Regional Management Corp. (RM) Q4 2016 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Regional Management Q4 2016 earnings conference call. At this this, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Garrett Edson, Senior Vice President, ICR. You may begin.

Thank you, Ashley and good afternoon. By now everyone should have access to our earnings announcement and slide presentation which was released prior to this call and which may also be found on our website at regionalmanagement.com. Before we begin our formal remarks, I need to remind everyone that part of our discussion today may include forward-looking statements, which are based on the expectations, estimates and projections of management as of today. The forward-looking statements in our discussion are subject to various assumptions, risks, uncertainties, and other factors that are difficult to predict and which could cause actual results to differ materially from those expressed or implied in the forward-looking statements. These statements are not guarantees of future performance and therefore undue reliance should not be placed upon them. We refer to all of you to our recent filings with the SEC for a more detailed discussion of the risks and uncertainties that could impact the future operating results and financial condition of Regional Management Corp. We disclaim any intentions or obligations to update or revise any forward-looking statements except to the extent required by applicable law. Also, our discussion today may include references to certain non-GAAP measures. Reconciliation of these measures to the most comfortable GAAP measure can be found within our earnings announcement and presentation deck posted on our website at regionalmanagement.com. I would now like to introduce Peter Knitzer, CEO of Regional Management Corp.

Thanks Garrett and welcome to our fourth quarter 2016 earnings call. As always, thanks to everyone for participating this afternoon and for your continued interest in our company. I am here with our CFO, Don Thomas. who will speak later on the call. I’m also here with some members from our financial team. For those with access to a computer or a mobile device, we’ve once again posted a supplemental presentation on our website at regionalmanagement.com to provide additional color to our remarks. Regional's business model continues to be focused on volume driven revenue growth, coupled with properly managing credit risk and expenses. We believe our business model is well positioned to create long-term shareholder value and we continue to work diligently toward that goal. The fourth quarter of 2016 was marked by continued strong finance receivable growth. As you can see on Slide 3, we hit a record $718 million and total finance receivables at the end of the year. Our focus on our core, small and marked portfolio continues to pay dividends and driver growth for the company. For the fourth quarter, we recorded GAAP net income of $6.5 million, down from $7.4 million in the prior year period. As you may recall, in last year's fourth quarter, we recorded a $1.2 million after-tax gain on the bulk sale of our charge-off loans. Excluding that bulk sale and a $100,000 after-tax expense for our loan system conversion cost in both 4Q 2015 and 4Q 2016, net income on a non-GAAP basis for the fourth quarter of 2016 was $6.6 million up 5% from $6.3 million in the prior year period. Diluted EPS was $0.55 versus $0.56 in the prior year period and on a non-GAAP basis, diluted EPS was $0.56 versus $0.48 in the fourth quarter of 2015. It was another strong quarter of topline performance. We grew revenue 13% and increased interest and fee income 16%, both driven by strong increase in average net receivables in our core portfolio. We did see noticeable increase in our provision and our late stage delinquencies remained elevated. Don will discuss these items in detail shortly. Importantly we kept operating expenses stable while growing the portfolio. On Slide 4, the $6.5 million of net income this quarter is in line with our seasonally driven bottom line pattern. The top graph on the slide tracks our earning net receivables and for the seventh consecutive quarter, they increased double-digits from prior year period, 14% to a record $718 million. As a reminder, our business is seasonal in nature and we do expect that the size of our portfolio will contract as it always does in the first quarter as customers pay down their outstanding loans, utilizing factory funds and-or bonuses. Turning to Slide 5, we break down our revenue into its main components. The 13% year-on-year revenue growth was driven by a 15% increase in our average net receivables as shown on the top and bottom right-hand charts. From yield perspective, the bottom left-hand graph shows the 80-point sequential decline. If you look to the following slide, you'll see that interest in fee yield income has remained relatively flat with only a 20 basis points yield decline. So, the majority of the sequential yield decline of full 60 basis points was attributable to insurance income, which was down $1.3 million on higher claims expense in part due to the effects of Hurricane Matthew. On Slide 7, you can see our product category trend. As I previously mentioned, at the end of 2016, our total portfolio was at $718 million, $89 million greater than prior year. Our core loan products were up $109 million led by our large loan category which now stands at $235 million or 33% of our total portfolio. Meanwhile our small loan categories saw a $20 million or 6% increase from prior year period and was up 3% from the end of the third quarter. Our other loan categories were down $6 million sequentially and $20 million from prior year, primarily due to our automobile loan category. As we discussed on our last call, we had expected a modest sequential decline in the fourth quarter for our auto portfolio. While the restructuring of the auto business is largely complete, for 2017 we expect to continue to focus our growth efforts on our core portfolio, while our auto business will remain a complementary product to meet our customer's needs. I'll now turn it over to Don, to go through the next few slides.

Thanks Peter and hello to everyone on the call. I am picking up on Slide 8 with the provision for credit losses. Our provision for credit losses of $19.4 million in the fourth quarter was up $6 million from the prior year period and up $3 million on a sequential basis. At the top of the slide, is in an eight-quarter trend of our provision for credit losses depicted by the blue line and the same eight quarter trend of our net credit losses depicted by the green bars. $11.8 million of fourth '15 net credit losses included a $2 million pretax gain on a bulk sale of charged out loans. Excluding the gain on the bulk sale, net credit losses for that period were $13.8 million and as a matter of convenience I am excluding that gain from the applicable amounts I referred to in the rest of the discussion on the slide. As you can see from the graph, the largest part of our provision expense is net credit losses. On last quarter's call, we said, we expected our 4Q '16 provision would move up as dollars in late stage delinquencies at the end of 3Q '16 were higher than prior quarters. Net credit losses in 4Q '16 were higher at $17.3 million, which is up $3.8 million sequentially and up $3.5 million over 4Q '15. Higher net credit losses pushed up our annualized net credit losses rate as a percentage of average net receivables to 9.8% in 4Q '16, which is up 80 basis points year-over-year. The rest of the provision for credit losses comes from the change in the allowance for credit losses. In 4Q '15, we released $0.3 million of allowance versus needing to build allowance of $2.2 million and 4Q '16. Building allowance versus releasing allowance resulted in a $2.5 million increase in the provision for credit losses in the 2016 quarter versus the prior year period. The 2016 build of allowance is due to the combination of growth in our portfolio and the elevated late stage delinquencies. As a percentage of ending finance receivables, the 4Q '16 allowance was 5.7% versus 6% for 4Q '15 due primarily to large loans becoming a significantly greater portion of our overall mix. Turning now to Slide 9, we show our seasonal pattern of delinquency with 1Q being the lowest quarter and 4Q typically the highest quarter. Our total delinquency of accounts one or more days past due as of 12-31-16 was 18.1%, which is a fourth consecutive quarter that this measure has been below 19%. Our 30-plus day delinquency level stood at 7.4%, an increase from 7.2% in the fourth quarter of 2015 and up from 7.1% at the end of the third quarter of '16, which is consistent with our normal seasonal pattern, while our early stage delinquency was in line with expectations. You can see that our later stage delinquency buckets were elevated and then were slightly higher than we anticipated, primarily due to underperforming segments with relatively higher rates and a less implementation in North Carolina and Hurricane Matthew, which impacted three of our states. Because of the elevated late stage delinquencies, we do expect net credit losses to be slightly higher sequentially in the first quarter of 2017 versus fourth quarter 2016. In order to improve our overall credit profile going forward, we are eliminating lending to specific segments that we've identified as go into losses at higher rates. Moving on to Slide 10, you can see from our G&A expense trend that continue to manage expenses closely. G&A expense of $28.8 million in fourth quarter of 2016 was up only $0.3 million from the prior year period, while down $1.6 million sequentially. Loan system conversion expenses in the quarter were only $150,000 as the slowdown in the state conversion schedule reduced amortization of current loan system software cost. Annualized G&A expense as a percentage of average net receivables was 16.3% for the fourth quarter, down from 18.6% in the prior year period and 18.1% sequentially. Consistent with the seasonality of our business, our quarterly results in the second half of each year tend to be our lowest quarters of G&A expenses as a percentage of receivables. Now that we're turning the page to 1Q '17, we expect to see an increase again in G&A expenses as a percent of average net receivables due to lower seasonal originations, which drive lower deferrals of salaries associated with those originations. That concludes my remarks and I'll now turn the call back to Peter who is going to provide some more color on our 2017 initiatives, including the ongoing loan system conversion.

Thanks Don. Let's turn to Slide 11 to give you an update on our current strategic initiatives. First and foremost is our origination and servicing system conversion. We are very pleased with the increased functionality and capability as the analysis and has already provided and will continue to provide our business. In the fourth quarter, we assessed our position and made the determination that before going ahead with converting our next stake, we wanted to build additional functionality into the operating platform. This includes completing the online customer portal, adding texting capability and integrating a document imaging solutions. As a result of this position, we will spend the first quarter completing the build and plan to resume state conversions in the second quarter. To that end, we're now expecting to complete the conversion of all states by the end of the year. While our timeline has been backed, we feel that adding important functionality now versus later, will provide more satisfying customer experience, limit future change management and Regional will succeed in the long term. Corresponding with this new timeline, we expect that conversion expenses will continue through the end of 2017 and we will incur approximately $2.5 million to $3 million of system conversion costs across the year compared to $1.6 million that we incurred in 2016. As you can see from Slide 12, approximately $1 million to $1.5 million is incremental to our prior year costs and our previous plans due to the incremental build and functionality and re-patterning of the conversion. While we continue to make progress on our new loan system, our growth strategy in 2017 will be similar to that in 2016. There is a significant opportunity to grow our account and receivable base within our existing branch footprint. For example, in the most recent quarter, that's fourth quarter, we grew our average finance receivables per branch by 11.5% on a year-over-year basis. As I noted on the last call, we've been testing improved targeting and segmentation in our direct mail campaign. I am pleased to say that the results of these tests have been very positive and I can now say with confidence, that we will productively spend up to a couple million dollars more in marketing in 2017 to drive additional traffic to our branches. While we still expect to add 10 to 15 de novo branches during 2017 in Virginia, this hybrid approach of growth within our footprint and de novo expansion, provides a flexible strategy to continue our strong growth momentum. With respect to our online strategy, the mantra of test and learn remains the same. The LendingTree referral program continues to show positive impact and assuming it continues to be successful, we'll look to fully integrate the program into our efforts by the end of the year. We still have plans to roll out our improved online functionality, which includes the ability to take a loan application completely digitally to all states in concert with the full conversion of the Nortridge loan management system. We've also been successfully testing centralized selections with some of our branches in Texas and as a result, we plan to expand our efforts on this front in the second quarter of 2017. So, to sum up, 2016 was an overall solid year for Regional as we grew our top and bottom lines despite the ongoing conversion of loan platform. Our core, small and large loan categories continue to drive double-digit growth in our loan portfolio. Credit increased a bit in the fourth quarter, but overall was relatively stable throughout the year and we will continue to manage expenses closely. For 2017, we look ahead to generating more profitable growth, while completing the buildout of our operating system and converting our remaining states to NOS. With this foundation and our multipronged go-to-market strategy, we continue to position Regional Management for success in 2017 and beyond. Thanks for your time and interest and I would like to now open up the call for questions.

[Operator instructions] Our first question comes from David Scharf from JMP Securities. Your line is open.

Hi David.

Yes hi. Good afternoon. Hi. Happy New Year, little belatedly. I was wondering, part of the answer to this question I realize is the product shift, as you noted about a third of the loan balance is now consisting of large loans, but when I look at the still healthy double-digit growth in same-store AR, I'm curious how much of that is a result of increased loan count? Whether it's walk-in traffic or response rates to the direct mailing versus how much of it is just the fact that you're writing bigger loans and that you may be actually putting some repeat borrowers who used to be small loan borrowers into large loans? It is something you're able to if not precisely quantify, give us a sense for?

Yes absolutely. It's a combination of all the above and as you know we've said on previous calls that two thirds of our large loans come from smaller loan categories for credit worthy to receive a larger loan. We're also -- drive a lot of traffic into our branches via our direct mail and we get referrals from the customers who are satisfied, suggesting their family or friends or whomever come to Regional to meet their financial needs. So, it's a combination of all the above. I think what you're going to see in 2017 with increased marketing efforts, you'll see more account growth and as well as more upsell to those who are creditworthy for larger loans. So, it's all part of our go-to-market strategy and so far, so good.

Got it. And the comment that you just made again about increased marketing in 2017, is that -- is that a reference to just relative to what had been your internal plan previously or you specifically guiding to just the dollar amount of the marketing expense line being higher in 2017 versus last year?

Well we, what I said on the last call is we were testing improved targeting and segmentation, identifying new swap-in and swap-out sets that were both more responsive and better credit quality. So, we were testing that in the third and fourth quarter and those tests really turned out to be actually terrific in terms of the results. So we already own that record and as of those results, we feel confident that we're going to spend more in 2017 because we're seeing such positive results. We're going to spend more in marketing because it's very productive.

Got it. Got it. I'll just ask one more and get back in queue. On the credit side, in addition to late stage delinquencies, running a little higher, you mentioned, it sounds like you're proactively eliminating lending to some segments. Can you expand on what those segments are? Are they defined by FICO band? Are they defined by product type geography? Curious as to what stood out in your mind such that it required a complete temporary pullback?

Well I would call really surgical criteria changes and that's not on a state-by-state basis geographically. We in addition to FICO, we pull in several attributes from the credit bureau and we were able to identify certain attributes that reduced a small percentage of our overall universe and a larger percentage of our losses. And so, we feel very good that we're not going to be decreasing volume by a lot and we're going to be capturing a higher percentage of our losses before we lend the money. So, we're going to cut out those segments and it's a variety of different attributes that we utilize. So, it's a geographic advantage as well as analytically based and we continue to refine credit, but we noticed in particular that these were segments that resulted in higher roll rates and higher losses and we're cutting them out.

Got it. Got it. Great. Thank you.

Sure. Thank you.

Our next question comes from the line of Sanjay Sakhrani from KBW. Your line is now open.

Hi guys. This is actually Steven Kwok filling in for Sanjay. Thanks for taking my question. I guess on the first one, when we look at the 90-plus delinquency rate, that has been rising year-over-year. When we look at, it's been about, it was 20 basis point to the start of '16 and now it's roughly up about 40 basis points. How should we think about the trajectory there heading into '17? Should it level off or even improve as the year progresses?

Well, some of the criteria that I just discussed from David's question really is to address those later stage delinquencies. If you look at our early stage delinquencies, they're actually quite good and so as we surgically go after the segments that are driving higher delinquency and ultimately driving higher losses, we feel that it should normalize into the second quarter of next year. So, we know that we're going to have as we said on the third quarter call, higher losses in the fourth quarter. Sequentially we'll have a higher cost of provision in the first quarter than the fourth quarter, but we feel that the changes that we're making should actually bring that down.

Got it. You mentioned that when you looked, when you're surgically reducing lending to specific segments, you don't expect much impact around origination volume, but how do we think about it from a yield perspective?

From a yield perspective, we're not really, I don't see any impact on the yield because this is not -- this is not going in and eliminating really lower FICO customers per se. It's using a combination of attributes. So, we don't see a mix shift in our business resulting from this and we've actually analyzed that to make sure that that was not the case. So, we don't see an impact toward yields in this.

Okay. Got it. Great. Thanks for taking my questions.

Absolutely. Thanks Sanjay.

Our next question comes from the line of Mike Del Grosso from Jeffries. Your line is open.

Good afternoon. Thanks for taking my questions. I guess I am going to attack the credit questions previously a little different way. Can you bifurcate the trends you're seeing in your credit book as far as what you're seeing from new customers versus your existing or recurring customers? The trends you see there as far as credit.

Yes, we can, absolutely.

We absolutely do, yes.

Okay. Are you seeing any material deterioration in one of those segments versus another or…

It's really in -- it's further across the board and mostly in new and that's where we're -- I would say it's across the Board pretty split, but we're looking at it geographically. The criteria that we're using applies to new borrowers as well as present borrowers. So, it will impact each somewhat, but it's mostly new borrowers or new loans that we're underwriting versus the present borrowers that we have.

Okay.

There is a little, but it seems more towards new borrowers.

Okay. So, some utilization both, but more towards new. I guess modelling related question, the weather related impacts this quarter and the insurance line item, can you -- what was the dollar impact of that again?

$1.3 million reduction in our insurance income.

Yes, and that all related to Hurricane Matthew, correct?

No, no.

We have several impacts within the line. We have increase in non-filing claims, in insurance and increase in life insurance claim and we also had an increase in property claims during the quarter. The property claims specifically were primarily from Hurricane Matthew which hit longer coast. We have branches in Georgia, South Carolina and North Carolina that were involved.

Okay. Okay. So, it seems like there was quite a few items in there, not just the hurricane impact. Can you help me size up the hurricane impact specifically?

Yes, that was somewhere between $200,000 and $300,000 Michael.

Got it. And then I guess the last one that is I guess stepping back when we look at the Nortridge rollout in 2017 and actually 2018 and beyond, what kind of scaling should we expect on the SG&A as a result of the new loan system and how much leverage do you see in the model?

Yes, we are spending the $2.5 million to $3 million this year Michael and have looked little further out at capital expenditures and run rate into the future. So, we'll see some reduction in 2018 from our overall spend even when the system is out and running. So, it will come down a little bit maybe half of that in 2018 will be a good way to think about it.

Got it. Appreciate the time. Thank you.

Thank you.

[Operator instructions] Our next question comes from the line of Bill Deslam – Titan Capital Management. Your line is open.

Thank you. A couple of questions. First of all, I want to [beg in] your answer here and would you please explain the non-filing claims and how that's different from say a filing claim?

I'll let Don handle that one.

Sure. Hi Bill. Good to speak with you. The personal property if we take the lateral loans, this is something that we don't take the time to spend the money to perfect for our UCC-1 filing and instead we'll buy insurance as probably non-filing insurance and if we lose our rights to the collateral, which can happen a variety of ways, but most frequently it's through a bankruptcy filing. And we're able to make a claim on that particular property. In our case, we reinsure the exposure under the non-filing insurance to our captive. So, it turns out to be an insurance claim and a consolidated financial statement. Did that help a bit?

That does help. Thank you very much. And I want to come back to the elimination of segment and you talk a little bit about that before, but in somewhat a vague terms, which maybe was intentional, but I am just going to ask specifically what are the criteria that you are going to be either changing or excluding to so that you can eliminate what segments?

That Bill is part of our primary underwriting criteria. That's sort of our secret sauce from our credit risks. So, it's certainly a combination of attributes that we look at hundreds of attributes from the credit bureau and identify through aggression analyses correlation between really good data the likelihood of someone going bad and we'll find that on an ongoing basis, but in terms of the specific attributes, that's part of our credit underwriting policy.

Excellent, well, we don't like to share the secret sauce, well, thank you.

Thanks Bill.

And then I do have one additional question, we've talked about the increase in late stage delinquencies, but your early stage delinquencies have actually demonstrated some favorable trends, would you discuss that and really contrasted with those late stages and ultimately are we seeing the beginning of the I am going to call the rat going through the snake, but in a good way where you have just better quality borrowers at the front end?

I think your latter comment is right and I think that in terms of there are some sub-segments, micro-segment that we have found that has particularly high roll rates where you would not expect them to roll into late stage that have been rolling and that's the sub-segment that we're going to cut out. So yes, I think that a little bit of whatever you said, the rat through the snake if that's the right metaphor and we'll closely monitor it and probably refine it as we go through. We're not going to cash all of the delinquencies, but we feel like we've really got a handle on the main factors that are driving it.

And may I presume that some of the things that you're discussing here specifically are result of the Dan and his new team?

Yes, we're thrilled with Dan and his team. He's made some additional hires and we continue to build out. We have a pretty robust credit department. My background is I started out in financial services and credit marketing before I became the Business Head. So, the value of operations, marketing and credit working together in concert to deliver a solid net credit margin is a philosophy that really has been with me throughout running businesses in this financial services. So yes, we're thrilled with Dan's team and on the progress that we keep making.

Great. Thank you, Peter and Don.

Thank you.

I am showing no further questions. I would like to turn the call back over to Peter Knitzer, for any further remarks.

Thank you, operator. Thank you, everybody for your interest and attention today. I think that concludes our fourth quarter 2016 earnings call and we'll see you next quarter. Thanks so much right now.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day.