Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation ST (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit). Yes ý No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Emerging growth company
Smaller reporting company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No ý
As of June 30, 2018, the Registrant’s common stock, par value $0.01 per share, held by non-affiliates had an aggregate market value of approximately $2.2 billion based on the closing price on that date on the New York Stock Exchange of $19.09 per share.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Outstanding at February 21, 2019
Common Stock ($0.01 par value)
Documents Incorporated By Reference
Portions of the registrant’s definitive proxy statement to its 2019 annual meeting of stockholders (the Proxy Statement) are incorporated by reference into Part III of the Annual Report on Form 10-K where indicated.
Unless otherwise specified or the context otherwise requires, the use herein of the terms “we,” “our,” “us,” “SC,” and the “Company” refer to Santander Consumer USA Holdings Inc. and its consolidated subsidiaries.
Cautionary Note Regarding Forward-Looking Information
This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any statements about the Company’s expectations, beliefs, plans, predictions, forecasts, objectives, assumptions, or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipates,” “believes,” “can,” “could,” “may,” “predicts,” “potential,” “should,” “will,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “intends,” and similar words or phrases. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, these statements are not guarantees of future performance and involve risks and uncertainties which are subject to change based on various important factors, some of which are beyond the Company’s control. Among the factors that could cause the Company’s actual performance to differ materially from those suggested by the forward-looking statements are:
the Company operates in a highly regulated industry and continually changing federal, state, and local laws and regulations could materially adversely affect its business;
the Company’s ability to remediate any material weaknesses in internal controls over financial reporting completely and in a timely manner;
adverse economic conditions in the United States and worldwide may negatively impact the Company’s results;
the business could suffer if access to funding is reduced or if there is a change in the Company’s funding costs or ability to execute securitizations;
the Company faces significant risks implementing its growth strategy, some of which are outside of its control;
the Company may not realize the anticipated benefits from, and may incur unexpected costs and delays in connection with exiting its personal lending business;
the Company’s agreement with FCA may not result in currently anticipated levels of growth and is subject to
performance conditions that could result in termination of the agreement, and is subject to an option giving FCA the right to acquire an equity participation in the Chrysler Capital portion of the Company’s business;
the business could suffer if the Company is unsuccessful in developing and maintaining relationships with automobile dealerships;
the Company’s financial condition, liquidity, and results of operations depend on the credit performance of its loans;
loss of the Company’s key management or other personnel, or an inability to attract such management and personnel, could negatively impact its business;
the Company is directly and indirectly, through its relationship with SHUSA, subject to certain banking and financial services regulations, including oversight by the Office of the Comptroller of the Currency (OCC), the Consumer Financial Protection Bureau (CFPB), the European Central Bank, and the Federal Reserve Bank of Boston (FRBB); such oversight and regulation may limit certain of the Company’s activities, including the timing and amount of dividends and other limitations on the Company’s business;
future changes in the Company’s ownership by, or relationship with, SHUSA or Santander, could adversely affect its operations; and
the other factors that are described in Part I, Item IA - Risk Factors of this Annual Report on Form 10-K.
If one or more of the factors affecting the Company’s forward-looking information and statements renders forward-looking information or statements incorrect, the Company’s actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements. Therefore, the Company cautions the reader not to place undue reliance on any forward-looking information or statements. The effect of these factors is difficult to predict. Factors other than these also could adversely affect the Company’s results, and the reader should not consider these factors to be a complete set of all potential risks or uncertainties as new factors emerge from time to time. Management cannot assess the impact of any such factor on the Company’s business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Any forward-looking statements only speak as of the date of this document, and the Company undertakes no obligation to update any forward-looking information or statements, whether written or oral, to reflect any change, except as required by law. All forward-looking statements attributable to the Company are expressly qualified by these cautionary statements.
The following is a list of abbreviations, acronyms, and commonly used terms used in this Annual Report on Form 10-K.
The maximum percentage of unpaid principal balance that a lender is willing to lend
A party that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is
under common control with an entity
Automotive Lease Guide
Annual Percentage Rate
Accounting Standards Codification
Accounting Standards Update
Bluestem Brands, Inc., an online retailer for whose customers SC provides financing
SC’s Board of Directors
Citizens Bank of Pennsylvania
Comprehensive Capital Analysis and Review
Chrysler Capital Auto Receivables Trust, a securitization platform
Chief Executive Officer
Consumer Financial Protection Bureau
Chief Financial Officer
Ten-year master private-label financing agreement with FCA
The early redemption of a debt instrument by the issuer, generally when the underlying portfolio has amortized to 10% or 15% of its original balance
U.S. Securities and Exchange Commission
A method such as overcollateralization, insurance, or a third-party guarantee, whereby a borrower reduces default risk
Discounted Cash Flow Analysis
A floorplan line of credit, real estate loan, working capital loan, or other credit extended to an automobile dealer
Comprehensive financial regulatory reform legislation enacted by the U.S. Congress on July 21, 2010
U.S. Department of Justice
Drive Auto Receivables Trust, a securitization platform
European Central Bank
Equal Credit Opportunity Act
Enterprise Risk Management Committee
Securities Exchange Act of 1934, as amended
Financial Accounting Standards Board
FCA US LLC, formerly Chrysler Group LLC
A common credit score created by Fair Isaac Corporation that is used on the credit reports that lenders use to assess an applicant’s credit risk. FICO® is computed using mathematical models that take into account five factors: payment history, current level of indebtedness, types of credit used, length of credit history, and new credit
Financial Institutions Reform, Recovery and Enforcement Act of 1989
A revolving line of credit that finances inventory until sold
Federal Reserve Board
Board of Governors of the Federal Reserve System
Federal Reserve Bank of Boston
Federal Trade Commission
Guaranteed Auto Protection
U.S. Generally Accepted Accounting Principles
SC’s Initial Public Offering
International Swaps and Derivative Association
J.D. Power and Associates
LendingClub Corporation, a peer-to-peer personal lending platform company from which SC acquired loans under terms of flow agreements
Managed assets included assets (a) owned and serviced by the Company; (b) owned by the Company and serviced by others; and (c) serviced for others.
Master Service Agreement
The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows of a portfolio acquired with deteriorated credit quality
New York Stock Exchange
Office of the Comptroller of the Currency
A credit enhancement method whereby more collateral is posted than is required to obtain financing
Original equipment manufacturer
Financing branded in the name of the product manufacturer rather than in the name of the finance provider
The controlled disposal of leased vehicles that have reached the end of their lease term or of financed vehicles obtained through repossession
The future value of a leased asset at the end of its lease term
Includes purchased non-credit impaired finance receivables
Restricted stock unit
Banco Santander, S.A.
Santander Bank, N.A., a wholly-owned subsidiary of SHUSA. Formerly Sovereign Bank, N.A.
Santander Consumer USA Holdings Inc., a Delaware corporation, and its consolidated subsidiaries
Santander Consumer International Puerto Rico, LLC
Santander Consumer USA Inc., an Illinois Corporation and wholly-owned subsidiary of SC
Servicemembers Civil Relief Act
Santander Drive Auto Receivables Trust, a securitization platform
U.S. Securities and Exchange Commission
Santander Holdings USA, Inc., a wholly-owned subsidiary of Santander and the majority owner of SC
Santander Prime Auto Issuing Note Trust, a securitization platform
Santander Retail Auto Lease Trust, a lease securitization platform
Reimbursement of the finance provider by a manufacturer for the difference between a market loan or lease rate and the below-market rate given to a customer
Troubled Debt Restructuring
Special purpose financing trusts utilized in SC’s financing transactions
Variable Interest Entity
A revolving line of credit generally used to fund finance receivable originations
The Company, was formed in 2013 as a corporation in the state of Delaware and is the holding company for SC Illinois, and subsidiaries, a specialized consumer finance company focused on vehicle finance and third-party servicing. The Company’s primary business is the indirect origination, securitization and servicing of retail installment contracts and leases, principally through manufacturer-franchised dealers in connection with their sale of new and used vehicles to retail consumers.
Santander Auto Finance (SAF) is our primary vehicle brand, and is available as a finance option for automotive dealers across the United States. Since May 2013, under the Chrysler Agreement with FCA, the Company has been operated as FCA’s preferred provider for consumer loans, leases and Dealer Loans and provide services to FCA customers and dealers under the Chrysler Capital (CCAP) brand. These products and services include consumer retail installment contracts and leases, as well as Dealer Loans for inventory, construction, real estate, working capital and revolving lines of credit. Retail installment contracts and vehicle leases entered into with FCA customers, as part of the Chrysler Agreement, represent a significant concentration of those portfolios and there is a risk that the Chrysler Agreement could be terminated prior to its expiration date. Termination of the Chrysler Agreement could result in a decrease in the amount of new retail installment contracts and vehicle leases entered into with FCA customers as well as Dealer Loans.
In June 2018, the Company announced that it was in exploratory discussions with FCA regarding the future of FCA’s U.S. finance operations. FCA has announced its intention to establish a captive U.S. auto finance unit and indicated that acquiring Chrysler Capital is one option it will consider. Under the Chrysler Agreement, FCA has the option to acquire, for fair market value, an equity participation in the business offering and providing the financial services contemplated by the Chrysler Agreement. The likelihood, timing and structure of any such transaction, and the likelihood that the Chrysler Agreement will terminate, cannot be reasonably determined. In July 2018, FCA and the Company entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party in accordance with Section 14.02 of the MPLFA until December 31, 2018.
The Company also originates vehicle loans through a web-based direct lending program, purchases vehicle retail installment contracts from other lenders, and services automobile and recreational and marine vehicle portfolios for other lenders. Additionally, the Company has other relationships through which it holds personal loans, private-label credit cards and other consumer finance products. However, in 2015, the Company announced its exit from personal lending, and accordingly, substantially all of its personal lending assets are classified as held for sale at December 31, 2018.
As of February 21, 2019, the Company was owned approximately 69.9% by SHUSA, a wholly-owned subsidiary of Santander, and approximately 30.1% by other shareholders.
The Company’s Markets
The consumer finance industry in the United States has approximately $3 trillion of outstanding borrowings as of December 31, 2018 and includes vehicle loans and leases, credit cards, home equity lines of credit, private student loans, and personal loans.
Sources: Federal Reserve Bank of New York; Consumer Financial Protection Bureau
The Company’s primary focus is the vehicle finance segment of the U.S. consumer finance industry. Vehicle finance includes loans and leases taken out by consumers to fund the purchase of new and used automobiles, as well as other vehicles such as marine and recreational vehicles. Within the vehicle finance segment, the Company maintains a strong presence in the auto finance market. The auto finance market features a fungible product resulting in an efficient pricing market, but it is highly fragmented, with no individual lender accounting for more than 10% of total market share. As of December 31, 2018, there were approximately $1.3 trillion of auto loans outstanding in the United States.
Net Percent of Banks Reporting Stronger Demand for Consumer Loans
Source: Federal Reserve Board - Senior Loan Officer Survey on Bank Lending Practices
The Company has a significant portfolio of prime loans and leases serviced for others, as it typically originates and then sells prime assets with servicing rights retained. Through the Chrysler Capital brand, the Company’s focus is on the new auto finance space by providing financing for the acquisition of new FCA vehicles. The Company also originates leases, substantially all of which are extended to prime borrowers. In 2018, there were 17.2 million new cars sold in the U.S. In 2018, through the third quarter, approximately 85% of total new auto sales were financed. Future growth of new auto sales in the United States, and the parallel growth of consumer loans and leases to finance those sales, are driven by improving economic conditions, new automobile product offerings, and the need to replace aging automobiles. Chrysler Capital loan and lease growth will be driven by the volume of new FCA vehicles sold in the United States.
Source: Ward’s Automotive Reports; U.S. Department of Commerce: Bureau of Economic Analysis
Source: FCA US LLC
In addition, the Company is a leading originator of nonprime auto loans. Although the Company originates both prime and nonprime vehicle loans, it maintains on its balance sheet primarily nonprime loans. National and regional banks have historically been the largest originators of used and nonprime vehicle loans and leases due to their broad geographic footprint and wide array of vehicle finance products. The Company primarily competes against national and regional banks, as well as automobile manufacturers’ captive finance businesses, to originate loans and leases to finance consumers’ purchases of new and used cars.
Most loans in the used auto finance space are extended to nonprime consumers, who comprise a significant portion of the U.S. population. Of the more than 300 million Americans with a credit history, 29% have Fair Isaac Corporation (FICO®) scores below 650. Although nonprime auto loans typically produce higher losses than prime loans, the Company’s data-driven approach, extensive experience, and adaptive platform enhance the Company’s ability to estimate future cash flows and effectively price loans for their inherent risk.
Source: FICO® Banking Analytics Blog Fair
Note: Nonprime based on FICO® Score <650
Historically, used car financing has made up a majority of the Company’s business. In 2018, through the third quarter, used automobiles accounted for 67% of total automobiles sold in the United States, and approximately 54% of used car purchases were financed. The primary metrics used by the market to monitor the strength of the used car market are the Manheim Used Vehicle Index and J.D. Power Price Index, measures of wholesale used car prices adjusted by their mileage or vintage. The projected average age of U.S. autos in 2018 remained at a record high of 11.7 years. As of December 31, 2018, used car financing represented 57% of the Company’s outstanding retail installment contracts, of which 82% consisted of nonprime auto loans.
Source: Manheim Inc., as of December 31, 2018 & JP Power used-Vehicle Price Index, as of December 31, 2018
Note: Indexed to a basis of 100 at 1995 levels.
In 2015, the Company made a strategic decision to exit the personal lending market to focus on its core objectives of expanding the reach and realizing the full value of its vehicle finance and serviced for others platforms. The Company believes this shift will create other opportunities, such as diversifying funding sources and growing capital. Throughout 2016, 2017, and 2018, the Company marketed personal lending assets to potential buyers. In 2016, the Company completed a sale of substantially all assets from its personal lending portfolio to an unrelated third party. In 2017, the Company sold the remaining portfolio comprised of personal installment loans to an unrelated third-party, which was comprised solely of LendingClub installment loans. As the Company refocuses on core objectives, it continues to perform under various other agreements under which specified volumes of personal loans originated by third parties are purchased.
In both the vehicle finance and personal lending markets, the Company generates originations indirectly and directly. The indirect model requires relationships with third parties who are generally active in the market, are looking for an additional source of financing for their customers, and agree to direct certain customers to the Company. The direct model requires an internally-managed platform through which consumers are able to make requests for credit directly to the Company. While the Company has historically focused on the indirect model, it has a presence in the direct vehicle finance market through the RoadLoans.com platform. Additionally, the Company continues to develop relationships with third parties to further broaden its origination channels.
The Company’s Business Strategy
The Company’s primary goal is to create stockholder value by leveraging its efficient, scalable technology and risk infrastructure and data to underwrite, originate and service profitable assets while treating customers, dealers, stockholders, employees and all stakeholders in a simple, personal and fair manner.
Expand the Company’s Vehicle Finance Franchise
Organic Growth in Indirect Auto Finance. The Company has extensive data on and experience with consumer behavior across the full credit spectrum and is a key player in the U.S. vehicle finance market. The Company expects to continue to increase market penetration in the vehicle finance sector, subject to favorable market conditions, via the number and depth of its dealer relationships. The Company plans to achieve this growth in part through alliance programs with national vehicle dealer groups and financial institutions, including banks, credit unions, manufacturers, and other lenders, in both the prime and nonprime vehicle finance markets. The Company’s technology-based platform enables the Company to integrate seamlessly with other originators and thereby benefit from their channels and brands.
Growth in Direct-to-Consumer Exposure. The Company is working to further diversify its vehicle finance product offerings by expanding its web-based, direct-to-consumer offerings. The Company is focused on engaging the consumer at the early stages of the car buying experience. The RoadLoans.com program is a preferred finance resource for many major vehicle shopping websites, including Cars.com and AutoTrader.com, each of which have links on their websites promoting RoadLoans.com for financing. The Company will continue to focus on securing relationships with additional vehicle-related websites. The Company anticipates that the next generation of its web-based direct-to-consumer offerings will include additional strategic
relationships, an enhanced online experience, and additional products and services to assist with all stages of the vehicle ownership life cycle, including research, financing, buying, servicing, selling, and refinancing.
Expansion of Fee-Based Income Opportunities. The Company seeks opportunities to leverage its technologically sophisticated and highly adaptable servicing platform for both prime and nonprime loans, as well as other vehicle finance (including recreational and marine vehicles) and personal lending products. The Company collects fees to service loan portfolios, and handles both secured and personal loan products across the full credit spectrum. Loans and leases sold to or sourced to banks through flow agreements and off-balance sheet securitizations also provide additional opportunities to service large vehicle loan and lease pools. The Company’s loan servicing business is scalable and provides an attractive return on equity. The Company intends to continue to expand fee-based income opportunities through its relationship with Santander.
The Company’s Products and Services
The Company offers vehicle-related financing products, primarily consisting of consumer loans and leases, and servicing of those assets.
Consumer Vehicle Loans
The Company’s primary business is to indirectly originate vehicle loans through automotive dealerships throughout the United States. The Company has a substantial dealer network, most of which consists of manufacturer-affiliated or large and reputable independent dealers. The Company uses a risk-adjusted methodology to determine the price to pay the automotive dealer for a loan, which may be above or below the principal amount of the loan depending on characteristics such as the contractual annual percentage rate (APR) and the borrower’s credit profile. The consumer is obligated to make payments in an amount equal to the principal amount of the loan plus interest at the APR negotiated with the dealer. The consumer is also responsible for charges related to past-due payments. Dealers may retain some portion of the finance charge as compensation. The Company’s agreements with dealers place a limit on the amount of the finance charges they are entitled to retain. Although the Company does not own the vehicles it finances through loans, it holds a perfected security interest in those vehicles. Loans with below-market APRs are frequently offered through manufacturer incentive programs. The manufacturer will compensate the originator of these loans for the amount of the financing rate that is below market. These payments are called rate subvention. The Company is entitled to receive rate subvention payments from FCA as its preferred provider through the Chrysler Agreement.
The Company also originates loans through its branded online RoadLoans.com platform. Additionally, the Company acquires loans in bulk from third parties. The loans acquired in bulk acquisitions have primarily been collateralized by automobiles. However, a small amount of such loans have been collateralized by marine and recreational vehicles. The Company generates revenue on these loans through finance charges.
The Company acquires leases primarily from FCA-affiliated automotive dealers and, as a result, becomes titleholder for leased vehicles. The acquisition cost for these leases is based on the underlying value of the vehicle, the contractual lease payments and the residual value, which is the expected future value of the vehicle at the time of the lease termination. The Company uses projected residual values that are estimated by third parties, such as Automotive Lease Guide (ALG) and internal forecasts based on current market conditions, and other relevant data points. The residual value used to determine lease payments, or the contractual residual value, may be adjusted upward as part of marketing incentives provided by the manufacturer of the vehicle. When a contractual residual value is written up, the lease payments the Company offers become more attractive to consumers. The marketing incentive payment that manufacturers pay the Company is equal to the expected difference between the projected ALG residual value and the contractual residual value. This residual support payment is a form of subvention. The Company is a preferred provider of subvented leases through Chrysler Capital. Substantially all of these leases are to prime consumers. The consumer, or lessee, is responsible for the contractual lease payments and any excessive mileage or wear and tear on the vehicle that results in a lower residual value of the vehicle at the time of the lease’s termination. The consumer is also generally responsible for charges related to past due payments. The Company’s leases are primarily closed-ended, meaning the consumer does not bear the residual risk.
The Company generates revenue on leases through monthly lease payments and fees and, depending on the market value of the off-lease vehicle, the Company may recognize a gain or loss upon remarketing. The Company’s agreement with FCA permits the Company to share any residual gains or losses over a threshold, determined on an individual lease basis, with FCA.
Servicing for Others
The Company services a portfolio of vehicle loans originated or otherwise independently acquired by SBNA and loans sold by the Company to Santander. The Company also services loans sold through flow agreements, through Chrysler Capital off-
balance sheet securitizations and several smaller loan portfolios for various third-party institutions. The Company generates revenue on these assets through servicing and other fees collected from the institutional owners and the borrowers, and may also generate a gain or loss on the sale of assets. The Company intends to continue growing this off-balance sheet portfolio and the stream of revenue it provides.
Origination and Servicing
The Company’s origination platform delivers automated 24/7 underwriting decision-making through a proprietary credit-scoring system designed to provide consistency and efficiency. Every loan application received is processed by the Company’s credit scoring system. The Company’s credit- scoring system is supported by an extensive market database that includes multiple years of historical data on the loans that the Company has acquired as well as extensive consumer finance third-party data. The Company continuously evaluates loan performance and consumer behavior to improve underwriting decisions. The Company’s systems are intended to be readily adaptable and scalable, with the ability to quickly implement changes in pricing and scoring credit policy rules and modify underwriting standards to match the economic environment. The Company’s credit-scoring system supports underwriting decisions for consumers across the full credit spectrum and has been designed to allow the Company to maximize modeled risk-adjusted yield for a given consumer’s credit profile.
The Company has built a servicing approach based on years of experience as a nonprime lender. The Company’s servicing activities consist largely of processing customer payments, responding to customer inquiries (such as requests for payoff quotes or complaints), processing customer requests for account revisions (such as payment deferrals), seeking to maintain a perfected security interest in the financed vehicle, monitoring vehicle insurance coverage, pursuing collection of delinquent accounts, and remarketing repossessed or off-lease vehicles. The Company has made significant investments in staffing and servicing systems technology intended to make servicing activities compliant with federal and local consumer lending rules in all 50 states.
Through its servicing platform, the Company seeks to maximize collections while providing outstanding customer service. The Company’s servicing practices are closely integrated with the originations platform, resulting in an efficient exchange of customer related data, market information and understanding of the latest trends in consumer behavior. The customer account management process is model-driven and utilizes predictive customer service and collection strategies. The Company validates its models with data back-testing and can be adjusted to reflect new information received throughout the Company, such as new vehicle loan and lease applications, refreshed consumer credit data, and consumer behavior observed through servicing operations. The Company’s robust processes and sophisticated technology support the servicing platform to maximize efficiency, consistent loan treatment, and cost control.
To provide the best possible customer service, the Company provides multiple convenient customer communication methods and has implemented strategies to monitor and improve the customer experience. In addition to live agent assistance, the Company’s customers are offered a wide range of self-service options via an interactive voice response system and through its customer website. Self-service options include demographic management (such as updating a customer’s address, phone number, and other identifying information), payment and payoff capability, and payment history reporting, as well as online chat and communication requests. Quality assurance teams perform account reviews and are responsible for grading phone calls to monitor adherence to policies and procedures as well as compliance with regulatory requirements. The Company’s analytics software converts speech from every call into text so that each conversation with a customer can be analyzed and subsequently data-mined. This is used to identify inappropriate words or phrases in real-time for potential intervention from a manager and to search for the omission of words or phrases that are required for specific conversations. A quality control team provides an independent, objective assessment of the servicing department’s internal control systems and underlying business processes. These processes help identify organizational improvements while protecting the Company’s franchise reputation and brand. Lastly, complaint tracking processes are designed to ensure customer complaints are addressed appropriately and that the customers receive status updates. These systems assign the account to a specialized team until the complaint is deemed to be closed. This team tracks and resolves customer complaints and is subject to a robust quality assurance program.
The servicing process is divided into stages based on delinquency status and the servicing agents for each stage receive specialized training. In the event that a retail installment contract becomes delinquent, the Company follows an established set of procedures that maximizes ultimate recovery on the loan or lease. Late stage account managers employ skip tracing, utilize specialized negotiation skills, and are trained to tailor their collection attempts based on the proprietary borrower behavioral score assigned to each customer. Collection efforts include calling generally within one business day when an obligor has broken a promise to make a payment on a certain date, and using alternative methods of contact such as location gathering via references, employers, landlords, credit bureaus, and cross-directories. If the borrower is qualified, the account manager may offer an extension of the maturity date, a temporary reduction in payment, or a modification permanently lowering the interest rate or principal. If attempts to work with the customer to cure the delinquency are unsuccessful, the customer is sent a “right to
cure” letter in accordance with state laws, and the loan is assigned a risk score based on the Company’s historical days-to-repossess data. This score is used to prioritize repossessions, and each repossession is systematically assigned to a third-party repossession agent according to the agent’s recent performance. Once the vehicle has been secured, any repairs required are performed and the vehicle is remarketed as quickly as possible, typically through an auction process.
Most of the Company’s servicing processes and quality-control measures serve a dual purpose in that they are both designed to ensure that the Company complies with applicable laws and regulations and that the Company delivers the best possible customer service. Additionally, the servicing platform and all of the features offered to customers are scalable and can be tailored through statistical modeling and automation.
The Company’s Relationship with FCA
The Company entered into the Chrysler Agreement, pursuant to which the Company became the preferred provider for FCA’s consumer loans and leases and Dealer Loans effective May 1, 2013. Business generated under terms of the Chrysler Agreement is branded as Chrysler Capital. During 2018, the Company originated more than $7.9 billion of Chrysler Capital retail installment contracts and approximately $9.7 billion of Chrysler Capital vehicle leases.
The Chrysler Agreement requires, among other things, that the Company bear the risk of loss on loans originated pursuant to the agreement, but also that FCA share in residual gains and losses from consumer leases over a threshold, determined on an individual lease basis. The agreement also requires that Santander maintain at least $5.0 billion in funding available for dealer inventory financing and $4.5 billion of financing dedicated to FCA retail financing. In turn, FCA must provide designated minimum threshold percentages of its subvention business to the Company.
The Chrysler Agreement has a ten-year term, subject to early termination in certain circumstances, including the failure by either party to comply with certain of their ongoing obligations. These obligations include, for the Company, meeting specified escalating penetration rates for the first five years, and, for FCA, treating the Company in a manner consistent with comparable OEMs’ treatment of their captive providers, primarily regarding sales support. In addition, FCA may also terminate the agreement if, among other circumstances, (i) a person other than Santander and its affiliates or its other stockholders owns 20% or more of its common stock and Santander and its affiliates own fewer shares of common stock than such person, (ii) the Company becomes, controls, or becomes controlled by, an OEM that competes with Chrysler, or (iii) if certain of the Company’s credit facilities become impaired.
In connection with entering into the Chrysler Agreement, the Company paid FCA a $150 million upfront, nonrefundable fee on May 1, 2013. This fee is considered payment for future profits generated from the Chrysler Agreement. Accordingly, the Company amortizes the Chrysler Agreement over the expected ten-year term as a component of net finance and other interest income. The Company has also executed an Equity Option Agreement with FCA, whereby FCA may elect to purchase, at any time during the term of the Chrysler Agreement, at fair market value, an equity participation of any percentage in the Chrysler Capital portion of the Company’s business.
For a period of 20 business days after FCA’s delivery to the Company of a notice of intent to exercise its option, the Company is to discuss with FCA, in good faith, the structure and valuation of the proposed equity participation. If the parties are unable to agree on a structure and FCA still intends to exercise its option, the Company will be required to create a new company into which the Chrysler Capital assets will be transferred and which will own and operate the Chrysler Capital business. If FCA and the Company cannot agree on a fair market value during the 20-day negotiation period, each party will engage an investment bank and the appointed banks will mutually appoint a third independent investment bank to determine the value, with the cost of the valuation divided evenly between FCA and the Company. Each party has the right to a one-time deferral of the independent valuation process for up to nine months. FCA will have a period of 90 days after a valuation has been determined, either by negotiation between the parties or by an investment bank, to deliver a binding notice of exercise. Following this notice, FCA’s purchase is to be paid and settled within 10 business days, subject to a delay of up to 180 days if necessary to obtain any required consents from governmental authorities.
Any new company formed to effect FCA’s exercise of its equity option will be a Delaware limited liability company unless otherwise agreed to by the parties. As long as each party owns at least 20% of the business, FCA and the Company will have equal voting and governance rights without regard to ownership percentage. If either party has an ownership interest in the business of less than 20%, the party with less than 20% ownership will have the right to designate a number of directors proportionate to its ownership and will have other customary minority voting rights.
Because the equity option is exercisable at fair market value, the Company could recognize a gain or loss upon exercise if the fair market value is determined to be different from book value. The Company believes that the fair market value of its Chrysler Capital financing business currently exceeds book value and therefore has not recorded a contingent liability for potential loss upon FCA’s exercise.
Subsequent to the exercise of the equity option, the Company’s rights under the Chrysler Agreement would be assigned to the jointly owned business. Exercise of the equity option would be considered a triggering event requiring re-evaluation of whether or not the remaining unamortized balance of the upfront fee the Company paid to FCA on May 1, 2013 should be impaired.
In June 2018, the Company announced that it was in exploratory discussions with FCA regarding the future of FCA’s U.S. finance operations. FCA announced its intention to establish a captive U.S. auto finance unit in the future and indicated that acquiring Chrysler Capital is one option it would consider. In addition, in July 2018, FCA and the Company entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party in accordance with Section 14.02 of the MPLFA until December 31, 2018.
FCA has not delivered a notice to exercise its equity option, and the Company remains committed to the success of the Chrysler Capital business. Although the likelihood, timing and structure of any such transaction, and the likelihood that the Chrysler Agreement will terminate, cannot be reasonably determined, termination of the Chrysler Agreement or a significant change in the business relationship between the Company and FCA could materially adversely affect the Company’s operations, including the origination of receivables through the Chrysler Capital portion of the Company’s business and the servicing of Chrysler Capital receivables. Moreover, there can be no assurance that the Company could successfully or timely implement any such transaction without significant disruption of its operations or restructuring, or without incurring additional liabilities, which could involve significant expense to the Company and have a adverse effect on its business, financial condition and results of operations.
Until January 2017, the Company had a flow agreement with Bank of America whereby the Company was committed to selling up to $300,000 of eligible loans to the bank each month. The company no longer sells loans to the bank under the flow agreement, but the Company retained servicing on all previously-sold loans and may receive or pay a servicer performance payment based on an agreed-upon formula if performance on the sold loans is better or worse, respectively, than expected performance at time of sale.
Until May 2017, the Company sold loans to CBP under terms of a flow agreement and predecessor sale agreements. The Company no longer sells loans to CBP under the flow agreement, but, the Company retained servicing on the previously-sold loans and will owe CBP a loss-sharing payment capped at 0.5% of the original pool balance if losses exceed a specified threshold, established on a pool-by-pool basis. Loss-sharing payments are due the month in which net losses exceed the established threshold of each loan sale.
The Company has two principal consolidated wholly-owned subsidiaries: Santander Consumer USA Inc. and Santander Consumer International Puerto Rico, LLC (a wholly-owned subsidiary of Santander Consumer USA Inc.).
At December 31, 2018, the Company had approximately 4,952 employees, none of whom is represented by a collective bargaining agreement.
The Company’s origination volume is generally highest in March and April each year due to consumers receiving tax refunds, which provides additional discretionary income. The Company’s delinquencies are generally highest in the period from November through January due to consumers’ holiday spending, which reduces income available for car payments.
The Company has the right to use the Santander name on the basis of a non-exclusive, royalty-free, and non-transferable license from Santander, which only extends to uses in connection with the Company’s current and future operations within the United States. Santander may terminate the license at any time Santander ceases to own, directly or indirectly, 50% or more of the Company’s common stock.
In connection with the Company’s agreement with FCA, the Company has been granted a limited, non-exclusive, non-transferable, royalty-free license to use certain FCA trademarks, including the term “Chrysler Capital”. The Company is required to adhere to specified guidelines and other usage instructions related to these trademarks, as well as to obtain prior
written approval of any materials, including financing documents and promotional materials, using the trademarks. This license does not grant the Company any ownership rights in FCA’s trademarks.
In connection with the 2008 acquisition of Roadloan.com, a direct-to-consumer online platform, the Company purchased the “Roadloan.com” trade name which constitutes an intellectual property right.
The automotive finance industry is highly competitive. The Company competes on the pricing offered on loans and leases as well as the customer service provided to automotive dealer customers. Pricing for these loans and leases is transparent because the Company, along with industry competitors, posts pricing for loans and leases on web-based credit application aggregation platforms. When dealers submit applications for consumers acquiring vehicles, they can compare the Company’s pricing against competitors’ pricing. Dealer relationships are important in the automotive finance industry. Vehicle finance providers tailor product offerings to meet each individual dealer’s needs.
The Company seeks to effectively compete through its proprietary credit-scoring system and industry experience, which are used to establish appropriate risk pricing. In addition, the Company benefits from FCA subvention programs through the Chrysler Agreement. The Company seeks to develop strong dealer relationships through a nationwide sales force and a long history in the automotive finance space. Further, the Company expects to continue deepening dealer relationships through the Chrysler Capital product offerings.
The Company’s primary competitors in the vehicle finance space are:
national and regional banks;
independent financial institutions; and
the affiliated finance companies of automotive manufacturers.
While the used car financing market is fragmented with no single lender accounting for more than 10% of the market, there are a number of competitors in both the new and used car markets that have substantial positions nationally or in the markets in which they operate. Some of the Company’s competitors may have lower cost structures, or funding costs, and be less reliant on securitizations. The Company believes it can compete effectively by continuing to expand and deepen its relationships with dealers. In addition, through its Chrysler Capital brand, the Company benefits from FCA’s subvention programs and relationships with its dealers.
Supervision and Regulation
The U.S. lending industry is highly regulated under various U.S. federal laws, including the Truth-in-Lending Act (TILA); Equal Credit Opportunity Act (ECOA), Electronic Fund Transfer Act (EFTA), Fair Credit Reporting Act (FCRA), Fair Debt Collection Practices Act (FDCPA), Consumer Leasing Act, Servicemembers Civil Relief Act (SCRA), Telephone Consumer Protection Act, Financial Institutions Reform, Recovery, and Enforcement Act, Dodd-Frank Act and Gramm-Leach-Bliley Act (GLBA), as well as various state laws. The Company is subject to inspections, examinations, supervision, and regulation by the Securities and Exchange Commission (SEC), the Consumer Financial Protection Bureau (CFPB), the Federal Trade Commission (FTC), and the Department of Justice (DOJ) and by regulatory agencies in each state in which the Company is licensed. In addition, the Company is directly and indirectly, through its relationship with SHUSA, subject to certain banking and financial services regulations, including oversight by the Office of the Comptroller of the Currency (OCC), the European Central Bank (ECB), and the Federal Reserve Bank of Boston (FRBB), which has the ability to limit certain of its activities, such as the timing and amount of dividends and certain transactions that it might otherwise desire to enter into, such as merger and acquisition opportunities, or to impose other limitations on the Company’s growth. Additional legal and regulatory matters affecting the Company’s activities are further discussed in Part I, Item 1A-Risk Factors of this Annual Report on Form 10-K.
Dodd-Frank Wall Street Reform and Consumer Protection Act
Congress enacted comprehensive financial regulatory reform legislation on July 21, 2010. A significant focus of the new law (the Dodd-Frank Act) is heightened consumer protection. The Dodd-Frank Act established the CFPB, which has regulatory, supervisory, and enforcement powers over providers of consumer financial products and services, including the Company, and explicit supervisory authority to examine and require registration of non-depository lenders and promulgate rules that can affect the practices and activities of lenders. Although the Dodd-Frank Act expressly provides that the CFPB has no authority to establish usury limits, some consumer advocacy groups have suggested that various forms of alternative financial services or specific features of consumer loan products should be a regulatory priority. It is possible that at some time in the future the
CFPB could propose and adopt rules making such lending services materially less profitable or impractical, which may impact finance loans or other products that the Company offers.
In addition to granting certain regulatory powers to the CFPB, the Dodd-Frank Act gives the CFPB authority to pursue administrative proceedings or litigation for violations of federal consumer financial laws. In these proceedings, the CFPB can obtain cease and desist orders (which can include orders for restitution or rescission of contracts, as well as other kinds of affirmative relief) and monetary penalties.
The Company is also subject to risk retention rules promulgated under the Dodd-Frank Act, which generally require sponsors of ABS to retain at least five percent of the credit risk of the assets collateralizing the ABS issuance. The rules also prohibit the transfer or hedging of the credit risk that the sponsor is required to retain.
Dividend Restrictions and Other Capital Actions
The Dodd-Frank Act also requires certain banks and bank holding companies, including SHUSA, to perform a stress test and submit a capital plan to the FRBB and to receive a notice of non-objection, or approval, to the plan from the FRBB before taking capital actions, such as paying dividends, implementing common equity repurchase programs, or redeeming or repurchasing capital instruments. In June 2018, SHUSA announced that the FRBB did not object to the planned capital actions described in SHUSA’s 2018 Capital Plan that was submitted as part of its annual CCAR submissions. Included in SHUSA’s capital actions were proposed dividend payments for the Company’s stockholders. As a result, we made dividend payments in 2018 and in the first quarter of 2019.
In February 2019, the FRBB announced that SHUSA, and certain other firms, would receive a one-year extension of the requirement to submit its 2019 capital plan until April 2020. The FRBB also announced that for the period beginning July 1, 2019 through June 30, 2020, SHUSA would be allowed to make capital distributions up to an amount that would have allowed SHUSA to remain well-capitalized under the minimum capital requirements for CCAR 2018. SHUSA and the Company are evaluating their planned capital actions, including any proposed dividend payments for the Company’s stockholders, for the period of July 1, 2019 through June 30, 2020 and intend to submit those planned capital actions to the FRBB soon.
Refer to Note 17-“Shareholders’ Equity” in the accompanying consolidated financial statements.
Regulation AB II
The Company is subject to final rules adopted by SEC known as “Regulation AB II”. Regulation AB II, among other things, expanded ABS disclosure requirements and modified the offering and shelf registration process. All offerings of publicly registered ABS and all reports under the Exchange Act for outstanding publicly registered ABS must comply with these rules and disclosure requirements.
Additional legal and regulatory matters affecting the Company’s activities are further discussed in Part I, Item 1A—Risk Factors.
Disclosure Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act
(Amount presented as actuals)
Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13(r) to the Securities Exchange Act of 1934, as amended (the Exchange Act), an issuer is required to disclose in its annual or quarterly reports, as applicable, whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with individuals or entities designated pursuant to certain Executive Orders. Disclosure is generally required even where the activities, transactions or dealings were conducted in compliance with applicable law.
The following activities are disclosed in response to Section 13(r) with respect to Santander UK and certain other affiliates of Santander (collectively, the Group). During the period covered by this annual report:
Santander UK holds two savings accounts and one current account for two customers resident in the U.K. who are currently designated by the U.S. under the Specially Designated Global Terrorist (SDGT) sanctions program. Revenues and profits generated by Santander UK on these accounts in the year ended December 31, 2018 were negligible relative to the overall profits of Santander.
During the period covered by this annual report, Santander UK held one savings account with a balance of £1.24, and one current account with a balance of £1,884.53 for another customer resident in the UK who is currently designated
by the US under the SDGT sanctions program. The customer relationship pre-dates the designations of the customer under these sanctions. The United Nations and European Union removed this customer from their equivalent sanctions lists in 2008. Santander UK determined to put a block on these accounts and the accounts were subsequently closed on January 14, 2019. Revenues and profits generated by Santander UK on these accounts in the year ended December 31, 2018 were negligible relative to the overall profits of Santander.
Santander UK holds two frozen current accounts for two UK nationals who are designated by the U.S. under the Specially Designated Global Terrorist (SDGT) sanctions program. The accounts held by each customer have been frozen since their designation and have remained frozen through 2018. The accounts are in arrears (£1,844.73 in debit combined) and are currently being managed by Santander UK Collections & Recoveries department. No revenues or profits were generated by Santander UK on these accounts in the year ended December 31, 2018.
The Group also has certain legacy performance guarantees for the benefit of Bank Sepah and Bank Mellat (stand-by letters of credit to guarantee the obligations - either under tender documents or under contracting agreements - of contractors who participated in public bids in Iran) that were in place prior to April 27, 2007.
In the aggregate, all of the transactions described above resulted in gross revenues and net profits in the year ended December 31, 2018, which were negligible relative to the overall revenues and profits of Santander. The Group has undertaken significant steps to withdraw from the Iranian market such as closing its representative office in Iran and ceasing all banking activities therein, including correspondent relationships, deposit taking from Iranian entities and issuing export letters of credit, except for the legacy transactions described above. The Group is not contractually permitted to cancel these arrangements without either (i) paying the guaranteed amount (in the case of the performance guarantees), or (ii) forfeiting the outstanding amounts due to it (in the case of the export credits). As such, the Group intends to continue to provide the guarantees and hold these assets in accordance with company policy and applicable laws.
All reports filed electronically by the Company with the SEC, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, as well as any amendments to those reports, are accessible on the SEC’s website at www.sec.gov. These forms are also accessible at no cost on the Company’s website at www.santanderconsumerusa.com. The information contained on the Company’s website is not being incorporated herein.
The Company is subject to a number of risks that could materially and adversely affect our business, financial condition and results of operations in addition to other possible adverse consequences. We operate in a continually changing business and regulatory environment and, therefore, new risks emerge from time to time. The following are the risks of which we are currently aware that could be material to our business.
Risks Related to Our Business
Legal, Regulatory and Compliance Risks
We are a consumer finance company with operations in all 50 states and the District of Columbia. Our industry is highly regulated, and continually changing federal, state and local laws and regulations could materially and adversely affect our business, financial condition and results of operations.
We must comply with all of the laws and regulations applying to our business in each and every jurisdiction in which we operate. Due to the highly regulated nature of the consumer finance industry, we are required to comply with a wide and changing array of federal, state and local laws and regulations, including a significant number of banking and anti-money laundering laws and fair lending, credit bureau reporting, privacy, usury, disclosure, debt collection, repossession and other consumer protection laws and regulations. These laws and regulations directly impact our origination and servicing operations and almost all other aspects of our business and require constant compliance, monitoring, and internal and external audits. Although we have an enterprise-wide compliance framework structured to continuously monitor our activities, compliance with applicable laws and regulations is costly, may create operational constraints and may not always be effective or perform as expected.
Legislatures and regulators have enacted a wide range of new laws and regulations impacting the consumer finance industry. Further, the enactment of other new laws and regulations could occur rapidly and unpredictably and could require us to change
our business or operations, resulting in a loss of revenue or a reduction in our profitability. New laws and regulations could also result in financial loss due to regulatory fines or penalties, restrictions or suspensions of business, or costs associated with compliance or mandatory corrective action as a result of failure to adhere to applicable laws, regulations and supervisory guidance. Failure to comply with these laws and regulations could also give rise to regulatory sanctions, customer rescission rights, actions by government and self-regulatory bodies, civil or criminal liability or damage to our reputation.
We are or may become involved in investigations, examinations and proceedings by government and self-regulatory bodies, which may materially and adversely affect our business, financial condition and results of operations.
In recent years, the supervision and regulation of consumer finance companies have expanded greatly. As an ordinary course of business, we are involved in formal and informal reviews, investigations, examinations, proceedings and information-gathering requests by government and self-regulatory bodies, including, among others, the FRBB, the CFPB, the DOJ, the SEC, the FTC and various federal and state regulatory and enforcement agencies.
We are and have been subject to such matters by many of these regulators in the past and have paid significant fines or provided significant other relief. Refer to Note 11- “Commitments and Contingencies” in the accompanying consolidated financial statements. We could also become subject to other or similar regulatory actions in the future. Given the inherent uncertainty involved in such matters, and the potentially large or indeterminate damages sought, there can be significant uncertainty regarding the liability we may incur as a result of these matters. The finding, or even the assertion of, legal liability against us could result in higher operational and compliance costs, could materially and adversely affect our business, financial condition and results of operations and may result in, among other actions, adverse judgments, significant settlements, fines, penalties, injunctions or substantial reputational harm. Further, we will continue to devote significant resources to complying with the requirements of consent orders, adverse judgments and other settlements to which we are subject.
We are subject to enhanced legal and regulatory scrutiny regarding credit bureau reporting, origination and debt collection practices from regulators, courts and legislators.
Consumer finance companies, including us, are subject to enhanced legal and regulatory scrutiny regarding credit bureau reporting, origination and debt collection practices from regulators, courts and legislators. Our balance sheet consists of predominantly nonprime consumers, which are associated with higher than average delinquency rates and charge-offs than prime consumers. Accordingly, we have significant involvement with credit bureau reporting, origination and the collection and recovery of delinquent and charged-off debt, primarily through customer communications, the filing of litigation against customers in default, the periodic sale of charged-off debt and vehicle repossession. Any future changes to our business practices in these areas, including our debt collection practices, whether mandated by regulators, courts, legislators or otherwise, or any legal liabilities resulting from our business practices, including our debt collection practices, could increase our operational or compliance costs and could materially and adversely affect our business, financial condition and results of operations.
We are subject to certain banking regulations that limit our business activities and may restrict our ability to take other capital actions and enter into certain business transactions.
Because our controlling shareholder, SHUSA, is a bank holding company and because we provide third-party services to banks, we are directly and indirectly subject to certain banking and financial services regulations, including oversight by the FRBB, the ECB and the OCC. We also are subject to oversight by the CFPB. Such regulations and oversight could limit the activities and the types of businesses that we may conduct. The FRBB has broad enforcement authority over bank holding companies and their subsidiaries. The FRBB could exercise its power to restrict SHUSA from having a non-bank subsidiary that is engaged in any activity that, in the FRBB’s opinion, is unauthorized or constitutes an unsafe or unsound business practice, and could exercise its power to restrict us from engaging in any such activity. This power includes the authority to prohibit or limit the payment of dividends if, in the FRBB’s opinion, such payment would constitute an unsafe or unsound practice. Moreover, certain banks and bank holding companies, including SHUSA, are required to perform a stress test and submit a capital plan to the FRBB on an annual basis, and to receive a notice of non-objection, or approval, to the plan from the FRBB before taking capital actions, such as paying dividends, implementing common equity repurchase programs, or redeeming or repurchasing capital instruments. Any future suspension of our ability to pay dividends or other limitations placed on us by the FRBB, the ECB or any other regulator and additional costs associated with regulatory compliance could materially and adversely affect us and the trading price of our common stock.
For example, in 2014, 2015 and 2016 we were prohibited from paying dividends or taking other capital actions without the FRBB’s prior written approval due to the FRBB’s objections, based on qualitative concerns, to SHUSA’s capital plan
submissions. Although we paid dividends in 2017 and in 2018 and implemented a stock repurchase program in 2018, there can be no assurance that other or similar restrictions on the taking of capital actions, including dividend payments and stock repurchases and redemptions, will not apply to us in the future.
The FRBB, the ECB or any other regulator may also impose substantial fines and other penalties for violations that we may commit or disallow acquisitions or other activities we may contemplate, which may limit our future growth plans. These limitations could place us at a competitive disadvantage because some of our competitors are not subject to these limitations.
We are subject to enhanced prudential standards as a subsidiary of SHUSA, which could materially and adversely affect our business, financial condition and results of operations.
As a subsidiary of SHUSA, we are subject to certain enhanced prudential rules mandated by Section 165 of the Dodd-Frank Act. Among other requirements, these rules require SHUSA to maintain a sufficient quantity of highly liquid assets to survive a liquidity stress event and implement various liquidity-related corporate governance measures and imposes certain requirements, duties and qualifications for the risk committee and chief risk officers of SHUSA. SHUSA calculates its liquidity figures on a consolidated basis with certain of its subsidiaries, including us. As a result, our predicted performance under the liquidity stress event must be taken into account when SHUSA conducts its liquidity stress event analysis. Due to these requirements, we are required to have an increased amount of liquidity and will incur increased costs of funding and liquidity capacity, which could materially and adversely affect our business, financial condition and results of operations.
Our business, financial condition and results of operations may be materially and adversely affected upon our implementation of the capital requirements under the U.S. Basel III final rules.
SHUSA is governed by federal banking regulations relating to capital, referred to as the U.S. Basel III final rules, which subject SHUSA to minimum risk-based capital ratios and a capital conservation buffer above these minimum ratios. SHUSA calculates its capital figures on a consolidated basis with certain of its subsidiaries, including us. Failure to remain well-capitalized would result in restrictions on our ability to take capital actions, including dividend payments and stock repurchases and redemptions, and to pay discretionary bonuses to executive officers.
If SHUSA were to fail to satisfy regulatory capital requirements, SHUSA, together with its subsidiaries, including us, may become subject to informal or formal supervisory actions by the FRBB. If any of these were to occur, such actions could prevent us from successfully executing our business plan and could materially and adversely affect our business, financial condition and results of operations.
The Dodd-Frank Act, and its associated rules and guidance, and CFPB supervisory audits will likely continue to increase our regulatory compliance burden and associated costs.
The Dodd-Frank Act introduced a substantial number of reforms that continue to reshape the tenor and structure of regulations affecting the consumer finance industry, including us. In particular, the Dodd-Frank Act, among other things, created the CFPB, which is authorized to promulgate and enforce consumer protection regulations relating to financial products and services.
The CFPB continues to recommend that indirect vehicle lenders, a class that includes us, take steps to monitor and impose controls over dealer markup policies where dealers charge consumers higher interest rates as compensation for facilitating the loan, with the markup shared between the dealer and the lender. The CFPB has conducted in the past, and continues to conduct, supervisory audits of large providers of vehicle financing, including us, with respect to possible ECOA “disparate impact” credit discrimination in indirect vehicle finance and other related matters. The CFPB and the DOJ have continued to enter into consent orders, memoranda of understanding and settlements with multiple lenders pertaining to allegations of disparate impact regarding vehicle dealer markups, requiring consumer financing companies, including us, to revise their pricing and compensation systems to substantially reduce dealer discretion and other financial incentives to mark up interest rates and to pay restitution to borrowers as well as fines and penalties.
If the CFPB continues to enter into consent decrees with lenders on disparate impact claims and related matters, it could negatively impact the business of the affected lenders, and potentially the business of dealers and other lenders in the vehicle finance market. This impact on dealers and lenders could increase our regulatory compliance requirements and associated costs.
Unlike competitors that are banks, we are subject to the licensing and operational requirements of states and other jurisdiction, and our business would be adversely affected if we lost our licenses.
Because we are not a nationally-chartered depository institution, we do not benefit from exemptions to state loan servicing or debt collection licensing and regulatory requirements. To the extent that they exist, we must comply with state licensing and various operational compliance requirements in all 50 states and the District of Columbia. These include, among others, requirements regarding form and content of contracts, other documentation, collection practices and disclosures, and record keeping. We are sensitive to regulatory changes that may increase our costs through stricter licensing laws, disclosure laws or increased fees.
In addition, we are subject to periodic examinations by state and other regulators. The states that currently do not provide extensive regulation of our business may later choose to do so. The failure to comply with licensing or permit requirements and other local regulatory requirements could result in significant statutory civil and criminal penalties, monetary damages, attorneys’ fees and costs, possible review of licenses, and damage to reputation, brand and valued customer relationships.
We are subject to potential intervention by any of our regulators or supervisors.
As noted above, our business and operations are subject to increasingly significant rules and regulations applicable to conducting banking and financial services business. These apply to, among other things, financial reserves and financial reporting. These requirements are set by the relevant central banks and state and federal regulatory authorities that authorize, regulate and supervise us in the jurisdictions in which we operate.
In their supervisory roles, the regulators seek to maintain the safety and soundness of financial institutions and the financial system as a whole, with the aim of strengthening, but not guaranteeing, the protection of customers and the financial system. The supervisors’ continuing supervision of financial institutions is conducted through a variety of regulatory tools, including the collection of information by way of prudential examinations and requests, reports obtained from skilled persons, visits to firms and regular meetings with management to discuss issues such as performance, risk management and strategy. In general, these regulators have a more outcome-focused regulatory approach that involves more proactive enforcement and more punitive penalties for infringement. As a result, we face increased supervisory intrusion and scrutiny (resulting in increasing internal compliance costs and supervision fees), and in the event we fail to meet regulatory obligations or expectations we are likely to face more regulatory fines. Some of the regulators focus intensely on consumer protection and on conduct risk, and have stated that they will continue to do so. This has included a focus on the design and operation of products, the treatment of customers and the operation of markets.
Some of the laws in the jurisdictions in which we operate give the regulators the power to make temporary product intervention rules either to improve a firm’s systems and controls in relation to product design, product management and implementation, or to address problems identified with financial products. These problems may potentially cause significant detriment to consumers because of certain product features or governance flaws or distribution strategies. Such rules may prevent institutions from entering into product agreements with customers until such problems have been solved. Some of the regulatory regimes in the relevant jurisdictions in which we operate require us to be in compliance across all aspects of our business, including the training, authorization and supervision of personnel, systems, processes and documentation. If we fail to be compliant with such regulations, there likely would be an adverse impact on our business from sanctions, fines or other actions imposed by the regulatory authorities.
Adverse outcomes to current and future litigation against us may materially and adversely affect our business, financial condition and results of operations.
We are party to various litigation claims and legal proceedings. Refer to Note 11- “Commitments and Contingencies” in the accompanying financial statements. As a consumer finance company, we are subject to various consumer claims and litigation seeking damages and statutory penalties. Some litigation against us could take the form of class action complaints by consumers or shareholder derivative complaints, and we are party to multiple purported securities class action lawsuits and shareholder derivative complaints. As the assignee of loans originated by vehicle dealers, we also may be named as a co-defendant in lawsuits filed by consumers principally against vehicle dealers.
Customers of financial services institutions, including our customers, may seek redress for loss as a result of inaccuracies or misrepresentations made during the sale of a particular product or through incorrect application of the terms and conditions of a particular product. An adverse outcome in litigation related to these matters, any penalties imposed or compensation awarded and the costs of defending the litigation could harm our reputation or materially and adversely affect our business, financial condition and results of operations.
Negative publicity associated with litigation, governmental investigations, regulatory actions and other public statements could damage our reputation.
From time to time, there are negative media stories about us or the nonprime credit industry. These stories may follow the announcement of actual or threatened litigation or regulatory actions involving us or others in our industry. Our ability to attract consumers is highly dependent upon external perceptions of our level of service, trustworthiness, business practices and financial condition. Negative publicity about such matters, our alleged or actual practices, or our industry generally could materially and adversely affect our business, financial condition and results of operations, including our ability to retain and attract employees.
Changes in taxes and other assessments may adversely affect us.
The legislatures and tax authorities in the tax jurisdictions in which we operate regularly enact reforms to the tax and other assessment regimes to which we and our customers are subject. Such reforms include changes in the rate of assessments and, occasionally, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. While the Tax Cuts and Jobs Act of 2017 had a positive impact on our net income for the year-ended 2017, the effects of any changes that result from enactment of future tax reforms cannot be quantified, and there can be no assurance that any such reforms would not materially and adversely affect our business, financial condition and results of operations.
Liquidity and Funding Risks
Our business, financial condition and results of operations could be materially and adversely affected if our access to funding is reduced.
We rely upon our ability to sell securities in the ABS market and upon our ability to access various credit facilities to fund our operations. The ABS market, along with credit markets in general, have experienced significant disruptions in the past, during which certain issuers have experienced increased risk premiums while there was a relatively lower level of investor demand for certain ABS (particularly those securities backed by nonprime collateral). Decreased demand for lower credit grade ABS could restrict our ability to access the ABS market for nonprime collateralized receivables. Also, regulatory reforms enacted under the Dodd-Frank Act generally require us to retain a minimum specified portion (5%) of the credit risk on assets collateralizing ABS issuances which could potentially reduce the amount of liquidity otherwise generally available through ABS programs. These and other adverse changes in our ABS program or in the ABS market generally, including rising interest rates, could materially adversely affect our ability to securitize loans on a timely basis or upon terms acceptable to us. This could increase our cost of funding, reduce our margins or delay issuing until investor demand improves.
We also depend on various credit facilities to fund our future liquidity needs. We cannot guarantee that these financing sources will continue to be available beyond the current maturity dates, on reasonable terms, or at all.
We continue to require a significant amount of liquidity to finance our volume of loan acquisitions and originations. We require borrowing capacity through credit facilities. The availability of these financing sources depends, in part, on our ability to forecast necessary levels of funding as well as on factors outside of our control, including regulatory capital treatment for unfunded bank lines of credit, the financial strength and strategic objectives of Santander and the other banks that participate in our credit facilities and the availability of bank liquidity in general. We may also experience the occurrence of events of default or breach of financial covenants, which could reduce our access to bank funding. In the event of a sudden or unexpected shortage of funds in the banking system, we cannot be sure that we will be able to maintain necessary levels of funding.
We are subject to general market conditions that affect issuers of ABS and other borrowers, and we could experience increased risk premiums or funding costs in the future. In addition, if the sources of funding described above are not available to us on a regular basis for any reason, we may have to curtail or suspend our loan acquisition and origination activities. Downsizing the scale of our business could materially and adversely affect our business, financial condition and results of operations.
Poor portfolio performance may trigger credit enhancement provisions in our revolving credit facilities or secured structured financings.
Our revolving credit facilities generally have net spread, delinquency and net loss ratio limits on the receivables pledged to each facility that, if exceeded, would potentially increase the level of credit enhancement requirements and/or redirect all excess cash to the credit providers. Generally, these limits are calculated based on the portfolio collateralizing the respective credit line; however, for certain of our warehouse facilities, delinquency and net loss ratios are calculated with respect to our serviced portfolio as a whole. Our facilities used to finance vehicle lease originations also have a residual loss ratio limit calculated with respect to our serviced lease portfolio as a whole based on maturing leases returned to SC.
The documents that govern certain secured structured financings also contain cumulative net loss ratio triggers on the
receivables included in each securitization trust. If, at any measurement date, the cumulative net loss ratio were to exceed the specified limits, provisions of the financing agreements would increase the target level of credit enhancement for that financing and delay excess cash payments to the residual holder of the ABS, which is generally us. Excess cash flows, if any, from the facility would be used to fund the increased credit enhancement levels rather than being distributed to us. Once an impacted trust reaches the new requirement, we would return to receiving a residual distribution from the trust.
We apply financial leverage to our operations, which may materially adversely affect our business, financial condition and results of operations.
We currently apply financial leverage, pledging most of our assets to credit facilities and securitization trusts, and we intend to continue to apply financial leverage in our retail lending operations. Our debt-to-assets ratio is 79.4% as of December 31, 2018. Although our total borrowings capacity is defined in our lending agreements, we may change our target borrowing levels at any time. Incurring substantial debt subjects us to the risk that our cash flow from operations may be insufficient to service our outstanding debt.
Our indebtedness and other obligations are significant, impose restrictions on our business and could materially and adversely affect our business and ability to react to changes in the economy or our industry.
We have a significant amount of indebtedness. At December 31, 2018 and 2017, we had approximately $34.9 billion and $31.2 billion, respectively, in principal amount of indebtedness outstanding (including $31.4 billion and $28.2 billion, respectively, in secured indebtedness). Interest expense on our indebtedness constituted 20% of our total net finance and other interest income, net of leased vehicle expense, for the twelve months ended December 31, 2018.
Our debt reduces operational flexibility and creates default risks. Our revolving credit facilities contain a borrowing base or advance rate formula that requires us to pledge finance contracts in excess of the amounts that we can borrow under the facilities. Accordingly, increases in delinquencies or defaults resulting from weakened economic conditions would require us to pledge additional finance contracts to support the same borrowing levels and may cause us to be unable to securitize loans to the extent we desire. These outcomes could materially and adversely affect our business, financial condition and results of operations, including our liquidity.
Additionally, the credit facilities generally contain various covenants requiring, in certain cases, minimum financial ratios, asset quality and portfolio performance ratios (portfolio net loss and delinquency ratios, and pool level cumulative net loss ratios), as well as limits on deferral levels. Generally, these limits are calculated based on the portfolio collateralizing the respective line; however, for certain of our third-party credit facilities, delinquency and net loss ratios are calculated with respect to our serviced portfolio as a whole. Covenants in the agreements governing our debts may also limit our ability to:
• incur or guarantee additional indebtedness;
• purchase large loan portfolios in bulk;
• sell assets, including our loan portfolio or the capital stock of our subsidiaries;
• enter into transactions with affiliates;
• create or incur liens; and
• consolidate, merge, sell or otherwise dispose of all or substantially all of our assets.
Additionally, certain of our credit facilities contain minimum tangible net worth requirements, and certain of our credit facilities contain covenants that require timely filing of periodic reports with the SEC. Failure to meet any of these covenants, or to obtain a waiver for any such failure, could result in an event of default under these agreements. If an event of default occurs under these agreements, potential actions lenders have on certain debt agreements include declaring all amounts outstanding under these agreements to be immediately due and payable, enforce their interests against collateral pledged under these agreements, restrict our ability to obtain additional borrowings under these agreements and/or remove us as servicer. Such an event of default could materially and adversely affect our business, financial condition and results of operations, including our liquidity.
If our debt service obligations increase, whether due to the increased cost of existing indebtedness or the incurrence of additional indebtedness, we may be required to dedicate a significant portion of our cash flow from operations to the payment of principal of, and interest on, our indebtedness, which would reduce the funds available for other purposes. Our indebtedness also could limit our ability to withstand competitive pressures and reduce our flexibility in responding to changing business and economic conditions.
In addition, certain of our funding arrangements may require us to make payments to third parties if losses exceed certain
thresholds, including, for example, certain of our flow agreements and arrangements with certain third-party loan originators of loans that we purchase on a periodic basis.
Our business, financial condition, liquidity and results of operations depend on the credit performance of our loans.
As of December 31, 2018, more than 82% of our vehicle consumer loans are nonprime receivables with obligors who do not qualify for conventional consumer finance products as a result of, among other things, a lack of or adverse credit history, low income levels and/or the inability to provide adequate down payments. These loans experience higher default rates than a portfolio of obligations of prime obligors. In the event of a default on a vehicle loan, generally the most practical alternative for recourse by the lender is repossession of the financed vehicle, although the collateral value of the vehicle usually does not cover the outstanding account balance and costs of recovery. Repossessions and foreclosure sales that do not yield sufficient proceeds to repay the receivables in full could result in losses on those receivables.
We are exposed to geographic customer concentration risk. An economic downturn or catastrophic event that disproportionately affects certain geographic regions could materially and adversely affect our business, financial condition and results of operations, including the performance of our loan portfolio.
Our allowance for credit losses and impairments may prove to be insufficient to absorb probable losses inherent in our loan portfolio.
We maintain an allowance for credit losses, established through a provision for credit losses charged to expense, that we believe is appropriate to provide for probable losses inherent in our originated loan portfolio. The determination of the appropriate level of the allowance for credit losses necessarily involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends using existing quantitative and qualitative information, all of which are subject to material changes.
For receivables portfolios purchased from other lenders at a discount to the aggregate principal balance of the receivables, the portion of the discount that was attributable to credit deterioration since origination of the loans is recorded as a nonacceptable difference. Any deterioration in the performance of the purchased portfolios after acquisition results in an incremental allowance. The determination of the appropriate level of the allowance for credit losses and nonacceptable difference for portfolios purchased from other lenders necessarily involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which are subject to change. Changes in economic conditions affecting borrowers, new information regarding our loans, and other factors, both within and outside of our control, may require an increase in the allowance for credit losses. Furthermore, growth in our loan portfolio generally would lead to an increase in the provision for credit losses. In addition, if net charge-offs in future periods exceed the allowance for credit losses, we will need to make additional provisions to increase the allowance. There is no precisely accurate method for predicting credit losses, and we cannot provide assurance that our current or future credit loss allowance will be sufficient to cover actual losses.
The process for determining our allowance for credit losses is complex, and we may from time to time make changes to our process for determining our allowance for credit losses. In addition, regulatory agencies periodically review our allowance for credit losses, as well as our methodology for calculating our allowance for credit losses and may require an increase in the provision for loan losses or the recognition of additional loan charge-offs, based on judgments different than those of management. Changes that we make to enhance our process for determining our allowance for credit losses may lead to an increase in our allowance for credit losses. Any increase in our allowance for credit losses will result in a decrease in net income and capital, and may have a material adverse effect on us. Material changes to our methodology for determining our allowance for loan losses could result in the need to restate our financial statements or fines, penalties, potential regulatory action and damage to our reputation.
Adverse macroeconomic conditions in the United States and worldwide may materially and adversely affect our business, financial condition and results of operations.
We are subject to changes in macroeconomic conditions that are beyond our control, and the macroeconomic environment remains susceptible to global events and volatility. A significant deterioration in economic conditions in the United States or worldwide could materially and adversely affect our business, financial condition and results of operations, including periods of slow economic growth; inflation and unemployment rates; changes in the availability of consumer credit and other factors that
impact consumer confidence, demand for credit, payment patterns, bankruptcies or disposable income; natural disasters, acts of war, terrorist attacks and the escalation of military activity; confidence in financial markets; the availability and cost of capital; interest rates and commodity prices (including gasoline prices); and geopolitical matters.
Some of the risks we face as a result of changes in these and other economic factors include the following:
Loss rates could increase. Our balance sheet consists of predominantly nonprime consumers, who are associated with higher-than-average delinquency rates. The actual rates of delinquencies, defaults, repossessions and losses from nonprime loans could be more dramatically affected by a general economic downturn than other loans.
Consumer demand for, and the value of, new and used vehicles and other consumer products securing outstanding accounts could decrease, including as a result of technological advancements or changes to trends in the automobile industry such as new autonomous driving technologies or car- and ride- sharing programs. Decreased demand would weaken collateral coverage and increase the amount of losses in the event of default.
Servicing costs could increase without a corresponding increase in our finance charge income.
Our compliance costs may increase as a result of increased regulation enacted in response to deterioration in economic conditions.
Dealership closures and decreases in sales and loan volume by our existing vehicle dealer base may occur, which could result in the reduction in scale of our business.
Financial market instability and volatility could negatively affect our liquidity and funding costs.
Changes in interest rates may adversely impact our profitability and risk profile.
Like other consumer finance companies, our profitability may be directly affected by interest rate levels and fluctuations in interest rates. As interest rates change, our gross interest rate spread on originations either increases or decreases because the rates charged on the contracts originated or purchased from dealers are limited by market and competitive conditions, restricting our ability to pass on increased interest costs to the consumer.
Interest rates have risen in 2016-2018 off historic lows set between 2008-2015 following the financial crisis. In December 2018, the Federal Reserve raised its benchmark rate for the fourth time in 2018, increasing its target range for its benchmark rate to 2.25%-2.5%. The Federal Reserve has recently signaled that further increases in its target range for its benchmark rate may occur given current economic activity and labor conditions and the current rate of inflation.
Although the Federal Reserve’s recent decisions to raise its benchmark rate may reduce prepayment risk, debt service requirements for some of our borrowers will increase, which may adversely affect those borrowers’ ability to pay as contractually obligated. This could result in additional delinquencies or charge-offs and negatively impact our results of operations.
Additionally, although the majority of our borrowers are nonprime and are not highly sensitive to interest rate movement, increases in interest rates may reduce the volume of loans we originate. While we monitor the interest rate environment and employ hedging strategies designed to mitigate the impact of increased interest rates, we cannot provide assurance that hedging strategies will fully mitigate the impact of changes in interest rates.
In July 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. The Alternative Reference Rates Committee ("ARRC") has proposed that the Secured Overnight Financing Rate ("SOFR") is the rate that represents best practice as the alternative to USD-LIBOR for use in derivatives and other financial contracts that are currently indexed to USD-LIBOR. ARRC has proposed a paced market transition plan to SOFR from USD-LIBOR and organizations are currently working on industry wide and company specific transition plans as it relates to derivatives and cash markets exposed to USD-LIBOR. If LIBOR ceases to exist, or if new methods of calculating LIBOR are established, interest rates on any financial instrument tied to LIBOR, as well as revenue and expenses associated with those financial instruments, may be adversely affected, and financial markets relevant to us could be disrupted.
Our business, financial condition and results of operations could be materially and adversely affected if used-vehicle values decline, resulting in lower residual values of our vehicle leases and lower recoveries in sales of repossessed vehicles.
General economic conditions, the supply of off-lease and other used vehicles to be sold, new vehicle market prices and marketing programs, vehicle brand image and strength, perceived vehicle quality, general consumer preference and confidence levels, tariff policy, seasonality, and overall price and price volatility of gasoline or diesel fuel, among other factors, heavily influence used-vehicle values and thus the residual value of our leased vehicles and the amount we recover in remarketing
repossessed vehicles. Our financial results are sensitive to used-vehicle values as leases continue to become a larger part of our business.
Our expectation of the residual value of a leased vehicle is a critical input in determining the amount of the lease payments at the inception of a lease contract. Our lease customers are responsible only for any deviation from expected residual value that is caused by excess mileage or excess wear and tear, while we retain the obligation to absorb any general market changes in the value of the vehicle. Therefore, our operating lease expense is increased when we have to take an impairment on our residual values or when the realized residual value of a vehicle at lease termination is less than the expected residual value for the vehicle at lease inception. In addition, the timeliness, effectiveness, and quality of our remarketing of off-lease vehicles affects the net proceeds realized from the vehicle sales. Lower used-vehicle values can reduce the amount we can recover when remarketing repossessed vehicles that serve as collateral on the underlying loans.
Used-vehicle values may decline in the future, and such declines in used-vehicle values could materially and adversely affect our business, financial condition and results of operations.
We are subject to market, operational and other related risks associated with our derivative transactions that could materially and adversely affect our business, financial condition and results of operations.
We enter into derivative transactions for economic hedging purposes. We are subject to market and operational risks associated with these transactions, including basis risk, the risk of loss associated with variations in the spread between the asset yield and the funding and/or hedge cost, credit or default risk, the risk of insolvency, or other inability of the counterparty to a particular transaction to perform its obligations thereunder, including providing sufficient collateral. Additionally, certain of our derivative agreements may require us to post collateral when the fair value of the derivative is negative. Our ability to adequately monitor, analyze and report derivative transactions continues to depend, to a great extent, on our information technology systems.
General Business and Industry Risks
Our relationship with FCA is a significant source of our loan and lease originations. Loss of our relationship with FCA, including as a result of termination of our agreement with FCA, could materially and adversely affect our business, financial condition and results of operations. Our agreement with FCA may not result in currently anticipated levels of growth and is subject to certain performance conditions that could result in termination of the agreement. In addition, FCA has the option to acquire an equity participation in the Chrysler Capital portion of our business.
In February 2013, we entered into the Chrysler Agreement with FCA under which we launched the Chrysler Capital brand. Through the Chrysler Capital brand, we originate private-label loans and leases to facilitate the purchase of FCA vehicles by consumers and FCA-franchised automotive dealers. The financing services that we provide under the Chrysler Agreement include credit lines to finance FCA franchised dealers, acquisitions of vehicles and other products that FCA sells or distributes, automotive loans and leases to finance consumer acquisitions of new and used vehicles at FCA-franchised dealerships, financing for commercial and fleet customers and ancillary services. In addition, we may facilitate, for an affiliate, offerings to dealers for dealer loan financing, construction loans, real estate loans, working capital loans and revolving lines of credit.
In accordance with the terms of the Chrysler Agreement, in May 2013 we paid FCA a $150 million upfront, nonrefundable payment, which is being amortized over ten years. The unamortized portion would be recognized as expense immediately if the Chrysler Agreement is terminated in accordance with its terms.
As part of the Chrysler Agreement, we received limited exclusivity rights to participate in specified minimum percentages of certain of FCA’s financing incentive programs, which include loan rate subvention and automotive lease residual support subvention. We have committed to certain revenue sharing arrangements. We bear the risk of loss on loans originated pursuant to the Chrysler Agreement, while FCA shares in any residual gains and losses in respect of automotive leases, subject to specific provisions in the Chrysler Agreement, including limitations on our participation in gains and losses.
In addition, under the Chrysler Agreement, FCA has the option to acquire, for fair market value, an equity participation in the business offering and providing the financial services contemplated by the Chrysler Agreement. FCA has announced its intention to establish a captive U.S. auto finance unit and indicated that acquiring Chrysler Capital is one option it will consider. There is no maximum limit on the size of FCA’s potential equity participation. Although the Chrysler Agreement contains provisions that are designed to address a situation in which the parties disagree on the fair market value of the equity participation interest, there is a risk that we ultimately receive less than what we believe to be the fair market value for such interest, and the loss of our associated revenue and profits may not be offset fully by the immediate proceeds for such interest.
There can be no assurance that we would be able to redeploy the immediate proceeds for such interest in other businesses or investments that would provide comparable returns, thereby reducing our profitability. Moreover, the likelihood, timing and structure of any such transaction, and the likelihood that the Chrysler Agreement will terminate, cannot be reasonably determined, but termination of the Chrysler Agreement or a significant change in the business relationship between FCA and us could materially adversely affect our operations, including the origination of receivables through the Chrysler Capital portion of our business and the servicing of Chrysler Capital receivables, and there can be no assurance that we could successfully or timely implement any such transaction without significant disruption of our operations or restructuring, or without incurring additional liabilities, which could involve significant expense to us and have a material adverse effect on our business, financial condition and results of operations.
The Chrysler Agreement is subject to early termination in certain circumstances, including the failure by either party to comply with certain of its ongoing obligations under the Chrysler Agreement. We were required to meet specified escalating penetration rates for the first five years of the agreement. We did not meet these penetration rates.
FCA may also terminate the agreement if, among other circumstances, (i) a person other than Santander and its affiliates or our other stockholders owns 20% or more of our common stock and Santander and its affiliates own fewer shares of common stock than such person, (ii) SC controls or becomes controlled by an OEM that competes with FCA or (iii) certain of our credit facilities become impaired.
Our ability to realize the full strategic and financial benefits of our relationship with FCA depends in part on the successful development of our Chrysler Capital business, which requires a significant amount of management’s time and effort, and as well as the success of FCA’s business. If FCA exercises its purchase option, or if the Chrysler Agreement were to terminate, or we are otherwise unable to realize the expected benefits of our relationship with FCA, including as a result of FCA’s bankruptcy or loss of business, there could be a materially adverse impact to our business, financial condition, results of operations, profitability, loan and lease volume, the credit quality of our portfolio, liquidity, reputation, funding costs and growth, and our ability to obtain or find other original equipment manufacturer relationships or to otherwise implement our business strategy could be materially adversely affected. On July 11, 2018, FCA and the Company entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party in accordance with Section 14.02 of the MPLFA until December 31, 2018.
We partially rely on third parties to deliver services. Our failure to effectively monitor or manage those third parties or the failure by those third parties to provide these services or meet contractual requirements could materially and adversely affect our business, financial condition and results of operations.
We depend on third-party service providers for many aspects of our business operations. For example, we depend on third parties like Experian to obtain data related to our market that we use in our origination and servicing platforms. In addition, we rely on third-party servicing centers for a portion of our servicing activities and on third-party repossession agents. If we fail to effectively monitor or manage a service provider or if a service provider fails to provide the services that we require or expect, or fails to meet contractual requirements, such as service levels or compliance with applicable laws, a failure could negatively impact our business by adversely affecting our ability to process customers’ transactions in a timely and accurate manner, otherwise hampering our ability to service our customers, or subjecting us to litigation or regulatory risk for poor vendor oversight. Such a failure could adversely affect the perception of the reliability of our networks and services, and the quality of our brands, and could materially and adversely affect our business, financial condition and results of operations.
Loss of our key management or other personnel, or an inability to attract such management and other personnel, could materially and adversely affect our business, financial condition and results of operations.
The successful implementation of our growth strategy depends in part on our ability to retain our experienced management team and key employees, attract appropriately qualified personnel and have an effective succession planning framework in place. Management turnover, including the loss of any key member of our management team or other key employees, could hinder or delay our ability to implement our growth strategy effectively or our ability to manage our business holistically through leadership support of change activities, ongoing and consistent communication of our growth strategy and proper employee training and awareness. Further, if we are unable to attract appropriately qualified personnel as we expand, we may not be successful in implementing our growth strategy. In either instance, our business, financial condition and results of operations could be adversely affected. The extent of our management team changes could result in disruption in our operations, negatively impact customer relationships and make recruiting for future management positions more difficult.
Due to our relationship with Santander, we also are subject to indirect regulation by the European Central Bank, which imposes
compensation restrictions that may apply to certain of our executive officers and other employees under Capital Requirements Directive 2013/36/EU (also known as CRD IV). These restrictions may impact our ability to retain our experienced management team and key employees and our ability to attract appropriately qualified personnel, which could materially and adversely affect our business, financial condition and results of operations.
Our risk management processes and procedures may not be effective in mitigating our risks.
We continue to establish and enhance processes and procedures intended to identify, measure, monitor and control the types of risk to which we are subject, including, but not limited to, credit risk, market risk, strategic risk, liquidity risk and operational risk. We seek to monitor and control our risk exposure through a framework that includes our risk appetite, enterprise risk assessment process, risk policies, procedures and controls, reporting requirements, risk culture and governance structure. Our framework, however, may not always effectively identify and control our risks. In addition, there may also be risks that exist, or that develop in the future, that we have not appropriately anticipated, identified or mitigated, including when processes are changed or new products and services are introduced. If our risk management framework does not effectively identify and control our risks, both those we are aware of and those we do not anticipate, including as a result of changes in economic conditions, we could suffer unexpected losses that could have a material and adverse effect on our business, financial condition and results of operations.
We face significant risks in implementing our growth strategy, some of which are outside our control.
We intend to continue our growth strategy to expand our vehicle finance franchise by increasing market penetration via the number and depth of our relationships in the vehicle finance market, pursuing additional relationships with OEMs, expanding our direct-to-consumer footprint and growing our serviced for others platform. Our ability to execute this growth strategy is subject to significant risks, some of which are beyond our control, including:
the inherent uncertainty regarding general economic conditions; our ability to obtain adequate financing for our expansion plans;
the prevailing laws and regulatory environment of each state in which we operate or seek to operate, and, federal laws and regulations, to the extent applicable, which are subject to change at any time;
the degree of competition in our markets and its effect on our ability to attract customers;
our ability to recruit qualified personnel, in particular, in areas where we face a great deal of competition; and
our ability to obtain and maintain any regulatory approvals, government permits, or licenses that may be required on a timely basis
Changes in our relationship with Santander may adversely affect our business, financial condition and results of operations.
Santander, through SHUSA, currently owns approximately 69.9% of our common stock. We rely on our relationship with Santander, through SHUSA, for several competitive advantages including relationships with OEMs and regulatory best practices and other commercial arrangements. Changes in our relationship with Santander, and changes affecting Santander, could materially and adversely affect our business, financial condition and results of operations.
Some of the risks we face as a result of potential changes in our relationship with, or changes affecting, Santander include the following:
Santander has provided and continues to provide us with significant funding support, through both committed liquidity and opportunistic extensions of credit, as well as guarantees of our obligations under the governing documents of certain warehouse facilities and privately issued amortizing notes. For example, during the financial downturn, Santander and its affiliates provided us with more than $6 billion in financing that enabled us to pursue several acquisitions and/or conversions of vehicle loan portfolios at a time when most major banks were curtailing or eliminating their commercial lending activities. During 2017 and 2018 we sold eligible prime loans through our SPAIN securitization platform to Santander under a flow agreement. In addition, during 2018 the Company began originating prime loans on behalf of SBNA which are serviced by SC. If Santander or its affiliates elect not to provide such support, not to provide it to the same degree or not to enter into additional agreements, we may not be able to replace such support ourselves or to obtain substitute arrangements with third parties. We may be unable to obtain such support because of financial or other constraints, or be unable to implement substitute arrangements on a timely basis on terms that are comparable, or at all, which could materially and adversely affect our business, financial condition and results of operations.
Santander may sell or otherwise reduce its equity interest in us. If Santander sells or otherwise reduces its equity interest in us, it may be less willing to provide us with the support it has provided in the past or to enter into agreements (such as our flow agreement with Santander or our origination services agreements with SBNA) with us on comparable terms, or at all, as it has in the past. In addition, our right to use the Santander name is on the basis of a non-exclusive, royalty-free, and non-transferable license from Santander, and only extends to uses in connection with our current and future operations within the United States. Santander may terminate such license at any time Santander ceases to own, directly or indirectly, 50% or more of our common stock. If we were required to change our name, we would incur the administrative costs and burden associated with revising legal documents and marketing materials, and also may experience loss of brand and loss of business or loss of funding due to consumers' and banks' relative lack of familiarity with our new name. Additionally, FCA may terminate the Chrysler Agreement if a person other than Santander and its affiliates or our other stockholders owns 20% or more of our common stock and Santander and its affiliates own fewer shares of common stock than such person.
Some terms of our credit agreements are influenced by, among other things, the credit ratings of Santander. If Santander were to suffer credit rating downgrades or other adverse financial developments, we could be negatively impacted, either directly or indirectly. For example, Santander’s short-term credit ratings downgrades in 2012, from A-I to A-2 (Standard & Poor's) and from P-1 to P-2 (Moody's), did not directly impact our cost of funds. However, due to the contractual terms of certain of our debt agreements, these downgrades resulted in the loss of our ability to commingle funds on most facilities. A similar downgrade today would result in an increase of approximately $2.5 million per month.
Santander applies certain standardized banking policies, procedures and standards across its affiliated entities, including with respect to internal audit, credit approval, governance, risk management and compensation practices. We currently follow certain of these Santander policies and may in the future become subject to additional Santander policies, procedures and standards, which could result in changes to our practices.
Our relationship with Santander or SHUSA could reduce the willingness of other banks to develop relationships with us due to general competitive dynamics among such financial institutions.
Our business, financial condition and results of operations could be materially and adversely affected if we fail to manage and complete divestitures.
We regularly evaluate our portfolio in order to determine whether an asset or business may no longer be aligned with our strategic objectives. For example, in 2015, we disclosed a decision to exit our personal lending business and to explore strategic alternatives for our existing personal lending assets. When we decide to sell assets or a business, we may encounter difficulty in finding buyers or alternative exit strategies on acceptable terms in a timely manner, which could delay the achievement of our strategic objectives. We may also experience greater costs and dissynergies than expected, and the impact of the divestiture on our revenue may be larger than projected. Additionally, we may ultimately dispose of assets or a business at a price or on terms that are less favorable than those we had originally anticipated. After reaching a definitive agreement with a buyer, we typically must satisfy pre-closing conditions and the completion of the transaction may be subject to regulatory and governmental approvals. Failure of these conditions and approvals to be satisfied or obtained may prevent us from completing the transaction. Divestitures involve a number of risks, including the diversion of management and employee attention, significant costs and expenses, and a decrease in revenues and earnings associated with the divested business. Divestitures may also involve continued financial involvement in the divested business, such as through continuing equity ownership, guarantees, indemnities or other financial obligations. Under these arrangements, performance by the divested businesses or other conditions outside of our control could materially and adversely affect our business, financial condition and results of operations.
Our two primary personal lending relationships have been with LendingClub and Bluestem. We completed the sale of substantially all of our LendingClub loans in 2016 and the remaining portfolio was sold in 2017. We continue to hold our Bluestem portfolio, which had a carrying balance of approximately 1.1 billion as of December 31, 2018, and we remain a party to agreements with Bluestem that obligate us, among other things, to purchase new advances originated by Bluestem and existing balances on accounts with new advances for an initial term ending in April 2020 and renewable through April 2022 at Bluestem’s option. Although we are seeking a third party to assume this obligation, we may not be successful in finding such a party, and Bluestem may not agree to the substitution. Until we find a third party to assume this obligation, there is a risk that material changes to our relationship with Bluestem, or the loss or discontinuance of Bluestem’s business, would materially and adversely affect our business, financial condition and results of operations. We continue to classify the Bluestem portfolio as held-for-sale. We have recorded significant lower-of-cost-or-market adjustments on this portfolio and may continue to do so as long as we hold the portfolio, particularly due to the new volume we are committed to purchase.
Our business, financial condition and results of operations could be materially and adversely affected if we are unsuccessful in developing and maintaining relationships with vehicle dealerships.
Our ability to originate and acquire loans and vehicle leases depends on our relationships with vehicle dealers. In particular, our vehicle finance operations depend in large part upon our ability to establish and maintain relationships with reputable vehicle dealers that direct customers to our offices or originate loans at the point-of-sale, which we subsequently purchase. Although we have relationships with certain vehicle dealers, none of our relationships is exclusive and any may be terminated at any time. In addition, an economic downturn or contraction of credit affecting either dealers or their customers could result in an increase in vehicle dealership closures or a decrease in the sales and loan volume of our existing vehicle dealer base, which could materially and adversely affect our business, financial condition and results of operation.
Our business, financial condition and results of operations could be materially and adversely affected if we are unsuccessful in developing and maintaining our serviced for others portfolio.
A significant and growing portion of our business strategy is to increase the revenue stream from our serviced for others portfolio by continuing to add assets to this portfolio. For example, beginning in 2018, we agreed to provide SBNA with origination support services in connection with the processing, underwriting and purchase of retail loans, primarily from Chrysler dealers, and to perform the servicing for any loans originated on SBNA’s behalf. We have also recently obtained servicing rights to certain third-party portfolios and we also serve as servicer in our securitization and may retain servicing rights in certain whole-loan sales. For the year-ended December 31, 2018, we maintained servicing rights for a portfolio with an outstanding principal balance of approximately $9 billion and we received servicing fees in the amount of $106,840. If an institution for which we currently service assets chooses to terminate our rights as servicer, or if we fail to add additional institutions or portfolios to our servicing platform, we may not achieve the desired revenue or income from this strategy.
We depend on the accuracy and completeness of information about borrowers and counterparties and any misrepresented information could materially and adversely affect our business, financial condition and results of operations.
In deciding whether to approve loans or to enter into other transactions with borrowers and counterparties in our retail lending and commercial lending businesses, we may rely on information furnished to us by or on behalf of borrowers and counterparties, including financial statements and other financial information such as income. We also may rely on representations of borrowers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the value of the loan may be significantly lower than expected. Whether a misrepresentation is made by the loan applicant, another third party or one of our employees, we generally bear the risk of loss associated with the misrepresentation. Our controls and processes may not have detected or may not detect all misrepresented information in our loan originations or from our business clients. Any such misrepresented information could materially and adversely affect our business, financial condition and results of operations.
Negative changes in the business of the OEMs with which we have strategic relationships, including FCA, could materially and adversely affect our business, financial condition and results of operations.
A significant adverse change in FCA’s or other vehicle manufacturers’ business, including (i) significant adverse changes in their respective liquidity position and access to the capital markets, (ii) the production or sale of FCA or other vehicle manufacturers’ vehicles (including the effects of any product recall), (iii) the quality or resale value of FCA or other vehicles, (iv) the use of marketing incentives, (v) FCA’s or other vehicle manufacturers’ relationships with their key suppliers, (v) FCA’s or other vehicle manufacturers’ bankruptcy or (vii) FCA’s or other vehicle manufacturers’ respective relationships with the United Auto Workers and other labor unions, and other factors impacting vehicle manufacturers or their employees could materially and adversely affect our business, financial condition and results of operations.
Under the Chrysler Agreement we originate private-label loans and leases to facilitate the purchase of FCA vehicles by consumers and FCA-franchised vehicle dealers. In the future, it is possible that FCA or other vehicle manufacturers with whom we have relationships could utilize other companies to support their financing needs, including offering products or terms that we would not or could not offer, which could materially and adversely affect our business financial condition and results of operations. Furthermore, FCA or other vehicle manufacturers could expand, establish or acquire captive finance companies to support their financing need; thus, reducing their need for our services.
There can be no assurance that the global vehicle market, or FCA’s or our other OEM partners’ share of that market, will not suffer downturns in the future, and any negative impact could in turn materially and adversely affect our business, financial condition and results of operations.
Future significant loan, lease or personal loan repurchase requirements could materially and adversely affect our business, financial condition and results of operations.
We have repurchase obligations in our capacity as servicer in securitizations and whole-loan sales. If a servicer breaches a representation, warranty or covenant with respect to the loans sold, the servicer may be required by the servicing provisions to repurchase that asset from the purchaser or otherwise compensate one or more classes of investors for losses caused by the breach. If significant repurchases of assets or other payments are required under our responsibility as servicer, it could materially and adversely affect our business, financial condition and results of operations. As we have increased the number of loans sold, the potential impact of such repurchases has increased.
We have treated sales of the debt and equity in certain of our securitizations as sales of the underlying finance receivables. The exercise of our clean-up call option on each of these securitizations when the collateral pool balance reaches 10%, or 15% of its original balance (depending on the securitization structure) would result in the repurchase of the remaining underlying finance receivables.
Competition with other lenders could materially and adversely affect our business, financial condition and results of operations.
The vehicle finance market is very competitive and is served by a variety of entities, including the captive finance affiliates of major vehicle manufacturers, banks, savings and loan associations, credit unions, and independent finance companies. The market is highly fragmented, with no individual lender capturing more than 10% of the market. Our competitors often provide financing on terms more favorable to vehicle purchasers or dealers than we offer. Many of these competitors also have longstanding relationships with vehicle dealerships and may offer dealerships or their customers other forms of financing that we do not offer. We anticipate that we will encounter greater competition as we expand our operations and as the economy continues to improve.
Certain of our competitors are not subject to the same regulatory regimes that we are. As a result, these competitors may have advantages in conducting certain businesses and providing certain services, and may be more aggressive in their loan origination activities. Increasing competition could also require us to lower the rates we charge on loans in order to maintain loan origination volume, which could materially and adversely affect our business, financial condition and results of operations.
As described above, we rely upon our ability to sell securities in the ABS market and upon our ability to access various credit facilities to fund our operations. Some of our competitors may have lower cost structures, or funding costs, and be less reliant on securitizations than we are.
Goodwill and intangible asset impairments may be required in relation to acquired businesses.
We have made business acquisitions for which it is possible that the goodwill and intangible assets which have been attributed to those businesses may have to be written down if our valuation assumptions are required to be reassessed as a result of any deterioration in the business' underlying profitability, asset quality or other relevant matters. Impairment testing with respect to goodwill and intangible assets is performed annually, or more frequently if impairment indicators are present. Goodwill and intangible asset impairment analysis and measurement is a process that requires significant judgment. Our stock price and various other factors affect the assessment of the fair value of our underlying business for purposes of performing any goodwill and intangible asset impairment assessment. We did not have any impairment on intangible assets during the years ended December 31, 2018, 2017 and 2016. There can be no assurance that we will not be required to record additional impairments on intangible assets in the future or that such impairments will not be material.
Developments stemming from the U.K.’s referendum on membership in the EU could have a material adverse effect on us.
The result of the United Kingdom’s (“UK’s”) referendum on whether to remain part of the European Union (“EU”) has had and may continue to have negative effects on global economic conditions and global financial markets. The results of the UK's referendum in 2016 to withdraw from the EU and the UK's implementation of that referendum means that the UK's EU membership will cease. The long-term nature of the UK’s relationship with the EU is unclear (including with respect to the laws and regulations that will apply as the UK determines which EU laws to replicate or replace) and, as negotiations continue, there is considerable uncertainty as to when the framework for any such relationship governing both the access of the UK to European markets and the access of EU member states to the UK’s markets will be determined and implemented. The result of the referendum has created an uncertain political and economic environment in the UK, and may create such environments in other EU member states. While the Company does not maintain a presence in the UK, political and economic uncertainty in countries with significant economies and relationships to the global financial industry have in the past led to declines in market
liquidity and activity levels, volatile market conditions, a contraction of available credit, lower or negative interest rates, weaker economic growth and reduced business confidence on an international level, each of which could adversely affect our business.
A successful security breach or a cyber-attack could materially and adversely affect our business, financial condition and results of operations.
In the normal course of business as a consumer finance company, we collect, process and retain sensitive and confidential consumer information and may, subject to applicable law share that information with our third-party service providers. This information is valuable to cyber-criminals and threat actors. Despite the security measures we have in place, our facilities and systems, and those of third-party service providers could be vulnerable to external or internal security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming or human errors or other similar events. A security breach or cyber-attack of our computer systems could interrupt or damage our operations or harm our reputation. If third parties or our employees are able to penetrate our network security or otherwise misappropriate our customers’ personal information or contract information, or if we give third parties or our employees improper access to consumers’ personal information or contract information, we could be subject to liability. This liability could include investigations, fines or penalties imposed by state or federal regulatory agencies or other government or self-regulatory bodies, including the loss of necessary permits or licenses. This liability could also include identity theft or other similar fraud-related claims, claims for other misuses, or losses of personal information, including for unauthorized marketing purposes or claims alleging misrepresentation of our privacy and data security practices.
We rely on encryption and authentication technology licensed from third parties to provide the security and authentication necessary to effect secure online transmission of confidential consumer information. Advances in computer capabilities new discoveries in the field of cryptography, or other events or developments may result in a compromise or breach of the algorithms that we use to protect sensitive consumer transaction data. A party who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. We may be required to expend capital and other resources to protect against such security breaches or cyber-attacks, or to alleviate problems caused by such breaches or attacks.
We have seen in recent years computer systems of companies and organizations being targeted, not only by cyber criminals, but also by activists and rogue states. We have been and continue to be subject to a range of cyber-attacks, such as denial of service, malware and phishing. Cyber-attacks could give rise to the loss of significant amounts of customer data and other sensitive information, as well as significant levels of liquid assets (including cash). In addition, cyber-attacks could give rise to the disablement of our information technology systems used to service our customers. As attempted attacks continue to evolve in scope and sophistication, we may incur increased insurance premiums or significant costs in our attempt to modify or enhance our protective measures against such attacks, to investigate or remediate any vulnerability or resulting breach, or in communicating cyber-attacks to our customers. If we fail to effectively manage our cyber-security risk by failing to update our systems and processes in response to new threats, this could harm our reputation and materially and adversely affect our business, financial condition and results of operations through the payment of customer compensation, regulatory penalties and fines and/or through the loss of assets.
Further, successful cyber-attacks of other market participants, whether or not we are impacted, could lead to a general loss of customer confidence that could negatively affect us, including harming the market perception of the effectiveness of our security measures or the financial system in general.
We are subject to many industry-specific and non-specific privacy laws. Further, our business is exposed to risk from potential non-compliance with policies, employee misconduct or negligence and fraud, which could result in regulatory sanctions and serious reputational or financial harm. It is not always possible to deter or prevent employee misconduct; and the precautions we take to detect and prevent this activity may not always be effective. In addition, we may be required to report events related to information security issues (including any cyber-security issues), events where customer information may be compromised, unauthorized access and other security breaches, to the relevant regulatory authorities. Any material disruption or slowdown of our systems could cause information, including data related to customer requests, to be lost or to be delivered to our clients with delays or errors, which could reduce demand for our services and products and could materially and adversely affect us.
Our information technology platforms may not support our future volumes and business strategies.
We rely on our proprietary software, commercial systems and third parties to continuously adapt our products and services to
evolving consumer behavior, changing vehicle finance and consumer loan products and third-party purchaser requirements. We employ engineers, product managers, designers, analysts and technical specialists to ensure that our technology and digital capabilities remain competitive. However, due to the continued rapid changes in technology, and potential for digital market disruptors to augment consumer digital behaviors, there can be no assurance that our technology solutions will continue to be adequate for our business or provide a competitive advantage.
Our technology platforms, underlying infrastructure and infrastructure of integrated third-party services are important to our operating activities, and any high-severity incidents or outages could disrupt our ability to process loan applications, originate loans or service our existing loan portfolios, which could materially and adversely affect our operating activities. We also rely on our technology platforms to process transaction information and produce financial reports. Outages may be caused by unforeseen catastrophic events, including natural disasters, terrorist attacks, large-scale power outages, software or hardware defects, computer viruses, cyber-attacks, external or internal security breaches, acts of vandalism, misplaced or lost data, programming or human errors, or other similar events. Although we maintain, and regularly assess the adequacy of, a business continuity plan and have designed our infrastructure for high availability to mitigate the risk of such events, we cannot be certain that our plan will function as intended, or otherwise resolve or compensate for such effects. Such a failure in business continuity, if and when experienced, may materially and adversely affect our business, financial condition and results of operations, including our ability to support and service our customer base and produce financial reports.
Our technology platforms may not be adequate for our business or provide a competitive advantage.
Due to the continued rapid changes in technology, including in the consumer finance industry, and potential for digital market disruptors to augment consumer digital behaviors, there can be no assurance that our technology platforms will be adequate for our business or provide a competitive advantage. Additionally, we may not be able to effectively implement new technology-driven products and services as quickly as some of our competitors or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the consumer financing industry could harm our ability to compete with our competitors and materially and adversely affect our business, financial condition and results of operations.
Financial Reporting and Control Risks
We are required to make significant estimates and assumptions in the preparation of our financial statements, and our estimates and assumptions may not be accurate. We also rely on pricing, accounting, risk management and other models which may fail to accurately predict outcomes.
The preparation of our consolidated financial statements in conformity with GAAP requires our management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the date of the consolidated financial statements, and the reported amounts of income and expense during the reporting periods. We also use estimates and assumptions in determining the residual values of leased vehicles. Critical estimates are made by management in determining, among other things, the allowance for credit losses, amounts of impairment and valuation of income taxes. The process we use to estimate losses inherent in our credit exposure requires complex judgments, including forecasts of economic conditions and how those economic conditions might impair the ability of our borrowers to repay their loans. The degree of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates, which may, in turn, impact the reliability of the process and the quality of our assets. If our underlying estimates and assumptions prove to be incorrect, our financial condition and results of operations may be materially and adversely affected.
We use models in various aspects of our business, including for pricing our extensions of credit, accounting determinations, risk management and other purposes and to assist with certain business decisions, and these models rely on many estimates and assumptions. The estimates and assumptions embedded in our models may prove to be inaccurate and furthermore our models may include deficiencies such as errors in coding or formulas, incorrect input or gathering of data, insufficient control over model changes and use of models other than for their intended purposes. If our models fail to accurately predict outcomes, we may not make appropriate business or financial decisions which could materially and adversely affect our financial condition and results of operations, including our capitalization and our relationships with regulators, customers and counterparties.
Furthermore, the Financial Accounting Standards Board, the SEC or other regulatory bodies may change the financial accounting and reporting standards to which we are subject, including those related to assumptions and estimates we use to prepare our financial statements. These changes may occur in ways we cannot predict and may impact our financial statements.
Lapses in internal controls, including internal control over financial reporting, could materially and adversely affect our
business, financial condition and results of operations, including our liquidity and reputation.
We have identified a material weakness in the controls around our financial reporting process for which remediation was still in process as of December 31, 2018. The control deficiency contributed to the restatement of the audited consolidated financial statements in our previously filed Annual Report on Form 10-K for the year ended December 31, 2015. See Part II, Item 9A, Controls and Procedures in this Annual Report on Form 10-K.
As of the filing of this Annual Report on Form 10-K, our management has completed the implementation of remediation efforts related to eight of the nine previously identified material weaknesses (six completed during 2017 and two completed in 2018) and considers them remediated. We are currently working to remediate the last outstanding material weakness, including assessing the need for additional remediation steps and implementing additional measures to remediate the underlying causes that gave rise to the material weaknesses. We are committed to maintaining a strong internal control environment and to ensure that a proper, consistent tone is communicated throughout the organization to ensure strict compliance with GAAP.
However, there can be no assurance that we will be able to fully remediate our existing material weakness. Further, there can be no assurance that we will not suffer other material weaknesses in the future. If we fail to remediate this material weakness or fail to otherwise maintain effective internal controls over financial reporting in the future, such failure could result in a material misstatement of our annual or quarterly financial statements that would not be prevented or detected on a timely basis and which could cause investors and other users to lose confidence in our financial statements, limit our ability to raise capital and have a negative effect on the trading price of our common stock. Additionally, failure to remediate the material weaknesses or otherwise failing to maintain effective internal controls over financial reporting may materially and adversely affect our business, financial condition and results of operations, and could impair our ability to timely file our periodic reports with the SEC, subject us to additional litigation and regulatory actions and cause us to incur substantial additional costs in future periods relating to the implementation of remedial measures.
Internal control over financial reporting may not prevent or detect all errors or acts of fraud.
We maintain disclosure controls and procedures designed to ensure that we timely report information as specified in the rules and regulations of the SEC. We also maintain a system of internal control over financial reporting. However, these controls may not achieve, and in some cases have not achieved, their intended objectives. Control processes that involve human diligence and compliance, such as our disclosure controls and procedures and internal control over financial reporting, are subject to lapses in judgment and breakdowns resulting from human failures. Controls can also be circumvented by collusion or improper management override of such controls. Because of such limitations, there are risks that material misstatements due to error or fraud may not be prevented or detected, and that information may not be reported on a timely basis. The failure of our controls to be effective could materially and adversely affect our business, financial condition and results of operations, including the market for our common stock, and could subject us to regulatory scrutiny and penalties.
We have previously identified material weaknesses in internal control over financial reporting for which remediation of one of the material weaknesses was still in process as of December 31, 2018. Certain of these material weaknesses involved the design of controls and failure of controls to operate effectively, resulting in misstatements in our previously filed public financial statements. As a result, we restated the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2015 and the unaudited financial statements included in certain of our previously filed Quarterly Reports on Form 10-Q. As of the filing of this Annual Report on Form 10-K, our management has completed the implementation of remediation efforts related to eight of the nine previously identified material weaknesses and considers them remediated. In addition, we are currently working to remediate the remaining material weakness.
If we are unable to effectively remediate and adequately manage our internal control over financial reporting in the future, we may be unable to produce accurate or timely financial information. As a result, we may be unable to meet our ongoing reporting obligations or comply with applicable legal requirements, which could lead to the imposition of sanctions or further investigation by regulatory authorities. Any such action or other negative results caused by our inability to meet our reporting requirements or comply with legal and regulatory requirements could lead investors and other users to lose confidence in our financial data and could adversely affect our business and the trading price of our common stock. Significant deficiencies or material weaknesses in our internal controls over financial reporting could also reduce our ability to obtain financing or could increase the cost of any financing we obtain.
Failure to timely satisfy obligations associated with being a public company may have adverse regulatory, economic and reputational consequences.
As a public company, we are required to prepare and file periodic reports containing our consolidated financial statements with
the SEC, prepare and distribute other stockholder communications in compliance with our obligations under the federal securities laws and applicable stock exchange rules, evaluate and maintain our system of internal control over financial reporting, and report on management’s assessment thereof, in compliance with the requirements of Section 404 of the Sarbanes-Oxley Act and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board (PCAOB); involve and retain outside legal counsel and accountants in connection with the activities listed above; maintain an investor relations function; and maintain internal policies, including those relating to disclosure controls and procedures.
Failure to file our periodic reports timely with the SEC or to otherwise comply with our obligations associated with being a public company may result in similar or other more significant adverse regulatory, economic and reputational consequences.
Risks and Other Considerations Related to Our Common Stock
So long as SHUSA controls us, our other stockholders will have limited ability to influence matters requiring stockholder approval, and Santander’s interest may conflict with the interests of our other stockholders.
As discussed above, Santander, through SHUSA, has significant influence over us, including control over decisions that require the approval of stockholders, which could limit other stockholders’ ability to influence the outcome of key transactions, including a change of control.
SHUSA currently owns approximately 69.9% of our common stock and is a party to the shareholder agreement between us and certain of our shareholders (Shareholder Agreement). Accordingly, SHUSA has significant influence over us. Pursuant to the Shareholders Agreement, SHUSA has the right to nominate a majority of our directors so long as minimum share ownership thresholds are maintained. The CEO of SHUSA is also our CEO. Further, because SHUSA owns a majority of our common stock, it has the power to elect our entire Board. Through our Board, and through functional reporting lines of SHUSA and our management, SHUSA controls our policies and operations, including, among other things, the appointment of management, future issuances of our common stock or other securities, the payment of dividends, if any, on our common stock, the incurrence of debt by us and the entry into extraordinary transactions.
If SHUSA and/or Santander owned 80% or more of our common stock, the Company could be consolidated with SHUSA and
Santander for tax filing and capital planning purposes, which would provide SHUSA and Santander with certain benefits. Among other things, tax consolidation would (1) facilitate certain offsets of the Company's taxable income, (2) eliminate the double taxation of dividends from the Company, and (3) trigger a release into SHUSA's income of the deferred tax liability established with respect to its ownership of the Company. In addition, SHUSA and Santander would recognize a larger percentage of our net income as its ownership increases and would likely realize an improvement in capital ratios.
Additionally, SHUSA may elect not to permit us to undertake certain actions or activities if SHUSA were to determine that such actions or activities could or would have negative regulatory implications to the Company, SHUSA, and/or Santander.
Further, the Shareholders Agreement provides the directors nominated by SHUSA with approval rights over certain specific material actions taken by us so long as minimum share ownership thresholds are maintained. These material actions include changes in material accounting policies, changes in material tax policies or positions and changes in our principal line of business.
The interests of SHUSA may conflict with the interests of our other stockholders. SHUSA’s influence and control over us may cause us to take actions that our other stockholders do not view as beneficial to them. In such circumstances, the market price of our common stock could be adversely affected. In addition, the existence of a controlling stockholder may have the effect of making it more difficult for a third party to acquire us, or may discourage a third party from seeking to acquire us.
Certain provisions of our amended and restated certificate of incorporation, and amended and restated bylaws, have antitakeover effects, which could limit the price investors might be willing to pay in the future for our common stock. In addition, Delaware law may inhibit takeovers of us and could limit our ability to engage in certain strategic transactions our Board believes would be in the best interests of stockholders.
Certain provisions of our amended and restated certificate of incorporation, and amended and restated bylaws, could discourage unsolicited takeover proposals that stockholders might consider to be in their best interests. Among other things, our amended and restated certificate of incorporation, and amended and restated bylaws, include provisions that:
do not permit cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
limit the ability of our stockholders to nominate candidates for election to our Board;
authorize the issuance of “blank check” preferred stock without any need for action by stockholders;
limit the ability of stockholders to call special meetings of stockholders or to act by written consent in lieu of a meeting; and
establish advance notice requirements for nominations for election to our Board or for proposing matters that may be acted on by stockholders at stockholder meetings.
The foregoing factors, as well as the significant common stock ownership by SHUSA, could impede a merger, takeover, or other business combination, or discourage a potential investor from making a tender offer for our common stock, which, under certain circumstances, could reduce the market value of our common stock.
In addition, Section 203 of the Delaware General Corporation Law (DGCL) generally affects the ability of an “interested stockholder” to engage in certain business combinations, including mergers, consolidations, or acquisitions of additional shares, for a period of three years following the time that the stockholder becomes an "interested stockholder. An “interested stockholder” is defined to include persons owning directly or indirectly 15% or more of the outstanding voting stock of a corporation. We elected in our amended and restated certificate of incorporation not to be subject to Section 203 of the DGCL. However, our amended and restated certificate of incorporation contains provisions that have the same effect as Section 203, except that they provide that each of SHUSA and its successors and affiliates and certain of its direct transferees are not deemed to be “interested stockholders,” and, accordingly, are not subject to such restrictions as long as SHUSA and its affiliates own at least 10% of our outstanding shares of common stock.
We are a “controlled company” within the meaning of the NYSE rules and, as a result, qualify for, and rely on, exemptions from certain corporate governance requirements. Our stockholders do not have the same protections afforded to stockholders of companies that are subject to such requirements.
SHUSA owns a majority of the voting power of our outstanding common stock. As a result, we qualify as a “controlled company” within the meaning of the NYSE corporate governance standards. As a controlled company, we have elected to be exempt from certain NYSE corporate governance requirements, including the requirements:
that a majority of our Board consist of independent directors;
that our executive committee (which has the responsibilities under its charter of a nominating and governance committee) be composed entirely of independent directors; and
that we have a compensation committee composed entirely of independent directors.
We have not elected to be exempt from certain other NYSE corporate governance requirements, including the requirement that we have a compensation committee with a written charter addressing the committee’s purpose and responsibilities. If we elect to be exempt from this or other NYSE corporate governance requirements, which we have done at times, our stockholders would not have the same protections afforded to stockholders of companies that are subject to these NYSE corporate governance requirements.
UNRESOLVED STAFF COMMENTS
The Company’s corporate headquarter is located in Dallas, Texas, where it leases approximately 373,000 square feet of office and operations space pursuant to a lease agreement expiring in 2026. The Company also leases a total of 409,000 square feet servicing facilities and operations space which includes;
a 200,000 square foot servicing facility in North Richland Hills, Texas,
a 117,000 square foot servicing facility in Mesa, Arizona,
a 43,000 and an adjacent 21,000 square foot servicing facility in Centennial, Colorado,
a 21,000 square foot servicing facility in San Juan, Puerto Rico,
a 1,000 square foot operation in Richardson, Texas,
a 3,000 square foot operations facility in Denton, Texas,
a 2,000 square foot operations facility in Costa Mesa, California, and
a 1,000 square foot operations facility in Aurora, Colorado.
These leases expire at various dates through 2027. Management believes the terms of the leases are consistent with market standards. For additional information regarding the Company’s properties refer to Note 11— “Commitments and Contingencies” in the accompanying consolidated financial statements.
Refer to Note 11 “Commitments and Contingencies” to the accompanying financial statements for information regarding legal proceedings in which the Company is involved.
MINE SAFETY DISCLOSURES
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is traded on the NYSE (under the symbol SC). The approximate number of record holders of the Company’s common stock as of February 21, 2019 was nine, although the Company estimates the number of beneficial stockholders to be much higher as many of its shares are held by brokers or dealers for their customers in street name.
Company Stock Performance
The following graph shows a comparison of cumulative stockholder return, calculated on a dividend reinvested basis, for the Company, the S&P 500 index, and the S&P 500 Financials index for the period from the Company’s IPO date (January 23, 2014) through December 31, 2018. The graph assumes $100 was invested in each of the Company’s common stock, the S&P 500 index, and the S&P 500 Financials index as of market close on January 23, 2014. Historical stock prices are not necessarily indicative of future stock price performance.
Equity Compensation Plan Information
The Company has an Omnibus Incentive Plan, which enables it to grant awards of non-qualified and incentive stock options, stock appreciation rights, restricted stock awards, restricted stock units and other awards that may be settled in or based upon the value of 5,192,641 shares of its common stock. At December 31, 2018, an aggregate of 2,507,009 shares were available for future awards under this plan.
The Company also manages its 2011 Management Equity Plan, under which eligible employees and directors were previously granted non-qualified stock options to purchase its common stock. Currently, no shares are available for issuance under this plan and, therefore, no future awards will be made under this plan.
Recent Sales of Unregistered Securities
Repurchase of Common Stock
In July 2018, the Board approved purchases by the Company up to $200 million, excluding commissions, of its outstanding common stock through June 2019.
The following table presents the number of shares purchased during the year ended December 31, 2018, the average price paid per share and the dollar value of shares that may yet be purchased pursuant to the Company’s repurchase authorization.
Total Number of Shares Purchased
Average Price paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs
July 1 - July 31
August 1 - August 31
September 1 - September 30
October 1 - October 31
November 1 - November 30
December 1 - December 31
During the year ended December 31, 2018, the Company purchased 9,473,955 shares of its common stock under its share repurchase program at a cost of approximately $182 million, excluding commissions. As of December 31, 2018, the Company was authorized to purchase additional shares of common stock having a cost of approximately $18 million, all of which was purchased in January 2019, at weighted average price of $18.40 per share.
SELECTED FINANCIAL DATA
Year Ended December 31,
(Dollar amounts in thousands, except per share data)
Income Statement Data
Interest on individually acquired retail installment contracts
Interest on purchased receivables portfolios
Interest on receivables from dealers
Interest on personal loans
Interest on finance receivables and loans
Net leased vehicle income
Other finance and interest income
Net finance and other interest income
Provision for credit losses on individually acquired retail installment contracts
Increase (decrease) in impairment related to purchased receivables portfolios
Provision for credit losses on receivables from dealers
Provision for credit losses on personal loans
Provision for credit losses on capital leases
Provision for credit losses
Income before tax expense
Income tax (benefit) / expense (a)
Weighted-average common shares outstanding
Earnings per share
Dividend paid per share
Balance Sheet Data
Finance receivables held for investment, net
Finance receivables held for sale, net
Goodwill and intangible assets
Allowance for credit losses
(a) Refer to Note 10 - “Income Tax” in the accompanying consolidated financial statements, for discussion around significant change in Income tax (benefit) / expense
Year Ended December 31,
(Dollar amounts in thousands)
Charge-offs, net of recoveries, on individually acquired retail installment contracts
Charge-offs, net of recoveries, on purchased receivables portfolios
Charge-offs, net of recoveries, on receivables from dealers
Charge-offs, net of recoveries, on personal loans
Charge-offs, net of recoveries, on capital leases
Total charge-offs, net of recoveries
End of period delinquent principal over 59 days, individually acquired retail installment contracts held for investment
End of period personal loans delinquent principal over 59 days
End of period delinquent principal over 59 days, loans held for investment
End of period assets covered by allowance for credit losses
End of period gross individually acquired retail installment contracts held for investment
End of period gross personal loans
End of period gross finance receivables and loans held for investment
End of period gross finance receivables, loans, and leases held for investment
Average gross individually acquired retail installment contracts held for investment
Average gross personal loans held for investment
Average gross individually acquired retail installment contracts held for investment and held for sale
Average gross purchased receivables portfolios
Average Gross receivables from dealers
Average Gross personal loans
Average Gross capital leases
Average Gross finance receivables and loans
Average Gross finance receivables, loans, and leases
Average managed assets
Average total assets
Average total equity
Yield on individually acquired retail installment contracts
Yield on purchased receivables portfolios
Yield on receivables from dealers
Yield on personal loans (1)
Yield on earning assets (2)
Cost of debt (3)
Net interest margin (4)
Expense ratio (5)
Return on average assets (6)
Return on average equity (7)
Net charge-off ratio on individually acquired retail installment contracts (8)
Net charge-off ratio on purchased receivables portfolios (8)
Net charge-off ratio on receivables from dealers (8)
Net charge-off ratio on personal loans (8)
Net charge-off ratio (8)
Delinquency ratio on individually acquired retail installment contracts held for investment, end of period (9)
Delinquency ratio on personal loans, end of period (9)
Delinquency ratio on loans held for investment, end of period (9)
Equity to assets ratio (10)
Tangible common equity to tangible assets (10)
Common stock dividend payout ratio (11)
Allowance ratio (12)
Common Equity Tier 1 capital ratio (13)
Includes finance and other interest income; excludes fees.
“Yield on earning assets” is defined as the ratio of Total finance and other interest income, net of Leased vehicle expense, to Average gross finance receivables, loans and leases.
“Cost of debt” is defined as the ratio of Interest expense to Average debt.
“Net interest margin” is defined as the ratio of Net finance and other interest income to Average gross finance receivables, loans and leases.
“Expense ratio” is defined as the ratio of Operating expenses to Average managed assets.
“Return on average assets” is defined as the ratio of Net income to Average total assets.
“Return on average equity” is defined as the ratio of Net income to Average total equity.
“Net charge-off ratio” is defined as the ratio of annualized Charge-offs on a recorded investment basis, net of recoveries, to average unpaid principal balance of the respective held-for-investment portfolio.
“Delinquency ratio” is defined as the ratio of End of period Delinquent principal over 59 days to End of period Gross balance of the respective portfolio, excluding capital leases.
“Tangible common equity to tangible assets” is defined as the ratio of Total equity, excluding Goodwill and intangible assets, to Total assets, excluding Goodwill and intangible assets. Management believes this non-GAAP financial measure is useful to assess and monitor the adequacy of the Company’s capitalization. This additional information is not meant to be considered in isolation or as a substitute for the numbers prepared in accordance with GAAP and may not be comparable to similarly-titled measures used by other financial institutions. A reconciliation from GAAP to this non-GAAP measure for the periods ended December 31, 2018, 2017, 2016, 2015 and 2014 is as follows:
Year Ended December 31,
(Dollar amounts in thousands)
Deduct: Goodwill and intangibles
Tangible common equity
Deduct: Goodwill and intangibles
Equity to assets ratio
Tangible common equity to tangible assets
“Common stock dividend payout ratio” is defined as the ratio of Dividends declared per share of common stock to Earnings per share attributable to the Company’s shareholders.
“Allowance ratio” is defined as the ratio of Allowance for credit losses, which excludes impairment on purchased receivables portfolios, to End of period assets covered by allowance for credit losses.
“Common Equity Tier 1 Capital ratio” is defined as the ratio of Total Common Equity Tier 1 Capital (CET1) to Total risk-weighted assets.
Year ended December 31,
(Dollar amounts in thousands)
Deduct: Goodwill and other intangible assets, net of deferred tax liabilities
Deduct: Accumulated other comprehensive income, net
Tier 1 common capital
Risk weighted assets (a)
Common Equity Tier 1 capital ratio (b)
Under the banking agencies’ risk-based capital guidelines, assets and credit equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. The resulting weighted values are added together with the measure for market risk, resulting in the Company’s total Risk weighted assets.
CET1 is calculated under Basel III regulations required as of January 1, 2015. The fully phased-in capital ratios are non-GAAP financial measures.
The following tables present an analysis of net yield on interest earning assets:
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Background and Overview
Santander Consumer USA Holdings Inc. is the holding company for Santander Consumer USA Inc., a specialized consumer finance company focused on vehicle finance, third-party servicing and delivering superior service to our more than 2.6 million customers across the full credit spectrum. The Company is majority-owned (as of February 21, 2019, approximately 69.9%) 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 marine and recreational vehicles. The Consumer Finance segment also includes its personal loan and point-of-sale financing operations.
SAF is our primary vehicle brand, and is available as a finance option for automotive dealers across the United States. Since May 1, 2013, under terms of the Chrysler Agreement, a ten-year private-label financing agreement with FCA, the Company has operated as FCA’s preferred provider for consumer loans, leases and Dealer Loans and provides services to FCA customers and dealers under the CCAP brand. These products and services include consumer retail installment contracts and leases, as well as Dealer Loans for inventory, construction, real estate, working capital and revolving lines of credit.
Under the terms of the Chrysler Agreement, certain standards were agreed to, including the Company meeting specified escalating penetration rates for the first five years, subject to FCA treating the Company in a manner consistent with comparable OEMs’ treatment of their captive providers, primarily in regard to sales support. The failure of either party to meet its respective obligations under the Chrysler agreement could result in the agreement being terminated. Chrysler Capital continues to be a focal point of the Company’s strategy and the Company continues to work with FCA to improve penetration rates.
In June 2018, the Company announced that it was in exploratory discussions with FCA regarding the future of FCA’s U.S. finance operations. FCA has announced its intention to establish a captive U.S. auto finance unit in the future and indicated that acquiring Chrysler Capital is one option it will consider. Under the Chrysler Agreement, FCA has the option to acquire, for fair market value, an equity participation in the business offering and providing the financial services contemplated by the Chrysler Agreement. In addition, in July 2018, FCA and the Company entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party in accordance with Section 14.02 of the MPLFA until December 31, 2018.
FCA has not delivered a notice to exercise its equity option, and the Company remains committed to the success of the Chrysler Capital business. Although the likelihood, timing and structure of any such transaction, and the likelihood that the Chrysler Agreement will terminate, cannot be reasonably determined, termination of the Chrysler Agreement or a significant change in the business relationship between the Company and FCA could materially adversely affect the Company’s operations, including the origination of receivables through the Chrysler Capital portion of the Company’s business and the servicing of Chrysler Capital receivables. Moreover, there can be no assurance that the Company could successfully or timely implement any such transaction without significant disruption of its operations or restructuring, or without incurring additional liabilities, which could involve significant expense to the Company and have a material adverse effect on its business, financial condition and results of operations
The Company’s average penetration rate for the year ended December 31, 2018 was 30%, an increase from 18% in 2017. The Company’s penetration rate has been constrained due to a more competitive landscape and low interest rates, causing its subvented loan offers not to be materially more attractive than other lenders’ offers. Chrysler Capital continues to be a focal point of its strategy, the Company continues to work with FCA to improve penetration rates, and it remains committed to the Chrysler Agreement.
The Company has dedicated financing facilities in place for its Chrysler Capital business worked strategically and collaboratively with FCA to continue to strengthen its relationship and create value within the Chrysler Capital program. The Company has partnered with FCA to roll out two new pilot programs, including a dealer rewards program and a nonprime subvention program. During the year ended December 31, 2018, the Company originated more than $7.9 billion in Chrysler Capital loans which represents approximately 46% of total retail installment contract originations (unpaid principal balance), with an approximately even share between prime and nonprime, as well as more than $9.7 billion in Chrysler Capital leases. Additionally, substantially all of the leases originated by the Company during the year ended December 31, 2018 were made under the Chrysler Capital Agreement. Since its May 1, 2013 launch, Chrysler Capital has originated more than $53.1 billion in retail loans (excludes SBNA originations program) and $33.3 billion in leases, and facilitated the origination of $3.0 billion in leases and dealer loans for an affiliate. As of December 31, 2018, the Company’s carrying value of auto retail installment contract portfolio consisted of $9.0 billion of Chrysler Capital loans, which represents 36% of the Company’s auto retail installment contract portfolio.
The Company also originates vehicle loans through a web-based direct lending program, purchases vehicle retail installment contracts from other lenders, and services automobile and recreational and marine vehicle portfolios for other lenders. Additionally, the Company has several relationships through which it has provided personal loans, private-label credit cards and other consumer finance products. In October 2015, the Company announced a planned exit from the personal lending business.
The Company has dedicated financing facilities in place for its Chrysler Capital business. The Company periodically sells consumer retail installment contracts through flow agreements and, when market conditions are favorable, it accesses the ABS market through securitizations of consumer retail installment contracts. The Company also periodically enters into bulk sales of consumer vehicle leases with a third party. The Company typically retains servicing of loans and leases sold or securitized, and may also retain some residual risk in sales of leases. The Company has also entered into an agreement with the buyer of its leases whereby the Company will periodically sell charged-off loans.
Economic and Business Environment
Unemployment rates continue to be at record low levels of 3.9% as reported by the Bureau of Labor Statistics for December 31, 2018. The Federal Reserve raised its federal funds rate by 25 basis points in December 2018.
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.
The following table shows the percentage of unpaid principal balance on the Company’s retail installment contracts by state concentration. Total unpaid principal balance of retail installment contracts held for investment was $28,463,236 and $26,036,361 at December 31, 2018, and 2017, respectively.
December 31, 2018
December 31, 2017
Installment Contracts Held for Investment
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 individually acquired retail installment contracts, loans and leases, and at the pool level for purchased portfolios, 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 (losses) — The Company’s flow agreements entered into in connection with the Chrysler Agreement 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).
Corrections to Previously Reported Amounts
As mentioned in Note 1 - “Description of Business, Basis of Presentation, and Significant Accounting Policies and Practices” in the accompanying consolidated financial statements, the Company identified and corrected two immaterial errors. The Company included the impact of these errors on the material accounts and disclosures presented in Note 1 - “Description of Business, Basis of Presentation, and Significant Accounting Policies and Practices” in the accompanying consolidated financial statements. The impact of these errors on other material items included within Management's Discussion and Analysis section are as follows:
As of December 31, 2017
Delinquent principal, 30-59 days past due
Delinquent principal over 59 days
For the year ended December 31, 2017
Net Charge-off ratio
Yield on individually acquired retail installment contracts
Recent Developments and Other Factors Affecting The Company’s Results of Operations
The Company’s other significant personal lending relationship is with Bluestem. The Company continues to perform in accordance with the terms and operative provisions of the agreements under which it is obligated to purchase personal revolving loans originated by Bluestem for a term ending in 2020, or 2022 if extended at Bluestem’s option. This revolving loan portfolios is carried as held for sale in the Company’s consolidated financial statements. Accordingly, the Company has recorded $367 million during 2018 in lower-of-cost-or market adjustments on this portfolio, and there may be further such adjustments required in future periods’ financial statements. The Company is currently evaluating alternatives for the sale of the Bluestem portfolio, which had a carrying value of $1.1 billion at December 31, 2018.
In 2018, SHUSA announced that the FRBB did not object to the planned capital actions described in SHUSA’s annual capital plan that was submitted as part of capital planning process. Included in SHUSA’s capital actions were proposed dividend payments for the Company’s stockholders. As a result, we made dividend payments in 2018 and in the first quarter of 2019. Refer to Note 17 - “Shareholders’ Equity” in the accompanying consolidated financial statements.
In February 2019, the FRBB announced that SHUSA, and certain other firms, would receive a one-year extension of the requirement to submit its 2019 capital plan until April 2020. The FRBB also announced that for the period beginning July 1, 2019 through June 30, 2020, SHUSA would be allowed to make capital distributions up to an amount that would have allowed SHUSA to remain well-capitalized under the minimum capital requirements for CCAR 2018. SHUSA and the Company are evaluating their planned capital actions, including any proposed dividend payments for the Company’s stockholders, for the period of July 1, 2019 through June 30, 2020 and intend to submit those planned capital actions to the FRBB soon.
Share Repurchases and Treasury Stock
In July 2018, the Board approved purchases by the Company up to $200 million, excluding commissions, of its outstanding common stock through June 2019.
During the year ended December 31, 2018, the Company purchased 9,473,955 shares of its common stock under its share repurchase program at a cost of approximately $182 million, excluding commissions. As of December 31, 2018, the Company was authorized to purchase additional shares of common stock having a cost of approximately $18 million, all of which was purchased in January 2019, at a weighted average price of $18.40 per share.
The Company has one reportable segment: Consumer Finance. This segment includes the Company’s vehicle financial products and services, including retail installment contracts, vehicle leases, and dealer loans, as well as financial products and services related to marine and recreational vehicles. It also includes the Company’s personal loan and point-of-sale financing operations.
The Company’s originations of individually acquired loans and leases, including revolving loans, average APR, and discount during the year ended December 31, 2018, 2017, and 2016 have been as follows:
For the Year Ended
December 31, 2018
December 31, 2017
December 31, 2016
(Dollar amounts in thousands)
Retail installment contracts
Average FICO® (a)
Personal loans (b)
Total originations retained
Retail installment contracts
Average FICO® (c)
Total originations sold
Total SC originations
Total originations (d)
Unpaid principal balance excluded from the weighted average FICO score is $1.9 billion, $1.5 billion and $2.1 billion for the years ended 2018, 2017, and 2016, respectively, as the borrowers on these loans did not have FICO scores at origination. Of these amounts $76 million, $164 million, and $364 million, respectively, were commercial loans.
Effective as of three months ended December 31, 2017, the Company revised its approach to define origination volumes for Personal Loans to include new originations, gross of paydowns and charge-offs, related to customers who took additional advances on existing accounts (including capitalized late fees, interest and other charges), and newly opened accounts. In the prior periods, the Company reported net balance increases on personal loans as origination volume. Included in the total origination volume is $304 million, $264 million, and $304 million for the years ended 2018, 2017, and 2016, respectively, related to newly opened accounts.
Unpaid principal balance excluded from the weighted average FICO score is $143 million, $318 million, and $451 million for the years ended 2018, 2017, and 2016, respectively, as the borrowers on these loans did not have FICO scores at origination. Of these amounts $76 million, $102 million, and $86 million, respectively, were commercial loans.
Total originations excludes finance receivables (UPB) of $74,086 purchased from a third party lender during the year ended December 31, 2018.
Total originations increased $6.8 billion, or 31%, from the year ended December 31, 2017 to the year ended December 31, 2018. The increase was primarily attributable to our new initiatives, starting in the second half of 2017, to improve our pricing as well as dealer and customer experience, which we believe 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. Chrysler Capital volume and penetration rates are influenced by strategies implemented by FCA, 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 loans, primarily from Chrysler dealers. In addition, the Company agreed to perform the servicing for any loans originated on SBNA’s behalf. During the year ended December 31, 2018, the Company facilitated the purchase of $1.9 billion of retail installment contacts.
The Company’s originations of individually acquired retail installment contracts and leases by vehicle type during the years ended December 31, 2018, 2017 and 2016 were as follows: