servicer for the Trusts. The Company's
securitizations may require an increase in credit enhancement levels if
Cumulative Net Losses, as defined in the documents in certain ABS transactions,
exceed a specified percentage of the pool balance. None of the Company's
securitizations have Cumulative Net Loss percentages above their respective
limits.
53
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The Company's on-balance sheet securitization transactions utilize
bankruptcy-remote special purpose entities, which are considered VIEs and meet
the requirements to be consolidated in the Company's financial statements.
Following a securitization, the finance receivables and the notes payable
related to the securitized retail installment contracts remain on the
consolidated balance sheets. The Company recognizes finance and interest income
as well as fee income on the collateralized retail installment contracts and
interest expense on the ABS issued. The Company also records a provision for
credit losses to cover the estimate of inherent credit losses on the retail
installment contracts. While these Trusts are consolidated in the Company's
financial statements, these Trusts are separate legal entities. Thus, the
finance receivables and other assets sold to these Trusts are legally owned by
these Trusts, are available only to satisfy the notes payable related to the
securitized retail installment contracts, and are not available to the Company's
creditors or its other subsidiaries.
The Company's securitizations generally have several classes of notes, with
principal paid sequentially based on seniority and any excess spread, once
targeted levels are reached, distributed to the residual holder. The company, at
times when economically favorable, retains the lowest bond class and the
residual, except in the case of off-balance sheet securitizations, which are
described further below. The Company uses the proceeds from securitization
transactions to repay borrowings outstanding under its credit facilities,
originate and acquire loans and leases, and for general corporate purposes. The
Company generally exercises clean-up call options on its securitizations when
the collateral pool balance reaches 10% of its original balance.
The Company also periodically privately issues amortizing notes in transactions
that are structured similarly to its public and Rule 144A securitizations but
are issued to banks and conduits. The Company's securitizations and private
issuances are collateralized by vehicle retail installment contracts, loans and
vehicle leases.
Flow Agreements
In addition to the Company's credit facilities and secured structured
financings, the Company has a flow agreement in place with a third party for
charged off assets. Loans and leases sold under these flow agreements are not on
the Company's balance sheet but provide a stable stream of servicing fee income
and may also provide a gain or loss on sale. The Company continues to actively
seek additional flow agreements.
Off-Balance Sheet Financing
Beginning in 2017, the Company had the option to sell a contractually determined amount of eligible prime loans to Santander, through securitization platforms. As all of the notes and residual interests in the securitizations were issued to Santander, the Company recorded these transactions as true sales of the retail installment contracts securitized, and removed the sold assets from the Company's consolidated balance sheets. Beginning in 2018, this program has been replaced with a new program with SBNA, whereby the Company has agreed to provide SBNA with origination support services in connection with the processing, underwriting and purchasing of retail loans, primarily fromFCA dealers, all of which are serviced by the Company. Cash Flow Comparison The Company has historically produced positive net cash from operating activities. The Company's investing activities primarily consist of originations, acquisitions, and collections from retail installment contracts. SC's financing activities primarily consist of borrowing, repayments of debt, share repurchases, and payment of dividends. For the Year Ended December 31, 2019 2018 2017 (Dollar amounts in thousands)
Net cash provided by operating activities
$ 3,941,346 Net cash used in investing activities (9,272,431) (10,415,788)
(3,590,333)
Net cash provided by financing activities 3,649,801 3,339,696
(186,785)
Net Cash Provided by Operating Activities Net cash provided by operating activities decreased by$0.7 billion from the year endedDecember 31, 2018 to the year endedDecember 31, 2019 , mainly due to lower origination of assets held for sale.Net Cash Used in Investing Activities 54 -------------------------------------------------------------------------------- Net cash used in investing activities decreased by$1.1 billion from the year endedDecember 31, 2018 to the year endedDecember 31, 2019 , primarily due to a decrease of$1.2 billion in leased vehicles purchased. Net Cash Provided by Financing Activities Net cash provided by financing activities increased by$0.3 billion from the year endedDecember 31, 2018 to the year endedDecember 31, 2019 , primarily due to the increase of proceeds from notes payable. Contingencies and Off-Balance Sheet Arrangements For information regarding the Company's contingencies and off-balance sheet arrangements, refer to Note 7 - "Variable Interest Entities" and Note 11 - "Commitments and Contingencies" in the accompanying consolidated financial statements. Contractual Obligations The Company leases its headquarters inDallas, Texas , its servicing centers inTexas ,Colorado ,Arizona , andPuerto Rico , and an operations facilities inCalifornia ,Texas andColorado under non-cancelable operating leases that expire at various dates through 2027. The Company also has various debt obligations entered into in the normal course of business as a source of funds. The following table summarizes the Company's contractual obligations as ofDecember 31, 2019 : 1-3 3-5 More than Less than 1 year years years 5 years Total (In thousands) Operating lease obligations $ 16,715$ 25,756
2,764,182 6,785,749 1,500,000 - 11,049,931
Notes payable - secured structured
financings (a) 203,114 10,381,235 11,461,822 6,160,727 28,206,898
Contractual interest on debt 1,082,851 1,105,445 270,848 94,436 2,553,580
Total $ 4,066,862 $ 18,298,185 $ 13,258,049 $ 6,274,854 $ 41,897,950 (a)Adjusted for unamortized costs of
Risk Management Framework
The Company has established a Board-approved Governance Framework that outlines governance principles organized into the following sections: strategic plan; risk identification and assessment; risk appetite; delegation of authority, decision making and accountability; risk management, risk taking and risk ownership; oversight and controls; monitoring, reporting and escalation; incentive compensation; shared services; recovery and resolution planning. The Company also uses three lines of defense risk governance structure that assigns responsibility for risk management among front-line business personnel, an independent risk management function, and internal audit. The Chief Risk Officer (CRO), who reports to the CEO and to the Risk Committee of the Board and is independent of any business line, is responsible for developing and maintaining a risk framework designed to ensure that risks are appropriately identified and mitigated, and for reporting on the overall level of risk in the Company. The CRO is also accountable to SHUSA'sChief Risk Officer . The Risk Committee is charged with responsibility for establishing the governance over the risk management process, providing oversight in managing the aggregate risk position and reporting on the comprehensive portfolio of risk categories and the potential impact these risks can have on the Company's risk profile. The Risk Committee meets no less often than quarterly and is chartered to assist the Board in promoting the best interests of the Company by overseeing policies, procedures and risk practices relating to enterprise-wide risk and compliance with regulatory guidance. Members of the Risk Committee are individuals whose experiences and qualifications can lead to broad and informed views on risk matters facing the Company and the financial services industry, including, but not limited to, risk matters that address credit, market, liquidity, operational, compliance and other general business conditions. A comprehensive risk report is submitted by the CRO to the Risk Committee of the Board at least quarterly providing management's view of the Company's risk position.
In addition to the Board and the Risk Committee, the CEO and CRO delegate risk responsibility to management committees. These committees include the Asset Liability Committee (ALCO), the Enterprise Risk Management Committee (EMRC), the
55
--------------------------------------------------------------------------------Executive Risk Committee, the Credit Risk Committee and the Pricing Committee. The CRO is a member of each of these committees and chairs the ERMC.
Additionally, the Company has established an Enterprise Risk Management (ERM) function and implemented a Board-approved Enterprise Risk Management Framework to manage risks across the organization in a comprehensive, consistent and effective fashion, enabling the firm to achieve its strategic priorities, including its business plan, within its expressed risk appetite. Accordingly, ERM oversees the implementation of the Board-approved Enterprise Risk Appetite Framework through which ERM manages the Company's Risk Appetite Statement, which details the type of risk and size of risk-taking activities permissible in the course of executing business strategy.
Credit Risk
The risk inherent in the Company's loan and lease portfolios is driven by credit and collateral quality, and is affected by borrower-specific and economy-wide factors such as changes in employment. The Company manages this risk through its underwriting, pricing and credit approval guidelines and servicing policies and practices, as well as geographic and other concentration limits. The Company's automated originations process is intended to reflect a disciplined approach to credit risk management. The Company's robust historical data on both organically originated and acquired loans is used by Company to perform advanced loss forecasting. Each applicant is automatically assigned a risk score using information fromCredit Bureau and credit application, placing the applicant in one of 80 pricing tiers. The Company continuously maintains and adjusts the pricing in each tier to reflect market and risk trends. In addition to the automated process, the Company maintains a team of underwriters for manual review, consideration of exceptions, and review of deal structures with dealers. The Company generally tightens its underwriting requirements in times of greater economic uncertainty to compete in the market at loss and approval rates acceptable for meeting the Company's required returns. The Company's underwriting policy has also been adjusted to meet the requirements of the Company's contracts such as the Chrysler Agreement. In both cases, the Company has accomplished this by adjusting risk-based pricing, the material components of which include interest rate, down payment, and loan-to-value. The Company monitors early payment defaults and other potential indicators of dealer or customer fraud and uses the monitoring results to identify dealers who will be subject to more extensive requirements when presenting customer applications, as well as dealers with whom the Company will not do business at all. Market Risk Interest Rate Risk The Company measures and monitors interest rate risk on at least a monthly basis. The Company borrows money from a variety of market participants to provide loans and leases to the Company's customers. The Company's gross interest rate spread, which is the difference between the income earned through the interest and finance charges on the Company's finance receivables and lease contracts and the interest paid on the Company's funding, will be negatively affected if the expense incurred on the Company's borrowings increases at a faster pace than the income generated by the Company's assets. The Company has policies in place designed to measure, monitor and manage the potential volatility in earnings stemming from changes in interest rates. The Company generates finance receivables which are predominantly fixed rate and borrow with a mix of fixed and variable rate funding. To the extent that the Company's asset and liability re-pricing characteristics are not effectively matched, the Company may utilize interest rate derivatives, such as interest rate swap agreements, to mitigate against interest rate risk. As ofDecember 31, 2019 , the notional value of the Company's interest rate swap agreements was$3.9 billion . The Company also enters into Interest Rate Cap agreements as required under certain lending agreements. In order to mitigate any interest rate risk assumed in the Cap agreement required under the lending agreement, the Company may enter into a second interest rate cap (Back-to-Back). As ofDecember 31, 2019 the notional value of the Company's interest rate cap agreements was$18.8 billion , under which, all notional was executed Back-to-Back. The Company monitors its interest rate exposure by conducting interest rate sensitivity analysis. For purposes of reflecting a possible impact to earnings, the twelve-month net interest income impact of an instantaneous 100 basis point parallel shift in prevailing interest rates is measured. As ofDecember 31, 2019 , the twelve-month impact of a 100 basis point parallel increase in the interest rate curve would decrease the Company's net interest income by$49 million . In addition to the sensitivity analysis on net interest income, the Company also measures Market Value of Equity (MVE) to view the interest rate risk position. MVE measures the change in value of Balance Sheet instruments in response to an instantaneous 100 basis point parallel increase, including and beyond the net interest income twelve-month horizon. As ofDecember 31, 2019 , the impact of a 100 basis point parallel increase in the interest rate curve would decrease the Company's MVE by$91 million . 56 -------------------------------------------------------------------------------- Collateral Risk The Company's lease portfolio presents an inherent risk that residual values recognized upon lease termination will be lower than those used to price the contracts at inception. Although the Company has elected not to purchase residual value insurance at the present time, the Company's residual risk is somewhat mitigated by the residual risk-sharing agreement withFCA . Under the agreement, the Company is responsible for incurring the first portion of any residual value gains or losses up to the first 8%. The Company andFCA then equally share the next 4% of any residual value gains or losses (i.e., those gains or losses that exceed 8% but are less than 12%). Finally,FCA is responsible for residual value gains or losses over 12%, capped at a certain limit, after which the Company incurs any remaining gains or losses. From the inception of the agreement withFCA through the year endedDecember 31, 2019 , approximately 89% of full term leases have not exceeded the first and second portions of any residual losses under the agreement. The Company also utilizes industry data, including the ALG benchmark for residual values, and employ a team of individuals experienced in forecasting residual values. Similarly, lower used vehicle prices also reduce the amount that can be recovered when remarketing repossessed vehicles that serve as collateral underlying loans. The Company manages this risk through loan-to-value limits on originations, monitoring of new and used vehicle values using standard industry guides, and active, targeted management of the repossession process. The Company does not currently have material exposure to currency fluctuations or inflation. Liquidity Risk The Company views liquidity as integral to other key elements such as capital adequacy, asset quality and profitability. The Company's primary liquidity risk relates to the ability to finance new originations through the Bank and ABS securitization markets. The Company has a robust liquidity policy that is intended to manage this risk. The liquidity risk policy establishes the following guidelines: •that the Company maintain at least eight external credit providers (as ofDecember 31, 2019 , it had thirteen); •that the Company relies on Santander and affiliates for no more than 30% of its funding (as ofDecember 31, 2019 , Santander and affiliates provided 14% of its funding); •that no single lender's commitment should comprise more than 33% of the overall committed external lines (as ofDecember 31, 2019 , the highest single lender's commitment was 23% (not including repo)); and •that no more than 35% and 65% of the Company's warehouse facilities mature in the next six months and twelve months respectively (as ofDecember 31, 2019 , two of the Company's warehouse facilities are scheduled to mature in the next six or twelve months). The Company's liquidity risk policy also requires that the Company's Asset Liability Committee monitor many indicators, both market-wide and company-specific, to determine if action may be necessary to maintain the Company's liquidity position. The Company's liquidity management tools include daily, monthly and twelve-month rolling cash requirements forecasts, long term strategic planning forecasts, monthly funding usage and availability reports, daily sources and uses reporting, structural liquidity risk exercises, key risk indicators, and the establishment of liquidity contingency plans. The Company also performs monthly stress tests in which it forecasts the impact of various negative scenarios (alone and in combination), including reduced credit availability, higher funding costs, lower Advance Rates, lending covenant breaches, lower dealer discount rates, and higher credit losses.
The Company generally seeks funding from the most efficient and cost effective source of liquidity from the ABS markets, third-party facilities, and Santander.
Additionally, the Company can reduce originations to significantly lower levels, if necessary, during times of limited liquidity. The Company had established a qualified like-kind exchange program to defer tax liability on gains on sale of vehicle assets at lease termination. If the Company does not meet the safe harbor requirements ofIRS Revenue Procedure 2003-39, the Company may be subject to large, unexpected tax liabilities, thereby generating immediate liquidity needs. The Company believes that its compliance monitoring policies and procedures are adequate to enable the Company to remain in compliance with the program requirements. The Tax Cuts and Jobs Act permanently eliminated the ability to exchange personal property afterJanuary 1, 2018 , which resulted in the like-kind exchange program being discontinued in 2018. Operational Risk The Company is exposed to operational risk loss arising from failures in the execution of our business activities. These relate to failures arising from inadequate or failed processes, failures in its people or systems, or from external events. The Company's operational risk management program includes Third Party Risk Management, Business Continuity Management, Information 57 -------------------------------------------------------------------------------- Risk Management,Information Risk Management , Fraud Risk Management, and Operational Risk Management, with key program elements covering Loss Event, Issue Management, Risk Reporting and Monitoring, and Risk Control Self-Assessment (RCSA). To mitigate operational risk, the Company maintains an extensive compliance, internal control, and monitoring framework, which includes the gathering of corporate control performance threshold indicators, Sarbanes-Oxley testing, monthly quality control tests, ongoing compliance monitoring with applicable regulations, internal control documentation and review of processes, and internal audits. The Company also utilizes internal and external legal counsel for expertise when needed. Upon hire and annually, all associates receive comprehensive mandatory regulatory compliance training. In addition, the Board receives annual regulatory and compliance training. The Company uses industry-leading call mining that assist the Company in analyzing potential breaches of regulatory requirements and customer service. Model Risk The Company mitigates model risk through a robust model validation process, which includes committee governance and a series of tests and controls. The Company utilizes SHUSA's Model Risk Management group for all model validation to verify models are performing as expected and in line with their design objectives and business uses. Critical Accounting Estimates Accounting policies are integral to understanding the Company's Management's Discussion and Analysis of Financial Condition and Results of Operations. The preparation of financial statements in accordance withU.S. Generally Accepted Accounting Principles (GAAP) requires management to make certain judgments and assumptions, on the basis of information available at the time of the financial statements, in determining accounting estimates used in the preparation of these statements. The Company's significant accounting policies are described in Note 1 - "Description of Business, Basis of Presentation, and Significant Accounting Policies and Practices" in the accompanying consolidated financial statements; critical accounting estimates are described in this section. An accounting estimate is considered critical if the estimate requires management to make assumptions about matters that were highly uncertain at the time the accounting estimate was made. If actual results differ from the Company's judgments and assumptions, then it may have an adverse impact on the results of operations, financial condition, and cash flows. The Company's management has discussed the development, selection, and disclosure of these critical accounting estimates with the Audit Committee of the Board, and the Audit Committee has reviewed the Company's disclosure relating to these estimates. Credit Loss Allowance The Company maintains a credit loss allowance (the allowance) for the Company's held-for-investment portfolio, excluding those loans measured at fair value in accordance with applicable accounting standards. For loans not classified as TDRs, the allowance is maintained at a level estimated to be adequate to absorb losses of recorded investment inherent in the portfolio, based upon a holistic assessment including both quantitative and qualitative considerations. For impaired loans, including those classified as TDRs, the allowance is comprised of impairment measured using a discounted cash flow model. The quantitative framework is supported by credit models that consider several credit quality indicators including, but not limited to, historical loss experience and current portfolio trends. The transition based Markov model provides data on a granular and disaggregated/segment basis as it utilizes the recently observed loan transition rates from various loan statuses to forecast future losses. Transition matrices in the Markov model are categorized based on account characteristics, such as delinquency status, TDR type (deferment, modification, etc.), internal credit risk, origination channel, months on book, thin/thick file and time since TDR event. The credit models utilized differ among the Company's retail installment contracts, personal loans, finance leases and receivables from dealers. The credit models are adjusted by management through qualitative reserves to incorporate information reflective of the current business environment. Management uses the qualitative framework to exercise judgment about matters that are inherently uncertain and that are not considered by the quantitative framework. These adjustments are documented and reviewed through the Company's risk management processes. Furthermore, management reviews, updates, and validates its process and loss assumptions on a periodic basis. This process involves an analysis of data integrity, review of loss and credit trends, a retrospective evaluation of actual loss information to loss forecasts, and other analyses. Accretion of Discounts and Subvention on Retail Installment Contracts 58 -------------------------------------------------------------------------------- Finance receivables held for investment consist largely of nonprime automobile finance receivables, which are primarily acquired individually from dealers at a nonrefundable discount from the contractual principal amount. The Company also pays dealer participation on certain receivables. The amortization of discounts, subvention payments from manufacturers, and other origination costs are recognized as adjustments to the yield of the related contracts. The Company applies significant assumptions including prepayment speeds in estimating the accretion rates used to approximate effective yield. The Company estimates future principal prepayments specific to pools of homogenous loans which are based on the vintage, credit quality at origination and term of the loan. Prepayments in our portfolio are sensitive to credit quality, with higher credit quality loans generally experiencing higher voluntary prepayment rates than lower credit quality loans. The impact of defaults is not considered in the prepayment rate; the prepayment rate only considers voluntary prepayments. The resulting prepayment rate specific to each pool is based on historical experience, and is used as an input in the calculation of the constant effective yield. Valuation of Automotive Lease Assets and ResidualsThe Company has significant investments in vehicles in the Company's operating lease portfolio. In accounting for operating leases, management must make a determination at the beginning of the lease contract of the estimated realizable value (i.e., residual value) of the vehicle at the end of the lease. Residual value represents an estimate of the market value of the vehicle at the end of the lease term, which typically ranges from two to four years. At contract inception, the Company determines the projected residual value based on an internal evaluation of the expected future value. This evaluation is based on a proprietary model using internally-generated data that is compared against third party, independent data for reasonableness. The customer is obligated to make payments during the term of the lease for the difference between the purchase price and the contract residual value plus a finance charge. However, since the customer is not obligated to purchase the vehicle at the end of the contract, the Company is exposed to a risk of loss to the extent the value of the vehicle is below the residual value estimated at contract inception. Management periodically performs a detailed review of the estimated realizable value of leased vehicles to assess the appropriateness of the carrying value of lease assets. To account for residual risk, the Company depreciates automotive operating lease assets to estimated realizable value on a straight-line basis over the lease term. The estimated realizable value is initially based on the residual value established at contract inception. Periodically, the Company revises the projected value of the lease vehicle at termination based on current market conditions, and other relevant data points, and adjusts depreciation expense appropriately over the remaining term of the lease. The Company periodically evaluates its investment in operating leases for impairment if circumstances, such as a systemic and material decline in used vehicle values, indicates that an impairment may exist. These circumstances could include, for example, shocks to oil and gas prices (which may have a pronounced impact on certain models of vehicles) or pervasive manufacturer defects (which may systemically affect the value of a particular vehicle brand or model). Impairment is determined to exist if fair value of the leased asset is less than carrying value and it is determined that the net carrying value is not recoverable. The net carrying value of a leased asset is not recoverable if it exceeds the sum of the undiscounted expected future cash flows expected to result from the lease payments and the estimated residual value upon eventual disposition. If our operating lease assets are considered to be impaired, the impairment is measured as the amount by which the carrying amount of the assets exceeds the fair value as estimated by discounted cash flows. No impairment was recognized in 2019, 2018 or 2017. The Company's depreciation methodology for operating lease assets considers management's expectation of the value of the vehicles upon lease termination, which is based on numerous assumptions and factors influencing used vehicle values. The critical assumptions underlying the estimated carrying value of automotive lease assets include: (1) estimated market value information obtained and used by management in estimating residual values, (2) proper identification and estimation of business conditions, (3) the Company's remarketing abilities, and (4) automotive manufacturer vehicle and marketing programs. Changes in these assumptions could have a significant impact on the value of the lease residuals. Expected residual values include estimates of payments from automotive manufacturers related to residual support and risk-sharing agreements, if any. To the extent an automotive manufacturer is not able to fully honor its obligation relative to these agreements, the Company's depreciation expense would be negatively impacted. Provision for Income Taxes In determining taxable income, the Company must make certain estimates and judgments. These estimates and judgments affect the calculation of certain tax liabilities and the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. The Company's largest deferred tax liability relates to leased vehicles. This liability is primarily due to the acceleration of depreciation for tax purposes and the deferral of tax gains through like-kind exchange transactions in prior years. The Tax Cuts 59 -------------------------------------------------------------------------------- and Jobs Act permanently eliminated the ability to exchange personal property afterJanuary 1, 2018 which resulted in the like-kind exchange program being discontinued in 2018. Because the volume of the Company's loan sales exceeds the "negligible sales" exception under section 475 of the Internal Revenue Code, the Company is classified as a dealer in securities for tax purposes. Accordingly, the Company must report its finance receivables and loans at fair value in the Company's tax returns. Changes in the fair value of Company's receivables and loans portfolios have a significant impact on the size of deferred tax assets and liabilities. Estimated fair value is dependent on key assumptions including prepayment rates, expected recovery rates, charge off rates and timing, and discount rates. In evaluating the Company's ability to recover deferred tax assets, the Company considers all available positive and negative evidence including past operating results and the Company's forecast of future taxable income. In estimating future taxable income, the Company develops assumptions including the amount of future pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates the Company is using to manage the Company's underlying businesses. Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. Management records the effect of a tax rate or law change on the Company's deferred tax assets and liabilities in the period of enactment. Future tax rate or law changes could have a material effect on the Company's results of operations, financial condition or cash flows. In addition, the calculation of the Company's tax liabilities involves dealing with uncertainties in the application of complex tax regulations inthe United States (includingPuerto Rico ). The Company recognizes potential liabilities and records tax liabilities for anticipated tax audit issues inthe United States and other tax jurisdictions based on estimates of whether, and the extent to which, additional taxes will be due in accordance with the authoritative guidance regarding the accounting for uncertain tax positions. The Company adjusts these reserves in light of changing facts and circumstances; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the tax liabilities. If the Company's estimate of tax liabilities proves to be less than the ultimate assessment, an additional charge to expense would result. If payment of these amounts ultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the period when the Company determines the liabilities are no longer necessary. For additional information regarding the Company's provision for income taxes, refer to Note 10 - "Income Taxes" in the accompanying financial statements. Fair Value of Financial Instruments The Company uses fair value measurements to determine fair value adjustments to certain instruments and fair value disclosures. Refer to Note 15 - "Fair Value of Financial Instruments" in the accompanying financial statements for a description of valuation methodologies used to measure material assets and liabilities at fair value and details of the valuation models, key inputs to those models, and significant assumptions utilized. The Company follows the fair value hierarchy set forth in Note 15 - "Fair Value of Financial Instruments" in the accompanying financial statements in order to prioritize the inputs utilized to measure fair value. The Company reviews and modifies, as necessary, the fair value hierarchy classifications on a quarterly basis. As such, there may be reclassifications between hierarchy levels due to changes in inputs to the valuation techniques used to measure fair value. The Company has numerous internal controls in place to ensure the appropriateness of fair value measurements, including controls over the inputs into and the outputs from the fair value measurements. Certain valuations will also be benchmarked to market indices when appropriate and available. Considerable judgment is used in forming conclusions from market observable data used to estimate the Company's Level 2 fair value measurements and in estimating inputs to the Company's internal valuation models used to estimate Level 3 fair value measurements. Level 3 inputs such as interest rate movements, prepayment speeds, credit losses, recovery rates and discount rates are inherently difficult to estimate. Changes to these inputs can have a significant effect on fair value measurements. Accordingly, the Company's estimates of fair value are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange. Recent Accounting Pronouncements Information concerning the Company's implementation and impact of new accounting standards issued by theFinancial Accounting Standards Board (FASB) is discussed in Note 1 - "Description of Business, Basis of Presentation, and Significant 60
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Accounting Policies and Practices" in the accompanying consolidated financial statements under "Recent Accounting Pronouncements." Market Data Market data used in this Annual Report on Form 10-K has been obtained from independent industry sources and publications, such as theFederal Reserve Bank of New York ; theFederal Reserve Bank of Philadelphia ; theFederal Reserve Board ;The Conference Board ; theCFPB ; Equifax Inc.;Experian Automotive ;FCA ; Fair Isaac Corporation; FICO® Banking Analytics Blog;Polk Automotive ; theUnited States Department of Commerce :Bureau of Economic Analysis ;J.D. Power ; and Ward's Automotive Reports. Forward-looking information obtained from these sources is subject to the same qualifications and the additional uncertainties regarding the other forward-looking statements in this Annual Report on Form 10-K. For purposes of this Annual Report on Form 10-K, the Company categorizes the prime segment as borrowers with FICO® scores of 640 and above and the nonprime segment as borrowers with FICO® scores below 640. Other Information Further information on risk factors can be found under Part II, Item 1A - "Risk Factors".
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