Regional Management Corp. (RM) Q3 2017 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Regional Management Corp. third quarter 2017 earnings call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]. I would now like to turn the call to Garrett Edson. Please go ahead.

Thank you and good afternoon. By now, everyone should have access to our earnings announcement and slide presentation, which was released prior to this call, 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 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. I would now like to introduce Peter Knitzer, CEO of Regional Management Corp.

Thanks Garrett and welcome to our third quarter 2017 earnings call. As always, I want to thank 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 am also here with some members of our financial team. For those of you with access to a computer or mobile device, we have a posted a supplemental presentation on our website at regionalmanagement.com to provide additional color to our remarks. As you can see on page three, we have diluted EPS of $0.45 which includes $0.18 of estimated negative impact form the hurricanes and a $0.05 benefit from the bulk sale of previously charged-off bankrupt accounts. Despite the hurricanes, we generated revenue growth of 10.8% driven by $78.7 million of year-over-year portfolio growth. This represents our fifth consecutive quarter of double digit growth in revenue and 10th consecutive quarter of double digit growth in finance receivables. While the cost of credit increased primarily due to the impact of the hurricanes for which we took a $3 million reserve, we believe that the reserve will capture all future credit losses related to the hurricanes. Later on, Don will show you that our core credit metrics are actually performing quite well. Most importantly, the hurricanes should have no impact on our overall business results and strategic plans for 2018 and beyond. Lastly, our interest expense increased due to growth, upsizing of our bank facility and higher cost of warehouse financing. Again, Don will take you through this in more detail. Turning to slide four. From a strategic standpoint, there are few significant items to highlight. At the beginning of October, we successfully completed the conversion of our Texas branches onto our new NLS system. With Texas is completed, we now have 80% of our loans running on our new platform, including our two largest states. As noted on last call, we expect a temporary slowdown in production and a temporary increase in delinquencies in Texas, just as we have experienced in every other state we have converted. That said, I am pleased to report that the system is running smoothly and our overall NLS conversion remains on track. This month, we are stopping the origination of auto loans. We will continue to service the loans as we have been for years. As I have said on previous calls, our primary focus is on our core small and large loan segments. This decision will enable regional to further dedicate our resources to our long-term strategic objectives. In terms of impact, although there will be some reduction in revenue from the auto portfolio in the coming quarters as it winds down, we believe that this impact will be largely mitigated by expense savings and growth in our core portfolio. In addition, as the auto business was one of our lower yielding portfolios, we expect the smaller auto portfolio to offset a portion of the yield impact from the mix shift is occurring as we migrate towards large loans from small loans. In addition, as I noted on our last call, during the quarter we accelerated the expansion of our centralized collections functions into additional states. We continue to be pleased with the collection team's performance with early results exceeding expectations albeit on a relatively small portion of our customer base. As we ramp up, we expect centralized collections to improve roll rates and lower future net credit losses. Further, we continue to make progress on our marketing and de novo branch strategies focusing on our hybrid approach to growth. We have maintained strong growth in existing branches with de novo level expansion as we complete the platform conversion. We are in the process of developing new tools for targeting both risk and response which will be implemented in 2018. We also plan to expand our de novo efforts next year. Lastly, our digital channel continues to evolve as we further expanded our relationship with LendingTree, as well as develop and test additional affiliates. Our texting and customer portals are rolling out with each state we convert to NLS and we have improved our website and search engine optimization. Before I turn it over to Don, I want to spend a few minutes on the impacts of the hurricanes that occurred in the third quarter. First and foremost, our thoughts continue to go out to our employees and customers affected by these storms and we are relieved that our employees and their families remained safe throughout these hurricanes. In the affected areas, we only lost a few days in most of our branches and up to a few weeks in those branches in the most severely affected areas. However, all of our branches impacted have since been reopened and have been running normally for some time. Given the magnitude of the flooding, we are fortunate that only minimal damage occurred in our branches and no damage to our customer files. However, many of our customers were impacted in terms of their ability to make their scheduled payments. Immediately in the aftermath, we provided free deferments and waived late fees for these customers. We are continuing to work closely with these customers to help them get back on their feet and return to normal. As I mentioned a few minutes ago, we reported an additional $3 million in provision for credit losses in the quarter, specifically attributable to these hurricanes. Ultimately while it's impossible to precisely quantify the entire impact of the hurricanes on our third quarter results, we estimate that the hurricanes impacted diluted earnings per share by $0.18. We also expect that there will be some limited lingering effects from the hurricanes in the fourth quarter. However and most importantly, our employees and customers are safe and from a business standpoint, our plans and ongoing initiatives for 2018 and beyond remain unchanged. So while the hurricanes impact affected our third quarter performance, there was still much to be pleased about from an operational standpoint. Double digit increases in revenue and finance receivables, credit performance excluding the impact from the hurricanes remained strong and we continue to execute on our loan platform conversion. We remain on pace to generate long term profitable growth. I will now turn the call over to Don to provide a little more color on the financials.

Thanks Peter and hello to everyone on the call. Picking up on slide six. Net finance receivables for the third quarter of 2017 increased more than 11% over the prior year. It's the 10th consecutive quarter with double digit growth for and net finance receivables. On slide seven, you can see the components of our ending net receivables. Core loan net receivables at September 30, 2017, stood at $672 million, growing 18.6% from the prior year period. Our large loan portfolio continues to be our growth engine as we saw $92 million or a 42.2% increase from the prior year and a 15.2% pickup from the end of the second quarter. The large loan portfolio now stands at $309 million and accounts for nearly 40% of our total portfolio. Meanwhile, our small and category saw $14 million or 4%increase from the prior year and a $15 million or 4% increase from the end of the second quarter. Out other loan categories were down $7 million sequentially and $27 million from the prior year, primarily due to the continued liquidation in our automobile loan category. Given our announcement that we are discontinuing auto loan origination in order to focus more squarely on our core loan portfolio, our receivables in our other loan categories will continue to decline in subsequent quarters. The 11% year-over-year revenue growth on slide eight was primarily driven by an 11.8% increase in our average finance receivables. This is the eighth consecutive quarter with double digit increases in average net receivables. Total revenue yield in the third quarter of 2017 declined 30 basis points year-over-year as shifting product mix more than offset the benefit of the line swing between revenues and provision for credit losses as a result of the insurance carrier change we have mentioned on previous calls. Sequentially, the third quarter 2017 benefit from the line swing was less than what it was in the second quarter. In addition, fees included in other income were lower than expected due to the hurricane. Lower fees collectively with the lower line swing resulted in a 20 basis points sequential decline in our total revenue despite a consistent interest and fee yield. Moving to the top of slide nine. Our provision for credit losses of $20.2 million in the third quarter was up $3.7 million from the prior year period and up $1.6 million on a sequential basis. The year-over-year increase was primarily driven by the additional $3 million allowance we incurred for estimated credit losses related to the hurricanes. The additional hurricane allowance was partially offset by a smaller build in the regular allowance over the prior year period. In 3Q 2016, we had a build of $2.9 million of allowance versus a build of $2.4 million of allowance in 3Q 2017 excluding the impact of hurricanes, of course, which reduced the provision for credit losses this quarter by $0.5 million versus the prior year period. Finally, net credit losses were up $1.3 million over the third quarter of 2016, but down sequentially. So the $3 million hurricane allowance and the $1.3 million increase in net credit losses were offset by $1.5 million lower build of the regular allowance, making up the $3.8 million total increase for the quarter. At the bottom of slide nine we show the trend of our net credit loss rate. Our annualized net credit loss rate as a percentage of average net receivables for the third quarter of 2017, including the bulk sale, was 7.8% which is a 210 basis points sequential improvement. Year-over-year, the annualized net credit loss rate was down 20 basis points. The bulk sale accounted for 50 basis points of the decline, but I would note that an offset in 50 basis point increase was due to the claims from the insurance line in the third quarter of 2017. That's the line swing and the bulk sale washed each other out. We do expect net credit losses to go up in the fourth quarter, consistent with the seasonal trend at the bottom of slide nine. Turning to slide 10, we show our seasonal pattern of delinquency. Our 30-plus day delinquency level stood at 6.8%, an improvement from 7.1% in the third quarter of 2016, while up from 6.5% in the second quarter of 2017. Importantly, our 90-plus day delinquency level stood at 2.9%, an improvement from our second quarter 2016 level of 3.1% and up from 2.7% in the second quarter of 2017. The biggest impact from the hurricanes is expected to be on early-stage delinquency. Therefore losses from the hurricanes will primarily flow-through in 2018, although we will have some small amount that could potentially come through in the fourth quarter of 2017. However, as Peter previously noted, we believe the estimated $3 million addition to the allowance has made is fully provisioned for potential losses as a result of the hurricanes. While there was considerable noise in the quarter, the key takeaway is that removing the unusual items in the quarter, our credit continues to remain solid overall. Moving on to slide 11. G&A expenses as a percentage of average net receivables declined slightly year-over-year. That said, our G&A expense of $33.8 million in the third quarter of 2017, was up $3.4 million from the prior year period. Personnel costs were $1.4 million of the increase and we incurred increases in staffing and our IT function, our new centralized collection function and for our branch network. Marketing costs were up $500,000 over the prior period and other expenses were up $1.2 million due to increased cost of implementation of electronic payments, for higher branch-based collection expenses, for higher NLS training costs and for higher amortization capitalized costs for the NLS loan system. Sequentially, G&A expense was up $2.2 million from the second quarter of 2017, slightly below our initial expectations and mostly attributable to the expected increases in personnel and marketing costs that we had discussed on our prior call. For the fourth quarter, we expect G&A expense to be flat to up $500,000. However, on a full-year basis, we continue to believe G&A expenses as a percentage of average net receivables will be slightly down in 2017 compared to 2016. Finally, as Peter noted at the beginning of his remarks, interest expense of $6.7 million was higher in the third quarter of 2017 for multiple reasons. The latest rate hike by the Fed moved the LIBOR rate on our bank facility above the 1% floor that we have been paying and increased our expense by about $300,000 in the quarter. In addition, we amended our bank credit facility in June and incurred incremental debt issue costs associated with bringing $128 million of new commitments into the facility while also enabling diversification of funding via new warehouse facility. Combining the bank facility debt issue cost with the increase in the outstanding balance due to growth in our portfolio increased interest expense in the quarter by $600,000. So the bank facility in total contribute about $900,000 of the increase in interest expense in total. In addition, debt issue cost, unused line fees and outstanding balances on the new warehouse facility increased interest expense by approximately $900,000 and this cost was also offset by $300,000 in reductions for the outstanding balance of amortizing loan credit facility. While the original margin on the new warehouse facility was 350 basis points, the margin fell to 325 basis points in October as we met a loan system implementation milestone and may fall to 300 basis points if we meet another loan system milestone in early 2018. With the next potential rate increase predicted in December, we expect interest expense in our fourth quarter to move up primarily in relation to funding needs for our growth for the quarter. Importantly, with this diversification and increase in our funding sources, we are very well positioned to continue the significant growth of our company over the next several years. That concludes my remarks. And I will now turn the call back to Peter to wrap up.

Thanks Don. To sum up, despite the short-term interruption caused by the hurricanes, we believe our prospects for 2018 and beyond remain completely unchanged. In the third quarter, we continued to generate double digit revenue and receivable growth while our credit, excluding the one-time hurricane impact, remains stable. We successfully completed the conversion of Texas on to our NLS system and a large majority of our branches and customer accounts are now functioning smoothly on our new platform. We still anticipate returning to an increased level of de novo branch openings in 2018. Finally, we continue to remain completely focused on building our core loan portfolio and the discontinuation of our auto originations only further emphasizes that point. In all, Regional remains squarely positioned to achieve ongoing long-term profitable growth. Thank you for your time and interest. I would like to now open the call up for questions.

[Operator Instructions]. The first question comes from Mike Del Grosso from Jeffries.

Good afternoon and thank you for taking my questions. I guess the first one is on the hurricane impacts. Was there any one-time callouts on the revenue or interest income related to the storms?

Yes. We estimate that about $400,000 to $500,000 of revenue was impacted by the storm. A lot of it was, we waived late fees and we gave free deferments for those customers who were in need. So we felt that those were good moves to make our customer base for those who really were in need from the hurricanes.

Understood. I guess the second one is a little more broad, pulling up a bit. At this juncture in the credit cycle, what are you seeing as far as consumer, the borrower straps or potential loan stacking? Can you comment on what you are seeing perhaps at the borrower level?

Sure. This is from our vantage point at Regional. We are seeing the credit cycle is benign for us within our customer base and prospects. So we don't see any particular erosion or deterioration in our credit numbers.

Understood. Thank you.

Thank you.

Our next question comes from Vincent Caintic of Stephens.

Hi. Thanks. Good afternoon guys. I had a couple of questions. On the charged-off sales you had this quarter, it had a good number there. I am just wondering how persistent that could be for more additional charged-off sales and what is the market looking like for charged-off paper in terms of the recoveries you can get? And maybe relatedly, you are building up your centralized collections effort, I am just may be wondering, as you build that up, if may be there won't be as much of an emphasis on sales? Just how you think about it? Thank you.

Sure. Thanks Vincent. In terms of our sales of our charged-off bankruptcies, the market was pretty healthy and we felt that it was a very good trade-off in the context of selling them versus working them throughout the lifecycle. So we felt, in doing the analysis, it was the right decision. In terms of charged-off bankruptcies in the future, we have a forward flow agreement in place for the next 12 months. With respect to centralized collections, we keep looking at the data and it's really impressive. Mind you, we only have about 30% to 35% of our total volume that we are doing centralized collections really late stage collections. But the initial results are encouraging and we will continue to roll that out throughout fourth quarter and 2018.

Okay. Got it. That's helpful.

Just one other comment, Vincent. I am sorry. There is a lead lag. We are hiring up a bunch of folks. So the expense comes in before the benefit in roll rates and in losses, but clearly the trade-off that we have seen is very strong.

Okay. That's helpful. And so right now they are working on, I am guessing, it's primarily 60-plus day delinquencies, but not until the charge-off point. So staying within that bucket?

Yes. We are working 60-plus delinquencies.

Okay. Got you. So I will expect maybe both of those to continue. Great. Another question I had was just on what you are thinking about marketing and customer acquisition costs? It seems like it's been working well with LendingTree referrals. I have been hearing that. May be that market is getting more competitive or at least more expensive. Just what you are thinking about there? And was there also any impact from the hurricanes in the sense of maybe there was some less marketing base if people were less able to borrow? Thanks.

So with respect to overall marketing. What we have found is, we were able to reduce our cost per piece, which made us much more efficient and lowered cost per account and cost per $1,000 book. So that's through our mail channel. With respect to digital channels, have because we are improving over time, the impact of higher cost per lead or cost per booked account has not really hit us because we have actually become more efficient and more effective in doing that. So we really see continued opportunity in that channel right now. Turning to the hurricane impact. We made some conscious decisions to stop mailing in those affected areas for a temporary period of time. Rationale is multi fold. Number one, the mail may not be delivered. Number two, we want to make sure that because this is a preapproved, in most cases a preapproved check, we want to make sure that those receiving it were able to pay. So what we did is, we held back, we have resumed all our campaigns in all the affected areas because now they are back pretty much to normal in terms of being able to deliver the mail, in terms of leveraging our prescreen criteria to identify those customers who are able to pay.

Great. Very helpful. Thanks very much.

Thank you.

[Operator Instructions]. Our next question comes from Bill Dezellem of Tieton Capital.

Thank you. Two questions. First of all, relative to the marketing spending, up $0.5 million from the second quarter, would you please discuss that decision and the degree to which that's incremental versus a shifting of your strategy?

Sure Bill. We continue to look at new tools and we are developing better marketing tools to target prospects in the marketplace. And the increase in spending is consistent with our ability to find credit qualified universe. There is some seasonality that occurs. Third quarter is typically the strongest quarter for customer acquisition and growth. And that's typical if you go back several years. That's been the case in our industry and in our business. So it's not atypical to see increased marketing spending in the third quarter.

Thank you. And then secondarily, you have touched on this from a couple of different direction. But I am just going to ask point blank, to what degree were your originations impacted by the hurricane?

Not to a great degree. I would say that, you know, under 10% roughly for curative two months. So when I think about that in the scheme of our overall campaigns, it really was not a big impact. And the 10% is imprecise. It's certainly no higher than that. But I don't have those numbers at my fingertips. It could be 5%, but it was not a huge portion of our planned acquisition activities, Bill.

Great. Thank you.

Thank you.

This concludes the question-and-answer session. I would now like to turn the conference back over to Peter Knitzer for any closing remarks.

Well, I appreciate everyone's interest in our company and I thank you for your time today and we look forward to continuing the dialogue as we go forward. Thank you all very much.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.