Open Lending Corporation

Good afternoon and welcome to the Open Lending's fourth quarter and full year 2022 earnings conference call. As a reminder, today's conference call is being recorded. On the call today are Keith Jesick, CEO, and Chuck Yale, CFO. Early today, the company posted its fourth quarter and fiscal year 2022 earnings release and investor supplement to its investor relations website. In the release, you will find reconciliations of non-GAAP financial measures to the most comparable GAAP financial measures discussed on this call. Before we begin, I'd like to remind you that this call may contain estimated and other forward-looking statements that represent the company's view as of today, February 23, 2023. Open Lending disclaims any obligation to update these statements to reflect future events or circumstances. Please refer to today's earnings release and our filings with the SEC for more information concerning factors that could cause actual results to differ from those expressed or implied with such statements. And now I'll pass the call over to Mr. Keith Jessick. Please go ahead.

Thank you, Operator, and good afternoon, everyone. We appreciate you joining us today for Open Lending's fourth quarter and full year 2022 earnings conference call. Before we begin, I would like to express my continued confidence in the long-term opportunities before us. The actions and behaviors of consumers, auto lenders, OEMs, and dealerships, and the corresponding pricing dynamics we have experienced are not without precedent. However, what's notably different in this cycle is the impact of the velocity and the magnitude of the Federal Reserve rate increases to the auto industry, and more specifically, to consumer affordability and lender liquidity. Having managed skilled businesses in the auto sector through the Great Recession, as well as serving on the Open Lending Board during this time, I'm encouraged by the response of our team, and I'm confident in our ability to manage through the current challenges. I'll speak more about how we are positioning the company to continue to gain share given our financial strength, our value proposition, and our competitive position after reviewing our results. For the year, we certified over 165,000 loans, a slight decrease from the previous year. Total revenue for the year was $180 million, down 17%, and at the lower end of our guidance. Adjusted operating cash flow for the year was $143 million, which was near the high end of our guidance. Now let's spend a few minutes on recent industry trends and expectations for 2023. First, on inventory. As many of you know, used vehicle sales in 2022 tumbled to their lowest levels in nearly a decade. Supply chain and chip shortage constraints have improved year over year, but sales for new autos remain well below historical levels as well. Second, on affordability, we believe this will remain the most significant challenge for us in the near term. The intended consequences of the Federal Reserve's rate increases in 2022 and 2023 are impacting the auto sector and our current addressable market. Near and non-prime consumers are being hit disproportionately by rising rates, resulting in lower disposable income. As the Fed continues a path to reduce inflation, a more expensive auto payment driven by higher rates is dampening demand. For example, the weighted average auto loan rate for both new and used vehicles in subsegments is up 200 to 300 basis points. Next, on loan originations, in speaking with the Treasury teams at credit unions and other financial institutions, they currently have alternatives for balance sheet capital in short-term duration instruments as well as risk-free bills, notes, and bonds in the Treasury markets. To the extent these alternatives are more attractive, liquidity within the auto-origination pool of capital is reduced. Callahan data shows total loan originations were about $160 billion in the fourth quarter of 2022, down 21% from a year earlier, and down 19% sequentially from the third quarter of 2022. In the peak of the pandemic, when liquidity was high and federal stimulus relief was running rampant, Credit unions held about 12 to 13 percent of their assets as cash, which was easily available to fund new loan demand. Now, credit unions on average are down to approximately 6 percent of their total assets in cash. Some of our largest credit unions have a loan-to-share ratio in excess of 100 percent. This reduction in liquidity has impacted the borrowers who are most in need and have been hit hardest by inflationary pressures to their rent, food, energy, and transportation. Finally, our refinance business made up 43% of our certified loan volume at its peak in February of 2022, but has declined to 11% in December 2022. This business has been severely impacted by the unprecedented Federal Reserve actions throughout 2022 and now into 2023. Again, this constitutes a significant impact on affordability of our near and non-prime borrowers. Based on prior cycles, it's our sense that when rates begin to stabilize, we should begin to see improvement in this part of our business. In summary, the industry backdrop for the auto loan sector is experiencing historic challenges. That said, we believe these challenges will be temporary. We remain committed to our goal of gaining market share, and we expect to be well positioned to meet pent-up demand as the industry recovers. With that in mind, I want to discuss our areas of focus as we move throughout 2023 to position us well for this year and beyond, areas which I believe will support and strengthen our long-term competitive advantages. First, we look to further refine and optimize our sales channels. Second, we will continue to enhance our technology offering. And equally as important, we are laser focused on attracting and retaining talent. Now to go into each area in a little bit more detail. First, sales, operations, and marketing. To power our go-to-market efforts, we increased our sales, marketing and account management teams by nearly 30% in 2022, and we plan to continue to thoughtfully invest in these areas throughout 2023. We will keep a watchful eye on these investments, measure performance, and ensure that they deliver the expected returns. To strengthen our team's future success, we organized our team into one group dedicated purely to selling, while the other focuses solely on account management. In short, we have aligned our efforts to maximize our sales efficiency. Our experienced sales team will continue to work primarily on closing new accounts. Their efforts will be aided by our expanded marketing team, which is supporting sales with a robust lead generation program to help secure new business. We are early in this initiative, but you may have already seen our earned media coverage in the Wall Street Journal, Automotive News, Auto Remarketing, Auto Finance News, Credit Union Times, and Payments.com. These are publications that decision makers read daily. so we believe this will further support our sales team. To lead these efforts, we've added a new senior vice president of marketing to our leadership team. We are encouraged by our strong December sales, as well as other recent wins, including the addition of Crescent Bank, a top 50 bank auto lender in the U.S. Our account management team will center their attention on continued engagement and collaboration with our customers with the simple priority of building our base of business from existing customers by expanding their use of our program. We've launched various targeted customer promotions via multiple channels, and we have produced a number of thought leadership pieces, including a highly attended National Association of Federal Credit Unions webinar on loan securitization. We have improved our implementation process and shortened the time to go live for a new institution. We've also added a Senior Vice President of Operations to improve client retention and drive operational best practices. While still early, We have seen significant progress from these investments. For the full year 2022, our non-OEM business, primarily credit unions, was up 16% driven by strong refinance volumes earlier in the year, while in contrast, the large universal banks reported auto loan originations down 25% to 30% year on year. Now let me turn to our technology. We continue to have a distinct competitive advantage with significant barriers to entry given our 20-plus years of proprietary data sophisticated technology, including five-second underwriting decisions, exclusive relationships with A-rated insurance partners, deep lender relationships, and regulatory know-how. And we will continue to strategically invest in our lenders production technology to remain a best-in-class risk-based solution for lenders seeking to serve non-prime customers. To make car ownership more accessible for those in near and non-prime credit segments, we increased our allowable vehicle age from 9 to 11 years. One of the criteria we set forth in conjunction with this modification was very specific mileage caps as determined by our proprietary data set of auto evaluations. With the average age of finance vehicles jumping from 5.4 to 6.4 years for FICO scores below 640, this change allows financial institutions to grow their portfolios while minimizing risk through Open Lending's default insurance and risk management program. Equally as important, vehicles 10 years and older comprise some 8% of all used car purchases. We've also expanded our loan approval expiration window from 30 days to 45 days for our direct and refinance channels. This change offers our customers and refinance partners sufficient time needed to complete their respective funding processes. To support our go-to-market strategy enhancements and streamline onboarding of new customers, we recently expanded our integration to three new technology partners. And lastly, as we strive to lower delivery costs and improve integration timelines, we continue to modernize our infrastructure with cloud computing technologies. We welcomed our new chief information officer in November to focus on our migration to the cloud, as well as on driving security, data integrity, DevOps, and IT operations. He joins us from AmeriFirst Home Mortgage and brings a wealth of industry and technical experience. We are confident that our technology investments allow us to improve our time to market for developing, testing, and developing secure applications that enhance customer satisfaction. Lastly, we are also committed to attracting and retaining talent, creating a best-in-class organization. To lead these efforts, late last year we announced the appointment of a chief human resources officer focused on building a strong people strategy to support and expedite open lending's mission. We expect to continue driving company culture centered on creating a diverse and collaborative environment to unlock value and foster growth for individuals, teams, and the business. To wrap up, I couldn't be more excited about our opportunity, now having almost five full months in the CEO seat. This is driven by the fact that we continue to have a large and growing total addressable market, a profound competitive advantage, and significant barriers to entry with our people and technology, as well as a business model that leverages both of these points. We are focused on areas that we are confident will position the company for success for years to come, With that, I would like to turn the call over to Chuck to review Q4 and the full year in further detail, as well as to provide our thoughts on 2023 outlook. Chuck?

Thanks, Keith. During the fourth quarter of 2022, we facilitated 34,550 certified loans compared to 42,639 certified loans in the fourth quarter of 2021 and 42,186 certified loans in the third quarter of 2022. Total revenue for the fourth quarter of 2022 was $26.8 million, which includes an ASC 606 negative change in estimate of $12.8 million associated with our profit share, compared to $51.6 million in the fourth quarter of 2021. When excluding the impacts of ASC 606 change in estimate from both periods, revenue during the fourth quarter of 2022 was only down $5.5 million, or 12% year-over-year. To break down total revenues in the fourth quarter of 2022, profit share revenue represented $6.1 million, program fees were $18.3 million, and claimed administration fees and other were $2.4 million. It is important to note that while our certified loan volume was down in the fourth quarter of 2022 from the fourth quarter of 2021, our program fee revenue only decreased slightly due to mix of business certified, which resulted in higher unit economics. Turning to profit share. I want to remind everyone that profit share revenue is comprised of the expected earned premiums, less the expected claims to be paid over the life of the contracts, less expenses attributable to the program. The net profit share to us is 72% and the monthly receipts from our insurance carriers reduce our contract asset each period. To further discuss the 6.1 million in profit share revenue in Q4, the profit share associated with new originations in the fourth quarter of 2022 was 18.9 million or $546 per certified loan, as compared to $24.7 million, or $580 per certified loan in the fourth quarter of 2021. As mentioned previously, we recorded a negative $12.8 million change in estimate as a result of an expected decrease of profit share in future periods due to higher than anticipated claims frequency and severity of losses. Notably, this was partially offset by lower anticipated prepaids due to the elevated interest rate environment. The Mannheim Used Vehicle Value Index, which tracks the prices car dealers pay wholesale at auction for used cars, is one of the macroeconomic factors we consider in evaluating our change in estimate each period end. This index fell nearly 15% year-over-year. That's the largest one-year decline in the history of the index. However, it's worth noting that it remains highly elevated compared to prior 10-year trailing levels and therefore continues to impact auto affordability. In comparison, during the fourth quarter of 2021, revenue included a positive $6.5 million change in estimated future revenues on certified loans originated in historical periods. This was primarily due to a positive realized portfolio performance attributable to lower frequency and severity of claims. Gross profit was $21.9 million, and gross margin was approximately 82% in the fourth quarter of 2022. As compared to $46.9 million and gross margin of approximately 91%, in the fourth quarter of 2021. For the quarter, the gross margin excluding ASC 606 negative change in estimate would have been 88%. Selling, general, and administrative expenses were $17.2 million in the fourth quarter of 2022 compared to $11.7 million in the fourth quarter of last year. The increase year-over-year is primarily due to additional employees to support our growth with a focus on our go-to-market sales strategy and investment in our technology as previously discussed by Keith. Operating income was $4.8 million in the fourth quarter of 2022 compared to $35.2 million in the fourth quarter of 2021. Net loss for the fourth quarter of 2022 was $4.2 million, which was driven by the $12.8 million negative adjustment to our profit share contract asset compared to net income of $27.8 million in the fourth quarter of 2021. Basic and diluted earnings per share was a loss of 3 cents in the fourth quarter of 2022 as compared to 23 cents in the previous year quarter. Adjusted EBITDA for the fourth quarter of 2022 was 8.5 million as compared to 36.6 million in the fourth quarter of 2021. There's a reconciliation of GAAP to non-GAAP financial measures that can be found at the back of our earnings press release. Adjusted operating cash flow for the quarter was 33 million as compared to $38 million in the fourth quarter of 2021. We exited the quarter with $380 million in total assets, of which $205 million was in unrestricted cash, $75 million was in contract assets, and $65 million in net deferred tax assets. We had $167 million in total liabilities, of which $147 million was outstanding debt. During the fourth quarter, we announced the authorization by our board of directors to repurchase $75 million of our common stock through November of this year. This program reflects the confidence of our board and the management team in our business model, free cash flow profile, and the overall strength of our balance sheet. During the quarter, we repurchased 2.6 million shares for approximately $18 million at an average price of $6.80 per share. We expect to continue to be opportunistic in open market purchases under the current authorization throughout the year. Before I touch on guidance, I would like to update you on a change within our insurance partner relationships. CNA, a partner of ours since 2017, has decided not to renew their agreement with Lenders Protection when their term concludes on December 31, 2023, due to a shift in CNA's capital allocation priorities. We would like to thank them for their partnership over the years and their support as we work through and manage the runoff of existing policies over the coming years. As a reminder, one of our key initiatives over the past few years has been to minimize concentration risk by bringing additional A-rated insurance carriers into our program. We have successfully executed on this initiative as we have strong relationships with our three other insurance carriers to provide credit default insurance coverage to our auto lender customers. Amtrust, which is under contract through fourth quarter of 2028, American National Insurance Company under contract through second quarter of 2026, and Arch Insurance North America under contract through second quarter of 2027. We are working with all three of these carriers to transition our lender customers who had been insured with CNA to them, all of whom are interested in absorbing additional business from the Lenders Protection Program. Now moving on to guidance. If inflation were to persist through 2023, it appears the Federal Reserve will stay the course and keep rates higher for a longer period. While the bond market at times has appeared to be indicating a more favorable rate environment later in 2023, Recent forecasts from the Federal Reserve are more conservative, with current indications that the terminal Fed funds rate will be in the 6% range. These factors, as well as other macro and auto industry lending-specific indicators, are ever-changing, and more specifically, it is difficult to have visibility into financial institutions' future liquidity and the corresponding pace of auto originations. So for these reasons, At this time, we feel it is prudent to take a more measured approach by providing only a quarterly outlook. Guidance for the first quarter of 2023 is as follows. We expect certified loans to be between $28,000 and $32,000, total revenue to be between $30 million and $34 million, and adjusted EBITDA to be between $13 million and $17 million. In our guidance, we have taken the following factors into consideration. the affordability index of our target credit score borrower due to the continued inflated used car values, inflation, rising interest rates, and overall consumer sentiment. An important driver in estimated profit share is the Mannheim Used Vehicle Value Index, which we expect will continue a path of moderate declines over the next year. Also, as Keith outlined earlier, we will continue to invest this year. While this impacts our margins, we have a strong balance sheet and will be well positioned as the overall macro and auto retail industry challenges subside. We would like to thank everyone for joining us today, and we will now take your questions. Also joining us on the call will be John Flynn, OpenLineage Chairman of the Board.

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. If you'd like to ask a question, you may press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of David Scharf with JMP Securities. Please proceed with your question.

Hi. Good afternoon. Thanks for taking my questions. You know, I wanted to dig in a little bit about profit sharing. going forward as it relates to your carrier relationships um can you can you kind of remind us um the 72 percent you know uh portion that you keep has always been very generous and my understanding has been is because the carriers like the product on their end because you you provide all the customer acquisition costs and underwriting and ultimately the default insurance they're underwriting is very high ROE. You know, given CNA's decisions, should we be thinking about whether your other three partners, given, you know, the credit performance of the portfolio now, whether they're rethinking that 72-28 mix? I mean, are there any discussions about, you know, the kind of returns that they require and whether they want those modified at all?

Yeah. Hi, David. It's Chuck. Good to visit with you. It's a great question. You know, we've got, you know, the three carriers that remain. And one, you know, CNA has been a great partner for a long time. And I tell you, the business has been very profitable for them. And, you know, this is more of a capital allocation change for them and an underwriting decision, you know, for different products. And not everybody can do everything. So it's been very profitable to them and very profitable for our other three carriers. So we are, you know, strong relationships with the other three. You know, Keith and I have met with them. You know, John and Ross had a great handoff to us of those relationships, and I've built them over the last couple of years as well. And the appetite is very strong for our business at the current terms in economics.

Got it. And maybe just as a follow-up, kind of the same topic – You know, I'm obviously kind of not surprised to see the contract asset, you know, prospectively be written down a bit. You know, non-prime auto has probably deteriorated more than most other consumer credit asset classes. But, you know, after the write-down, how should we think about maybe a more – kind of normalized level of profit share per loan, you know, throughout 2023, you know, given all the affordability issues that are going to persist.

Another great question. And, you know, David, what I'd tell you is, you know, as we analyze that, you know, the contract asset and our profit share, you know, every quarter, you know, the biggest driver for obviously the 12.8 negative, you know, change in the quarter. And I'll tell you year to date, you know, that's like 5.7 for the year negative. You know, it basically, the Mannheim went down 15%, you know, in 2022, which is the largest single decline in the history of the index. And as we thought about this at Q3, you know, just to give you a little bit more history, you know, we anticipated that it would be down about 11% in full year 22. So the accelerated decline in the fourth quarter. You know, as we put the Q4 originations on the books at the $546,000, we took that into consideration as well as stress into 23 on defaults increasing as well as the severity of loss due to the Mannheim coming down. So as we put that on, we booked that 546 per loan at about a 62% loss ratio. And I'll tell you, as we think about that, at a baseline of about 50% loss ratio, which is kind of historical averages that we book to, We put about 23% stress on the Q4 originations, which got it down to the 546, which it started at about, I call it a 788 profit share per cert. So we feel good about the 546 per cert, but obviously as we kind of navigate through, you know, these volatile times in the economy and the auto industry specific and delinquencies, you know, we'll continue to review that. But we feel good about our book at 1231, you know, 22, and we'll continue to monitor that.

Got it, got it. It sounds like the Mannheim actually more than consumer payments. Thank you. Yes, sir. Yes.

Go ahead, John. Chuck, I have one more comment to the insurance carriers.

Yes, sir.

And again, just worth noting, keep in mind that because this is written as a surplus line policy and that every loan is targeting a 60% loss ratio, if it ever got out of whack and if it started to climb way beyond that, The 72% is, you know, percentage of X of the premium. So we can adjust the premium going forward to maintain the loss ratio that carriers are looking for. So I don't think they'd be negotiating any of our percentages down. It's a matter of as rates are rising everywhere in the country, the only thing a rate increase would do is increase the rate to the consumer which would be, you know, easy to cover.

Understood. Very helpful. Thanks so much, John.

Thanks, David. And thanks, John.

Our next question comes from the line of Joseph Fafi with Canaccord. Please proceed with your question.

Hey, guys. Good afternoon. Thanks for taking our questions. I know, Keith, you mentioned, you know, a lot of hires and a lot of investment in the business. Were there some other moving parts in the G&A line that drove it up so materially here in Q4? And then another follow-up on that.

Hey, Joe, I'll start. This is Chuck. Good to visit with you. If you think about the SG&A throughout 2022, we hired several folks in 2022 to help as we grow our go-to-market sales strategy and enhance our technology. So that's kind of been throughout the year. You know, the year-over-year, you know, Q4 to Q4, you know, $12 million to call it $17 million, that $5 million has progressed throughout the year. Sequentially from Q3, you know, we're actually down slightly from Q3, about $500,000. So I wouldn't say it's up sequentially, but year-over-year is just the headcount ads to kind of support our investment in the business as we wait for this pent-up demand that will be there as we know the industry recovers. Fair enough.

And then on the ads, I know you mentioned Crescent being added here in the quarter. Maybe we could get a higher level view of Appetite from new logos now. I mean, obviously, there's a lot of headwinds and everything from the credit unions having lower cash balances to just inventories being down across the board. Is How are prospective clients moving forward now versus maybe six months ago? And then if you could mention what those new tech partner integrations might mean to the business, that would be helpful. Thanks, guys.

Yeah, sure. And as we mentioned in the comments, and this is Keith, Joe, I was mentioning in the comments, you know, December was a really, really strong sales month for us. So that's very encouraging, especially, you know, kind of given the end of the year. And as we step off into 2023, just encouraged with the pipeline, you know, a lot of the efforts of the new and expanded go-to-market strategies have been around segmentation and prioritization of the pipeline. And we really want to go after, you know, lending, you know, partners, you know, in a number of various segments. But first and foremost, just to kind of categorize them by first and foremost, their potential for volume. Second, whether or not they open all three channels, so they'd be that indirect, direct, or refinance. Their current loan to share or their liquidity balance. For most of them, the type of LOS that they have, the loan origination system, to make sure that we're already integrated with it. And then finally, most importantly, do they have the appetite to lend to this segment? And what I'll tell you is that the pipeline is robust for 23 as we start the year, and the value proposition is still the same as it's ever been. There's the need to serve the folks that perhaps they haven't historically served.

Fair enough. And then on those integrations?

Yeah, Joe, this is Chuck. You know, from a tech partner's perspective, you know, integrating with additional LOSs that make, you know, our time to first revenue quicker, so, you know, integrated, for example, with XLOS, a project with DeFi Solutions, as well as, you know, adding a new refi partner with GetJerry. So a lot, you know, things that we're working on there to be ready and also, you know, grow search as we can and control what we can. Great. Thanks a lot, guys.

Thank you, Joe. Thank you, Joe.

Our next question comes from the line of Peter Heckman with DA Davidson. Please proceed with your questions.

Hey, good afternoon. So the cash flows for the company were very strong, and I assume that is a reflection of the slowing of the business and just cash collections on the existing loan book of business. I guess when you think about that, I mean, the volatility that we've seen in acknowledging this has been a very, very unique and dynamic environment for auto sales. auto pricing, interest rates, but the dynamic around these really significant changes in profit sharing under ASC 606 really just make it very, very difficult for a public company and the expectations for a public company. Given the underlying cash flow, do you feel that open lending needs to remain a public company? Or would this business be more appropriately held within either a larger business or held as a private company where the quarter-to-quarter volatility and earnings, you know, wasn't really going to be this big of an issue?

Well, maybe I'll repeat on that last question. You know, I definitely don't want to speculate on that. You know, we are a public company today and, you know, are working very hard for our shareholders to maximize, you know, value. You know, your question around, you know, ASC 606 and the volatility, I mean – I mean, you know, yes, we had a lot of positive performance in 2021 and, you know, a good ways into 22. And, you know, the changes in the industry and the macro, you know, obviously impact us. But, you know, we provide transparency there and good disclosures we fill. But I'll tell you that from a cash perspective, you know, obviously the cash flow statement, we generate about $90 million in cash in 2022. And, you know, we've got a healthy cash balance at year end at $200 million. And, you know, it's obviously we started the share buyback program and invested there. So, you know, you know, which is, you know, in the volatility, you know, that's out there and which is why we thought it was prudent to, you know, go to quarterly guidance this time, just because of the, you know, the precision and visibility into our, you know, customers liquidity is, is, as well as, you know, auto loan originations. So, you know, that's, you know, but we will continue to generate a free, a lot of free cash on this business. It's a great cash business. And if you think about maybe a, Instead of an adjusted operating cash flow metric, maybe even a free cash flow metric at about, call it 85% to 90% of adjusted EBITDA, that's kind of what we target. Yeah.

No, I hear what you're saying, and I sympathize. If you're having a hard time forecasting it, then it's just that much more difficult for us. So I guess I'll continue to listen in and think about some of those factors driving the reversal here this quarter.

Okay, Pete. Thank you.

Our next question comes from the line of Vincent. Can you take which Stevens please proceed with your question?

I, uh, thanks for taking my question. Good afternoon. Um, wanted to go back to the profit share. So if you could kind of go into more detail about, you know, in the fourth quarter, kind of what the big changes in assumptions, uh, were plus, um, you know, what gives you comfort that, you know, what you built into the expectations for profit share now are, you know, are where they should be? Or could you give a sensitivity around, you know, if used car prices or different things move around, you know, what could profit share do? Thank you.

Yeah. Hi, Vincent. You know, I think I said, you know, earlier when David asked the question around profit share, you know, maybe I start with, you know, what changed in the fourth quarter It was an accelerated decline of the Mannheim, unprecedented 15% for the year. When we were at Q3, we projected the Mannheim to be down about 11%. Used car values is a direct drive of our estimate of future claims and severity of loss, so it had a significant impact on us in the quarter. As you may recall, earlier in the year, Cox was forecasting the Mannheim to be down in Q1 and Q2 only 3% for the year. So it was a significant change here in the later part of the year. You know, as we think about, you know, sensitivities around it, you know, the $546 that, you know, we discussed earlier where we put the Q4 originations on the books. And, you know, we stress that, you know, call it about 23% from what we call the baseline, which is a 50% loss ratio. And that's stress on default increasing as well as severity of loss. So, you know, that's our estimate at this point in time. And if you think about it, that $546, you know, if you think about sensitivity around it, you know, for an example of every 5% maybe an incremental loss ratio or claims going up, you know, that could be about $100 in unit economics in our profits year just from just an average unit, you know, sensitivity. Okay.

Okay, that's helpful. Thank you. And then on the insurance company, sir, I appreciate you gave us the, I guess, how long each company's contract goes up into. But I'm sort of wondering if, you know, before a contract ends, can an insurance company change anything? So can they slow down approvals or change, otherwise change things that might affect the volume and all else being equal? Thank you.

Yeah, I mean, we have great relationships, as we said earlier, and it's a partnership with our carriers. And, you know, we review all, you know, changes, underwriting changes together with, you know, our approval as well as theirs. So, I mean, again, it's a strong appetite for our business, and it's been very profitable, you know, for AmTrust, you know, in particular, as well as, you know, Arch and Anaco going forward. And, you know, they're excited to get more flow of our business, you know, as CNA exits and changes their priorities. So we continue... You know, origination volume, you know, it is, you know, this year was $4.7 billion for us. And, you know, obviously with our, you know, going into 23, it's, you know, volume is going to be down. But there's plenty of capacity, not only for 2023, a lot of growth into the future with our three carriers. Okay. That's helpful. Thank you.

Chuck, it's also worth noting not one carrier can make a change. All three have to agree to it. So it's not like one carrier. and decide they want to slow down by changing an underwriting rule.

Yeah, great point, John. Thank you.

Our next question comes from the line of John Davis with Raymond James. Please proceed with your question.

Good afternoon. This is Madison on for JD. I wanted to start on OpEx. I think it will step down again in one queue based on the guide. But is there a way you can help us, you know, think about the right OpEx run rate just given – the current macro backdrop and some of your comments around retention and investments throughout the year?

Yeah, I mean, Madison, you know, as you pointed out, you know, at the midpoint of the guide for Q1, since we just went to a Q1 outlook, you know, I think, you know, a slight downtick there from obviously Q4 levels. But, you know, again, as we think about our investments in 2023, as we invest in the businesses, You know, these are measured, thoughtful investments, and, you know, we can slow those down if we need to, the pace of those investments in our business. So I'd just say, you know, in that range of Q4, but probably slightly down a bit just on the Q1 guide on OpEx.

Okay, that's helpful. And then, you know, I understand near-term margins are under pressure a lot given the macro headwinds. But just as we think about the longer-term model, is there anything structurally that's changed that would limit your ability to get back to that 60% plus EBITDA margin over time?

You know, if we think about margins, you know, we want to grow our business, you know, and obviously there's headwinds today and challenges that as we invest, you know, if you think about the Q1 outlook, you know, the margins are so, you know, 43%, EBITDA margins to 50, you know, from the low to the high. You know, we think that's temporary as we invest in the business now. You know, as others are retrenching and not, we look at this as an opportunity to really be positioned well for the pent-up demand as the industry and the auto-specific recovers. So we believe our margins will improve as our revenues, you know, go up and we can leverage the SG&A that's on the books today.

And Madison, this is Keith. And thanks, Chuck. I'll just add on those investments and why we feel it's the right time. You know, as Chuck mentioned, These are all measured and prudent investments that are based on through the lens of data and analytics to make sure that they're the right investments at the right time. And they fall into two very simple camps. The first is increasing our capacity and number of lender partners. As capacity per lender customer is down, it's important to grow overall capacity. So when the market comes back, it'll rise together. And then the second one is in the technology investment and product. And that's simply to help our application volumes flow as best they can through our funnel, especially when the time when applications are down. So they're around increased market penetration, and they're around increasing volume of app flows given the current environment.

Okay, got it. I appreciate the color, and thanks for taking the questions.

Thanks, Madison. Thanks, Matt.

Our next question comes from the line of Farza Ali with Deutsche Bank. Please proceed with your question.

Yes. Hi. Thank you. So first I wanted to follow up on the point I think John made around premium increases to account for that ASC 606 or to offset some of those ASC 606 headwinds. So curious if there have been any premium increases to date and if that's included within the adjustment this quarter. And if not, sort of how quickly do you think those premium increases can happen?

John, do you want to start? And then I'll kind of jump in as well.

Yeah. At this point, we've never had a premium increase. In all the years we've been doing business, we've had one reduction in premium of 15%. And that was a significant time ago. If you remember in following us over the last few years, one of the things we have done which effectuate almost what would look like a premium increase is we have reduced the advance rate on a loan. If you remember how we price loans, you've got 95% LTV, 100%, 105, and so on. So if we were only doing an advance off of 90% of the value, that would appear to be a higher premium to insure that loan. So we did that twice. I think it was a 5% back when COVID first happened and two and a half not that long ago. To answer the second part of your question, how quickly could it happen, if we feel the need to increase premiums, it's a 30-day notice to the insured. So we could send one notice out to all of our insured credit unions, banks, funding sources, and within 30 days have that premium increase in place.

Got it. Thank you. And then just a follow-up question broadly on the macro environment. And, you know, I'm curious in terms of what do you need for you know, for a recovery or really for normalization in your business. Because obviously, there have been a number of headwinds over the last, you know, call it three years. And it seems like the headwinds have been shifting and coming from different angles. And at this point, it seems like, you know, there's obviously supply chain headwinds that have been continuing. There seem to be, you know, seem to be multiple headwinds as it relates to whether it's affordability and then some of the issues that you're talking about as it relates to defaults, things like that. And then it seems like there's an issue with the credit union funding. So what do you need to happen from a macro perspective for things to normalize?

Yeah, and Faiza, this is Keith. I think you articulated it pretty well. I mean, it is the conundrum of our wonderful automotive retail industry that, you know, supply chain was buffeted and supply was hurt, you know, during COVID and right after COVID. And once as an industry, we've started to figure that out a little bit, albeit manufacturer specific. Now we have this demand shortage. So, you know, we kind of got supply figured out and now we have this demand dynamic. And it's captured, I think, best in the Cox Moody's Affordability Index, which, as I'm sure everyone on the call is aware, is now at 44 weeks on average to pay for the median used car. So that's at an all-time high. So that's the key factor. What do we need to make that affordability go away? It's very straightforward. We've got to have used car prices come down, which we're forecasting that they are going to happen in 2023. And we need rates to stabilize and come down. So that's one of the most important things for the business I think one of your follow-on questions is just liquidity. You know, our thought and thinking, and, you know, John or Chuck, you know, please jump in, is that especially as it relates to credit unions, that that liquidity and the balance sheets are going to get better in the second half of the year for the very simple reason of, one, they have more deposits coming in as they've raised rates to attract those deposits, and secondly, just as their current loan, auto loan portfolio, you know, starts to roll off. I mean, John or Chuck, anything to add?

Well, the one thing I would add to that, too, Keith, and And one of the things you'll find for these credit unions is because some of them have stuck with these low interest rate loans on longer term loans, you know, that makes them gun shy to go out there and do these seven year, 10 year, 15 year mortgages. They'd rather, and NCUA is a real proponent of a shorter duration, you know, average life two and a half to three and a half years on a loan at a decent return. I think you're going to see credit unions particularly get back to their core business, which is helping those near prime consumers, the underserved people, get into an affordable car to get to work them back while being able to generate a decent yield with a short duration loan.

Understood. Thank you so much.

Hey, Fazio, one thing I'll follow up. You know, as John mentioned that we've not, you know, ever had a formal, you know, actually price increase, or I guess not many, You know, when we put in the vehicle value discount, as John referenced, in 2020 and then also, again, in 2022, you know, that 2.5% vehicle value discount kind of equates to about a 10% to 11% effective premium increase. And that's still in effect that we put in April of last year.

Our next question comes from the line of Mike Grundle with Northland Securities. Please proceed with your question.

Hey, guys. Any update on the two OEMs and any outlook on any future OEM customers?

Well, my key, and hey, this is Keith, happy to take that. Just on the future OEM customers, let me just say that really encouraged currently by the frequency of our engagement with what's in the pipeline, and then, you know, based on relationships that I've had just in the past throughout my career, the introduction of two or multiple new logos into that sales pipeline. I'm further encouraged by just with the activity there is that a number of the prospects have passed through quantifiable stage gates and kind of the flow of from prospect to close. Now, to be clear, these are very, very large accounts. Their closing is unpredictable, but just to repeat, very encouraged by the frequency of interaction and then the formal passing through of stage gates to get to the ultimate relationship.

Yeah, and, Mike, I'll jump in. You know, on OEM 1 and 2, you know, obviously you can look at our key performance indicators and our, you know, supplemental deck, you know, down, you know, year over year, you know, quarter as well as full year. But we're encouraged that, you know, Q3 to Q4, you know, that's stabilized and that business is actually going up a bit. So it's good to see that momentum in OEM 1 and 2.

Got it. And good to hear on the future. Did you guys disclose, like, what percent of your volume CNA was?

No, we haven't. And, you know, they've been with us, you know, over the years since 2017. But they're not our largest, you know, carrier.

Got it. Okay.

Hey, thank you. Thanks, Mike.

Our next question comes from the line of Spencer James with William Blair. Please proceed with your question.

Hi. Thanks for taking the question. This is Spencer on for Bob Napoli. The core non-refi, non-OEM certs were a bit stronger seasonally than we anticipated. Could you talk about what customer activity is driving that and maybe how we should think of mix of certs between OEMs, refi, and core for your March quarter guide?

Yeah, you know, obviously, maybe start with, you know, the refi. You know, I think Keith, in a prepared comment, you know, our refi business is down, you know, obviously with the, you know, seven rate hikes in 22 and then, you know, one already in 23. That's severely impact our refinance channel, you know, there. So it's 43%, you know, Feb of 22 and as low as called 11%. in December. So if you think about year over year, Spencer, the core non-OEM business, if you will, is up 16%, which we're pleased to see. In fourth quarter, it was down, but obviously when we revised the guide for the year, that was taken into consideration in the liquidity constraints on our large customers primarily. And And, you know, as we think about, you know, going forward, you know, I think the OEMs are on track to continue to, you know, at the pace they are and we believe have hopefully troughed and are going to be adding more to us as we go forward. But, you know, the mix of the business, you know, it's hard to say, you know, right now with, you know, not giving a full year outlook and, you know, we're learning each day on kind of where we're heading here. But, you know, maybe Keith has something to add more about the kind of the non-core versus core customers.

Yeah, I mean, we're encouraged by the growth of just the large majority of our customers and look forward to that, you know, continued participation in the program in 2023. Right.

Okay, thank you for the color. And as a follow-up, average program fee per cert has continued to improve, and it looks like the improvement in program fee per cert has somewhat lagged the increase in average loan size. Could you talk about what drives the lag in program fee versus loan size? Is it a lag or is there another, is there a mix-related component that I'm missing?

No, I think it's more of a mix-related component because it's, you know, our program fee is based on a percentage of the loan amount, so there wouldn't be a lag there. You know, larger, you know, volume customers, you know, get a discount there on the program fee, Spencer, so it's just really a mix and lower concentration in some of our you know, larger customers that did more volume in the past that brought that down a bit.

Okay, I appreciate it. And there's been a ramp in program fee per cert over the course of the year. Should we expect that to be primarily correlated with loan size for 23, or are there other factors to consider?

Yeah, I think so.

Appreciate it. Thank you. Thanks, Spencer.

There are no further questions in the queue. I'd like to hand the call back to Keith Jesick for closing remarks.

Well, thank you, Operator. Just as we close, if I may, I'd just like to share a thought or two on the industry. As many of you know, I've dedicated my entire career, the majority of my entire career, serving automotive retail for many reasons, but the most simple is the fact that at trillions of dollars, automotive retail is the single largest non-healthcare-related consumer retail on the planet. 93% of households in the U.S. have at least access to at least one car, and that far outpieces the number of consumers who own a cell phone or a smartphone at 85%. What we're seeing now is an especially strong cyclicality, and what I've observed throughout my career is that automotive, and automotive for dance in particular, always comes back. The manufacturers, the OEMs, will ramp up production. They'll run multiple shifts. They'll produce cars and then follow those with wonderful incentives for consumers. Dealers are wildly resilient. They always find a way to put people in cars, whether it be new or used cars. And lenders especially will regain their appetite for auto loans, which are comparatively short duration and exhibit historically very, very low delinquencies. And when the industry comes back, It's almost always led by used cars, which is good for us because, as we all know, used cars is the primary source of our business. Eighty-five percent of our volume comes from used, while 15 is from new. And it comes back quickly in used, and the reason for that is very, very straightforward. Consumers can defer or delay the purchase of a new car, but they can't defer or delay the purchase of transportation. And with the average age of the car on the road approaching 13 years, we think there's phenomenal pent-up demand And so I just wanted to share my perspective just over my career in the auto sector and couldn't be more enthused about the future of open lending. And with that, I'd like to thank everybody for joining us today.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.