Open Lending Corporation

Good afternoon, and welcome to Open Lending's third quarter 2023 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. Earlier today, the company posted its third quarter 2023 earnings release and supplemental slides to its investor relations websites. 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 views as of today, November 7, 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 Jesick. Please go ahead, sir.

Well, thank you, Operator, and good afternoon, everyone. Thank you for joining us today for Open Lending's third quarter 2023 earnings conference call. It was another quarter of positive results in execution by our team. Through our Lenders Protection Program, we continue to execute on our mission to serve the underserved consumer and provide unmatched loan analytics, risk-based pricing, risk modeling, and default insurance to our lender customers. I am proud of our team's focus and accomplishments, specifically our recent launch of an enhanced scorecard, our continued improvements in technology, thoughtful underwriting changes, and strengthening our marketing and sales capabilities to further capture market share. For the third quarter of 2023, we generated approximately 30,000 certified loans, which was near the high end of our guidance range. And excluding the impact of the non-cash profit share change in estimate that Chuck will discuss in more detail, we exceeded the high end of our guidance range for both revenue and adjusted EBITDA. I would like to thank all our team members at Open Lending who executed and delivered these positive results in a challenging environment. I'd like to turn to the specific market conditions that are impacting our lender customers the most and ultimately impacting our performance at open lending. First, let's review the automotive sector, which continues to navigate through multiple challenges. New vehicle inventory levels in the third quarter of 2023 grew over 65% year-over-year, and the new SAR increased by nearly 10% in the same period. The increase in inventory levels has begun to drive down average transaction prices and is slightly improving consumer affordability. However, the used auto market remains depressed due to low inventory levels, which declined 8% year over year and remains over 20% below pre-pandemic levels. Even though used auto list prices and the Mannheim Used Vehicle Value Index, or the MOVIE, a leading indicator of retail used auto prices, have declined from recent highs, prices remain 40 percent higher than pre-pandemic levels importantly cox automotive forecasts the movie will likely remain at these levels as we exit 2023 implying used auto prices are unlikely to decline materially in the near term we expect that low inventory levels combined with elevated prices will continue to negatively impact the used auto market in the near term To be clear, I am confident that we are well positioned to benefit when this market inevitably rebounds, as it has in past cycles. Near and non-prime borrowers continue to face affordability challenges with elevated vehicle prices, decades-high interest rates, and higher total cost of ownership. For example, vehicle insurance costs have increased 20% year-over-year between 2022 and 2023, which represents the second consecutive year of double-digit growth. This further contributes to the affordability challenges for consumers at a time when they are already facing a high inflationary environment, the return of student loan payments, declining savings, and flattening disposable income growth. Now turning to our core customer, credit unions, which have significantly slowed all lending activity. Based on the most recent data, which is on a quarter lag, credit unions are experiencing a significant slowdown in share or deposit growth with only a 1.7% increase year-over-year in Q2 2023. To put this in perspective, share growth peaked at about 24% in Q1 2021. Notably, prior to this year, the lowest annual share growth over the past decade was approximately 4%. This directly impacts credit union lending growth, which is down to 13% year-over-year growth in Q2 2023, from a peak of nearly 20% achieved in the second half of 2022. Specifically within used auto lending, there has been a significant decrease as loan growth slowed to approximately 9% in Q2 2023, down from almost 16% in Q2 2022. The combination of these factors generates a loan-to-share ratio of 83% across all credit unions. However, many of our customers' loan-to-share ratio is near 100%. With this lending slowdown, credit unions are now the number three auto lender type behind captives and banks, down from the number one auto lender just three quarters ago. To combat low share growth, credit unions have increased the rate they pay their members for deposits. Accordingly, we began seeing a meaningful increase in our customers' average cost of funds earlier this year, and as of October 2023, Our customer's average cost of funds is almost 80 basis points higher than at the end of April, outpacing the increase in the Fed funds rate during that same period. This rate movement makes credit unions less competitive when consumers have multiple options at the dealership. In addition, we have seen most all auto lenders move away from the near and non-prime consumer. Loan originations in this segment have decreased from 35% of total auto loan originations in 2022 to 32% in the latest data released by the New York Fed. We understand the desire of lenders to look for safety by shifting to prime and super prime auto borrowers. However, we have conviction that this is the best time for lenders with available liquidity to go deeper in the credit spectrum utilizing our lenders protection program. Our solution and mission, as it has always been, allows lenders to better serve the underserved consumer while being protected by our credit default insurance, which provides a risk-mitigated solution for lenders to continue lending to near and non-prime consumers throughout cycles. Recall also that these consumers yield a higher return on assets than their prime and super prime counterparts and generally remain more loyal to their lender over the long run. As a testament to this conviction in our business, we continue to make investments with demonstrable ROIs to improve our core product and technology that will position us well to capture the pent-up demand when the industry inevitably rebounds. Last week, we announced the enhancement of our Lenders Protection proprietary scorecard with three additional alternative data sources beyond LexisNexis. The additional comprehensive data includes approximately 350 million detailed transactions, over 170 million consumer checking accounts, and most importantly, an expanded suite of credit report attributes developed and maintained by TransUnion. Our model leverages AI and machine learning algorithms and is trained and validated against a large set of proprietary lender's protection data to identify the most predictive credit risk attributes for our underserved consumers. With the increased predictive power of our new scorecard, we're even better positioned to serve our lenders, the underserved consumers, and our insurance carrier partners. In combination with the rollout of our new scorecard, we made some specific enhancements to our insurance underwriting. First, we improved our co-application underwriting logic for better alignment to our default probabilities. Second, our new scorecard offers enhanced risk-based pricing, which will result in more competitive rates for higher credit score, lower risk consumers. We are proud to deliver this enriched solution that will help financial institution customers engage a wider range of deserving borrowers by offering risk-mitigated auto loans and continuing to maximize the financial institution's return on assets. Beyond our investments in product and technology, we continue to focus on our sales and marketing capabilities to drive new customer acquisition. We added eight new lenders in the third quarter of 2023. we remain focused on targeting new accounts that are more likely to contribute meaningful certified loan volume. In addition, we continue to enroll financial institutions who operate loan-origination systems for which we already have existing technology integrations. And due to the constrained liquidity environment I discussed earlier, we further refined our customer acquisition strategy by targeting prospects with lower loan-to-share ratios that have the liquidity to lend. For example, two of the lenders added in the quarter have combined total assets of over $5 billion, and both have a low loan-to-share ratio of approximately 65%, compared to an industry average of 83%, evidencing the successful execution of our strategy. We recently held our most well-attended executive leadership roundtable with existing customers and prospects in September of this year. In fact, the annual event was so successful, we are planning to conduct regional lending summits in 2024, allowing customers and prospects to interact with those within their region facing similar market conditions. We were recently named as a finalist for the 2023 Credit Union Times Luminaries Awards in the Product Innovation category, and as a finalist for the NAFQ Services 2023 Innovation Award. I am proud of the work our team has done to build strong partnerships with our lender partners throughout the country. In closing, I have now been in the CEO role at Open Lending for one year. It has been a challenging year from an auto sector and macroeconomic perspective. However, our business has performed well considering these market conditions. As I reflect, I am proud of our team's many accomplishments. We made numerous enhancements to our product and have invested in our technology, including launching a new scorecard, deploying a new claim adjudication platform, streamlining our automated application workflows, and moving to the Azure cloud environment, which provides enhanced stability, better performance, and reduced costs. We launched multiple thought leadership pieces to elucidate how lenders can more effectively lend to the near and non-prime consumer. We implemented underwriting changes to help our lenders to be more competitive, such as pre-qualified decisions that bolster our lenders' ability to provide a better direct-to-consumer digital car buying experience. In addition, we extended loan terms to 84 months to help with consumer affordability, increased our insurance premiums to appropriately priced for the risk we are taking, extended our allowable vehicle age from 9 to 11 years as the average age of autos continue to increase, and extended our expiration window from 30 to 45 days for our direct and refinance channels to allow sufficient time for our customers to complete the funding process. This past year has only solidified my belief that our value proposition remains as strong as ever to the various players within the automotive lending ecosystem. Now with that, I would like to turn the call over to Chuck to review Q3 in further detail, as well as to provide our thoughts on the outlook for Q4. Chuck?

Thanks, Keith. During the third quarter of 2023, we facilitated 29,959 certified loans compared to 42,186 certified loans in the third quarter of 2022. Total revenue for the third quarter of 2023 was $26 million compared to $50.7 million in the third quarter of 2022. To break down total revenues in the third quarter of 2023, profit share revenue represented $8 million, program fees were $15.4 million, and claims administration fees and other total $2.6 million. Total revenue for the third quarter of 2023 includes a negative profit share change in estimate of $8.1 million. Excluding the impact of this change in estimate, total revenue for the third quarter of 2023 was $34.1 million and at the high end of our guidance range. Now let's turn to profit share. As a reminder, 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. Profit share revenue in the third quarter of 2023 associated with new originations was $16.1 million or $537 per certified loan as compared to $24.9 million or $589 per certified loan in the third quarter of 2022. Recall, we increased our insurance premiums by an additional 5% earlier this year with the full impact realized in the third quarter of 2023 profit share unit economics. With this adjustment, we now have increased our insurance premiums by nearly 20% since the second quarter of 2022 to appropriately price for the continued risk in the current macroeconomic environment. U.S. GAAP revenue recognition rules related to variable consideration require that we reevaluate our cumulatively reported prior period profit share revenue estimate based on new available information each quarter. During the quarter, and not like others in the auto lending space, our customers observe rising delinquencies and higher claim submissions associated with the continued economic pressure on the consumer resulting in higher default frequency, the primary driver of the 8.1 million negative profit share change in estimate in the third quarter. This was partially offset by benefit and severity of loss in the near term as our prior quarter conservative forecasting of the movie is largely in line with the current quarter forecast. And we realized and forecasted lower prepayment speeds in this current environment. As noted, the higher frequency of default is not limited to open lending's customers as the industry has seen 30 plus and 60 plus days delinquency rates rise across all auto and other consumer asset classes. To put this into perspective, we have over 400,000 insured in-force loans in our portfolio and have recognized over $370 million in profit share revenue since adopting ASC 606 in 2019. The $8.1 million negative adjustment represents approximately 2% of our previously recognized revenue. also important to note our cumulative profit share change in estimates since 2019 represents 20 million in net positive change in estimate adjustments over this period which is net of the negative adjustment recognized in the third quarter of 2023 operating expenses were 16.1 million in the third quarter of 2023 compared to 17.7 million in the third quarter of 2022 and compared to 16.3 million in second quarter of 2023 Operating income was $4.5 million in the third quarter of 2023 compared to $27.8 million in the third quarter of 2022. Net income for the third quarter of 2023 was $3 million compared to net income of $24.5 million in the third quarter of 2022. Basic and diluted earnings per share were two cents in the third quarter of 2023 as compared to 19 cents in the previous year quarter. Adjusted EBITDA for the third quarter of 2023 was $10.3 million as compared to $29.4 million in the third quarter of 2022. Excluding profit share revenue change and estimate, we generate $18.4 million in adjusted EBITDA, which also exceeded the high end of our guidance range. There's a reconciliation of gap to non-gap financial measures that can be found at the back of our earnings press release. We exited the quarter with $383.4 million in total assets, of which $232.6 million was in unrestricted cash, $49.2 million was in contract assets and $64.7 million in net deferred tax assets. We had $168.7 million in total liabilities, of which $144.9 million was outstanding debt. Year to date, we generated $61.2 million in cash before acquiring 31.3 million or 4.3 million shares of our common stock at an average price of $7.29 per share. We have $25.7 million remaining under our current share repurchase program, which was extended by our board of directors and will now terminate at the end of the first quarter of 2024. Now moving on to our Q4 23 guidance. Although we're encouraged that new auto inventory has improved, there are other market conditions, as Keith mentioned, that are impacting our lender customers and ultimately open lending's performance, including Low used vehicle inventory levels driving elevated used vehicle prices combined with high inflation and high interest rates continue to create affordability challenges for the consumer. Credit unions continue to face liquidity challenges, increased cost of funds leading to credit unions being less competitive when consumers have other options at the dealership, tightening underwriting standards leading to lenders shifting towards the perceived safety of the prime and super prime borrowers, and evolving geopolitical environment which may further impact market conditions. Accordingly, our guidance for the fourth quarter of 2023 is as follows. Total certified loans to be between $22,000 and $26,000, total revenue to be between $25 million and $29 million, and adjusted EBITDA to be between $11 million and $14 million. That said, we have a strong balance sheet, no near-term debt maturities, and generate positive cash flow. all of which will afford us the resilience needed to navigate current market conditions. As sector and macroeconomic conditions inevitably recover, we expect to capture pent-up demand and capitalize on the thoughtful investments we continue to make during economically challenging times. We would like to thank everyone for joining us today, and we will now take your questions.

Ladies and gentlemen, if you would like to ask a question, please press star 1 on your telephone keypad and 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 keys. And our first question comes from the line of Joseph Vafi with Kennecourt Genuity. Please proceed.

Hey guys, good afternoon. I thought maybe we just kind of dig down a little bit into the change of estimate in the profit share. I know you did cite that there was rising delinquencies and could you maybe kind of provide a little more color on the 8.1 million change of estimate? Is this, you know, how far does that go in terms of creating a little more conservatism relative to the forward look and how much delinquency activity is kind of captured in that 8.1, not just what we've seen so far, but on a prospective basis. And then I'll have a quick follow-up.

Hey, Joe, it's Chuck. Good to talk to you. Yeah, you know, if you think about just even from Q2 to Q3 is what we've seen in the rising delinquencies in that 30-plus and 60-plus in our prepared comments and just higher claim submissions in this challenging, you know, economic backdrop that we have. You know, the 60-plus day, you know, delinquent, you know, it opened lending about 4.7% at Q3, and that's sequentially compared to Q2. was 3.9%. So an 80 basis point uptick, just, you know, sequential quarter, as well as, you know, year over year, about 140 basis points from, you know, as compared to Q3 of 22. So, you know, as we kind of think about the back book and the, you know, the disclosure or the transparency in the script, you know, if you think about that 8 million, you know, it's on 400,000 plus insured loans and our, you know, recognition of about 370 million of prior profit share. So, you know, about 2% of that income booked. And, you know, the stress going forward on claim frequency is, you know, historically the benchmark is about 15% or 15 of 100, you know, would default in a normal environment. You know, we've stressed that even greater to, you know, call it about an additional 24% to, you know, between 19 and 20% ultimate default stress. in the portfolio, and we've carried that through Q4 into the second half of 24.

So just to understand, you've stressed the underwriting estimates kind of well above where delinquencies are right now. Is that the right way to look at it?

Yes, sir. That's right, and our delinquencies are in line with the industry and actually slightly below on the 60-plus category. And if you think about, you know, and severity, you know, of loss, you know, as you know, the components of the change in estimate aren't just default frequency. It's severity of loss as well as prepay speeds. And those were positive impacts in the quarter in the net 8.1 million. So, yeah, but we stress that out on the default frequency into the future, you know, and we'll continue in each quarter as new information, you know, comes to us. Got it.

Great. Thanks, guys.

Hey, Joe, and one other thing I'll add is on our Q3 originations, because it's important to note that what the 8.1 was 100% on the back book of business of the 400,000, we'll call it 380,000 loans in the portfolio. On the Q3 profit share unit economics, we booked a little under 540 per loan. And that's at a loss ratio of about 60, almost 64%. So we've stressed that, you know, call it an additional 27% from our benchmark of about 50% loss ratio. So not only did we, you know, right-size-the-back book based on this information, we've stressed the new originations as well. And we've maintained, you know, over four quarters about, you know, between 540 and 550 profit share unit economics. And the defensive moves that we've taken to preserve those unit economics, but with our price increase, insurance premium increases of 5%, you know, recently and fully ramped in Q3, and then, you know, call it 13%, 14% last year. So we're protecting our unit economics.

Got it. Thanks for that extra call, Chuck. Much appreciated. Yes, sir.

Our next question comes from the line of Vincent Cantik with Stevens. Please proceed.

Thanks for taking my questions. Just to actually follow up on the profit share. So I appreciate all the detail of what you're assuming now. It sounds like it's putting more stress on your assumptions. So I appreciate that. I was wondering if there was You know, anything in the quarter specifically that drove that, you know, given that you gave the guidance in the mid-quarter, in the second quarter earnings call? And then does that have, does the assumptions that you're making now have an impact in your underwriting and what you're pricing the loans to be? Just sort of wondering how that maybe has an impact on pricing and volume. Thank you.

Yeah, hi, Vincent. Yeah, I mean, we'll start maybe with the pricing and the premiums. You know, my last comment there to Joe on the, you know, call it 537 per cert unit economics, you know, that's after the price increase we took in the second quarter of about 5% and also the premium increase last year. So that's baked into our underwriting, and that's a stressed unit economics. You know, I think it's important to note that, you know, we put roughly 27% stress on the new originations, And, you know, the profit share unstressed would be, you know, call it 800 plus per unit. And by the way, the new book, you know, since we put the price increases in, you know, call it second quarter of 22, are performing better than those older vintages that were put on the books at the peak of the movie or the Mannheim. So, yeah, the price is baked in.

Okay. I appreciate it. Thank you. And a second question. So good to hear about you lenders this quarter. I think in the past you've talked about ramping your sales force. I'm just wondering what we should be expecting in terms of sales productivity and that pipeline. So should we be expecting more new lender growth? Thank you.

Yeah, I'll address that. And this is Keith. Certainly I like to remind ourselves of the opportunity in front of us. There's approximately 4,500 credit unions in the U.S. We serve 450, so call it 10%, and that means we have a massive runway and opportunity in front of us. And then even after the strict segmentation that we've accomplished that we've talked about on prior calls around segmentation around their asset sizes, around LOSs, around their loan to share, around their need to serve the underserved and things like that, the pipeline is larger and stronger than it's ever been before. And roughly two-thirds of those are in a really, really favorable LTS position. So we feel really good about future prospects. Many of those that are in the pipeline right now are at the bottom of the sales funnel, so we feel good about the performance coming into Q4 and heading into 2024.

Okay, great.

Thanks very much. Thank you. Thank you.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. And our next question comes from the line of Lance Jesserun with BTIG. Please proceed.

Hey guys, thanks for taking my question today. Just a super quick one on the UAW strike. Can you talk about impact to you guys, any outlook there, any color you've heard in terms of industry and you know, how that's affecting supply, et cetera?

Yeah, happy to take that one. And this is Keith. Glad to see that that is behind us for sure. Really no impact for us. As you'll recall, we're roughly 85%, maybe even 87% used, so no direct impact. And then also on the new side, interesting to note that the Detroit 3 had the largest day supply of any manufacturers out there. And in fact, their average day supply was was 2x the day supply of most other vehicle manufacturers here in the U.S. So they were positioned to handle the strike better than other manufacturers, and I think the swift resolution of that is not going to lead to much impacts at all. I hope that helps.

Got it. That's great. Thanks. And then talking about OEMs as well, obviously you did a very good job of talking about the demand side on the on the credit union side and their cost of deposits, but I'd be interested in hearing some of the color you're hearing from OEMs in terms of their demand for your product, how talks are going there, given a tougher backdrop. That'd be great, thanks.

Yeah, and again, Keith, happy to take that one. As we mentioned, credit unions moving from number one to number three, the segment of the market of auto lenders that has moved to number one is the OEM captives. And we actually see that in our volumes. We see year-to-date volumes of our captive customers up 19%, so strong growth there. And our share of that growth is continuing to improve. The pipeline is as strong as it's ever been. I think in past years, Calls, I've talked about the fact that that pipeline is the highest count it's been. Happy to report that that account is even higher. Our value proposition is as strong as it's ever been in our offering to this segment. And then I would finally just say that with multiple of the large accounts in the pipeline, we've achieved really important milestones on the way to a path to a sale. All that to be caveated, of course, by the fact that these are very large enterprises, many of them global. And approvals and launches can take some time.

Got it. Thanks so much. Thank you.

And our next question comes again from the line of Vincent Cantik with Stevens. Please proceed.

Hey, thanks for the follow-up. Just one more question. Just your thoughts about share repurchases. You know, the stock's been under pressure. It seems like aftermarket, it's also looking like it's under pressure. And understanding that maybe there's some macro industry difficulties, but you're, it sounds very optimistic in terms of the long-term trajectory of the company. You've had low leverage and good cash balances. So just wanted to get your updated thoughts about share repurchases and how you think about the value of the company. Thank you.

Yeah, thanks, Vincent. Yeah, I mean, we currently have a board-authorized $75 million plan that's out there, and we acquired about $10 million of our stock at $8.32 a share in the third quarter, and we still have about $26 million under our current authorization that was going to expire here in a couple of weeks, and our board extended it to the end of the first quarter. So obviously we see that as a good investment and a good use of capital to buy our stocks.

Great, thanks again.

Thank you.

Thank you. Ladies and gentlemen, there are no further questions at this time. I would like to turn the call back to management for closing remarks.

Well, thank you. Let me just conclude, and this is Keith speaking, by saying that the opportunity to lead this company, as I have said from day one, remains compelling as ever, as open lending exhibits all the attributes I look for in a great company. We have a large and growing total adjustable market, and importantly, our penetration into this market remains low. We have a profound competitive advantage and significant barriers to entry, and a business model that leverages both one and two. With that, I'd like to thank everybody for joining the call today.

This concludes today's conference. You may now disconnect your lines at this time, and thank you for your participation.