Regional Management Corp. (RM) Q2 2018 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Regional Management Q2 2018 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference back over to Garrett Edson, ICR. 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 would 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. 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, President and CEO of Regional Management Corp.

Thanks, Garrett, and welcome to our second quarter 2018 earnings call. As always, I want to thank everyone for participating this afternoon and for your continued interest in our company. I'm here with our Executive Vice President and CFO, Don Thomas. He will speak later on the call. For those of you with access to a computer and a mobile device, we once again posted a supplemental presentation on our website at regionalmanagement.com to provide additional color to our remarks. We continued to execute on our plan in the second quarter, generating double-digit top and bottom line growth, stable-to-improving credit performance and discipline with respect to our operating costs. Turning to Page 3. For the second quarter, we reported diluted EPS of $0.70, with net income growth of 38.3% versus the prior year period. We generated year-over-year revenue growth of nearly 11%, driven by $120 million or a 17% increase in finance receivables. Our core small and large loan business grew 26% or $160 million versus the prior year period. This represents our eighth consecutive quarter of double-digit revenue growth and 13th consecutive quarter of double-digit growth in finance receivables. Provision for credit losses in the second quarter of 2018 was up 9% versus the prior year period, while growth in finance receivables was up 17%. Again, showing the stability of our credit performance. Meanwhile, annualized total G&A expenses as a percentage of finance receivables decreased 170 basis points from the prior year period. Turning to Slide 4. I want to take a couple of minutes to discuss our ongoing strategic initiatives. First, our operating system continues to perform very well. The modernization of our platform has provided enhanced functionality, such as automated underwriting, electronic payments, texting and our online portals. All of this new functionality helps provide our customers with a significantly enhanced service experience, allowing them to get loans approved more seamlessly and interact with Regional at their convenience. On the credit front, our custom scorecards, which I've mentioned on previous calls, are on track to begin an initial test in 2 states by the end of August. These new tools should further enhance our underwriting, improving our overall credit capabilities. Our goal is to roll out these new scorecards across the branch network later this year, which ultimately should lead to an improved cost of credit. From a growth perspective, our hybrid approach of increasing receivables per branch within our existing footprint while building out our de novo branches remains unchanged. We will open between 25 and 30 de novo branches in the back half of 2018, including branches in Missouri and Wisconsin, take advantage of what we believe will be a strong opportunity for our core small and large loan products. We expect to realize significant financial benefits from these new branches in 2019 and beyond. On the marketing front, we are finalizing the development of our next-generation response and risk target models, designed specifically for our mail campaigns. We should make our marketing dollars more efficient and ensure our mail campaigns are targeting customers with healthier credit profiles. On the digital side, our relationship with LendingTree remained strong and new partnerships with other affiliates are beginning to pay dividends. We are also actively pursuing additional affiliate relationships which will further our ability to originate loans, and we continue to focus on our search engine optimization efforts. And finally, as Don will discuss in more detail, we successfully completed our first term securitization, completely backed by our large loan receivables. Importantly, we lowered our overall cost of capital and further diversified our funding capabilities. I'll now turn the call over to Don to provide additional color on the financials.

Thanks, Peter, and good afternoon to everyone on the call. Turning to Slide 5. Our net income for the second quarter of 2018 of $8.5 million was up 38% compared to $6.1 million in the second quarter of 2017. Diluted earnings per share for the quarter was $0.70 based on a share count of 12.1 million. Picking up on Slide 6. Our ending finance receivables at June 30, 2018, were $847 million, which reflects a $121 million or 16.6% increase over the prior year period. On a sequential basis, ending finance receivables grew by $42 million from where they stood on March 31 of this year. On Slide 7, we break out the components of our ending finance receivables. As of June 30, 2018, core finance receivables stood at $777 million and now represent 92% of our total portfolio. Our growth continues to be primarily led by our large loan portfolio, which increased $124 million or 46% from the prior year and rose 8% from the end of the first quarter. Large loan finance receivables now stand at $392 million and continue to make up a majority of our core loan finance receivables. Meanwhile, our small loan category saw a $36 million or 10% increase from the prior year and a $24 million or 7% increase from the end of the first quarter. Our other loan categories were down $10 million sequentially and $40 million from the prior year as we continue to gradually wind down our automobile loan category, which now comprises less than $40 million of finance receivables. We expect finance receivables in our auto portfolio to continue to decline as we runoff the portfolio. On Slide 8, our 11% year-over-year revenue growth was primarily driven by 16% increase in our average finance receivables. This is our 11th consecutive quarter with a double-digit increase in average finance receivables. Revenue growth was tempered a bit by lower yield compared to the prior year period. Total revenue yield of 35.4% in the second quarter of 2018 declined 150 basis points year-over-year. Lower year-over-year interest and fee yield due to changes in our product mix resulted in about 110 basis points of the decline. As you can tell from the product mix chart earlier in the slide presentation, we continue to migrate towards large personal loans, which have a lower interest rate than small personal loans. Sequentially, our interest and fee yield in the second quarter of 2018 was 20 basis points higher than the first quarter, as we have taken discrete pricing steps. The pricing actions we have taken should continue to increase our interest and fee yield sequentially in the third quarter of 2018. Moving to the top of Slide 9. We show the trend of our net credit loss rate. Our annualized net credit loss rate as a percentage of average finance receivables for the second quarter of 2018 was 9.5%, an improvement of 40 basis points from the prior year period. The net credit loss rate for the second quarter of 2018 includes 50 basis points related to the hurricanes, and the impact of the hurricanes have now completely flowed through our portfolio. At the bottom of Slide 9, our provision for credit losses of $20.2 million in the second quarter was up 9% from the prior year period. The 9% increase resulted from a 17% increase in ending finance receivables and was partially offset by the declining net credit loss rate in the current year period. From a dollars perspective, net credit losses for the second quarter of 2018 increased $1.9 million due primarily to growth in our portfolio. Turning to Slide 10. We show our seasonal pattern of delinquencies. Our 30-plus day and 90-plus day delinquency levels at June 30, 2018, stood at 6.3% and 2.6%, respectively. Our 30-plus day delinquencies were down 20 basis points both year-over-year and sequentially. The last 3 delinquency buckets are in good shape, and we believe we should see some improvement in net credit losses in the third quarter. Overall, we're pleased with our delinquency trends and stable credit profile. Moving on to Slide 11. Annualized G&A expenses as a percentage of average finance receivables declined 170 basis points over the prior year period from 17.9% to 16.2%. G&A expenses of $33.2 million in the second quarter of 2018 rose $1.6 million from the prior year period. Personnel costs continue to make up the majority of the increase and were driven by branch labor to service more accounts and higher incentive claim costs. Sequentially, in the third quarter of 2018, we expect to see seasonal increases in G&A expenses for branch labor to serve additional portfolio growth as well as higher incentive costs, some of which are expensed based on the calendarization of profits for the company. In addition, we plan to begin opening more de novo branches, which will also increase our total G&A expenses. As a result, we expect our total G&A expenses for the third quarter of 2018 will be about $3 million greater than the third quarter of 2017. While our operating expense ratio will move up some in the third and fourth quarters from where our second quarter ratio came in, we continue to believe G&A expenses as a percentage of average finance receivables for the full year 2018 will improve on a year-over-year basis. Interest expense of $7.9 million was higher in the second quarter of 2018 due to higher long-term debt amounts outstanding, primarily related to finance receivable growth and interest rate increases. Interest expense was lower than our expectations for a $1 million to $1.2 million sequential increase due to lower mark-to-market adjustments on our rate caps. At the end of the quarter, we announced the successful completion of our first securitization, resulting in the issuance of $150 million of asset back notes secured by large loan receivables. Notably, the senior class received a AA rating from DBRS. The all-in interest cost of the securitization is about 50 basis points lower than the warehouse lending cost, assuming a fully utilized warehouse facility. The securitization further diversified our sources of funding and increases our capacity to grow at a longer term. For the third quarter of 2018, we expect interest expense to be about $0.9 million to $1.0 million higher than it was in the second quarter of 2018 driven by higher interest rates and our growing loan portfolio and outstanding debt balances. That concludes my remarks, and I'll now turn the call back to Peter to wrap up.

Thanks, Don. To sum up, I'm proud of our entire team at Regional for their amazing efforts over the past few years. Our investments and their hard work have really paid dividends for us in 2018. Core small and large loan portfolios continue to drive double-digit top line growth. Credit remains stable to improving. We remain focused on managing our expenses. Looking at the balance of 2018, we're focused on our hybrid growth strategy, including expanding our footprint into the Midwest. We're investing in the back half of 2018 for an even more successful 2019 and strongly positioning us to deliver long-term shareholder value. Thanks for your time and interest. I'd like to now open up the call for questions. Operator, could you please open up the line?

[Operator Instructions]. Our first question comes from David Scharf from JMP Securities.

To start with, Peter, I'm wondering given the pace of loan growth you're experiencing, you outlined how many successive quarters we've seen double-digit expansion. I'm wondering, is this more demand driven or is it much more a function of both the mix shift to larger loans as well as perhaps branch managers being freed up now that collections are centralized, trying to get a sense of, if this has been more sort of coming from the consumer or direct actions you've taken?

David, I think it's a combination of all these factors you've mentioned. Consumers, we think that all signs lead to them being healthy, and we haven't seen changes to that. The large loan growth clearly has -- stand our receivables and driven a lot of our growth. We also are growing small loans. We had a nice over 10% year-over-year increase in our small loan receivables. As you mentioned, the ability for our personnel and the branches to spend more time selling and servicing with Centralized Collections has helped. And we're starting our de novo expansion, again, which will help even further. There is the drag, as you know, of the auto portfolio [indiscernible], but by and large, we've been able to grow it at nice pace. We're not looking for home runs. We really want to grow at a predictable, possible level. So we feel like we're in good shape, and we expect the growth not at the exact same rate, but to continue over time.

Got it. It sounds very broad-based. Maybe one other question on the demand origination front. I know it's still early with some of these affiliates, channel partners. But can you give a sense, I guess, LendingTree and any other affiliate, I mean, on a combined basis, is it a meaningful contributor of origination volume at this point?

It's growing. We're using today our digital channels for both lead generation and for servicing. So it's growing from virtually nothing a couple of years ago to the mid-teens and will continue to grow nicely as we bring out more affiliates in terms of our loan production. As far as servicing, we have texting. We have customer portal. We have electronic payments. We find those to be very important to a lot of our customers to interact with us, how they want, when they want. We also provide all the account detail on the customer portal. So it's really a combination of both sales generation as well as servicing.

Okay. But mid-teens is a percentage of kind of recent origination volume, is that correct?

Yes, yes, that's right.

Okay. And maybe just one last question for Don on the credit side. I know there is typically a pretty noticeable seasonal drop in loss rates from Q2 to Q3. It sounds like excluding the final hurricane rolls, that may be 9.0% was a more normalized level in Q2. Can -- I mean, should we be sub-8% in Q3, I mean, if we were to look at kind of the previous year's sequential movements?

Yes. I think if you look, David, at the last 3 delinquency buckets, that expense suggests a decent decline in the third quarter from that 9% adjusted rate that you mentioned for the second quarter. So I wouldn't disagree with that.

Our next question comes from Sanjay Sakhrani with KBW.

This is Maja stepping in for Sanjay. First one is, I know that the total yield has been coming down as you've been increasing your percentage of larger loans. Is that -- is there a point that we should think about that it'll become a little bit more stable over the near to intermediate term?

Yes. I think you saw some change even in the second quarter as the yield went up 20 basis points. The interest and fee yield went up. And it's going to go up again in the third quarter. So I think you're seeing that stabilization now in the middle of 2018.

Okay. And then on your originations growth this quarter, it was a bit slower from the first quarter. How should we think about it for the rest of the year, and then also into 2019 with the additional branch openings?

Yes. I think some of it has to do with mix, and so I think we see seasonally different growth in different categories that contributes to that a little bit. But as move into the end of the third quarter, and especially, into the fourth quarter, we'll be opening 25 to 30 additional branches. And the amount of growth we'll see will be more significant in the fourth quarter than the third. And it'll depend specifically on exactly the timing of getting the branches open. So the sooner we get it done the more growth you can see.

Our next question comes from Vincent Caintic with Stephens.

First, on the securitization. So you got really good execution when you put out that securitization. Just kind of wondering what the thought is on the rate mix of your funding coming from securitizations, and particularly, could we see more margin expansion if you do take up your securitization mix and utilize more of this cheaper funding?

Yes. I think, in this first securitization, Vincent, that -- we were successful in reducing the cost of the warehouse funding, certainly, by some 50 basis points assuming the warehouse was completely full. And more than that, for a less than full warehouse. So we're pleased to get the first one done. Everything that we have used in terms of funding the company is secured. And so I think you'll continue to see us use secured funding moving forward. We'll continue to use the securitization market for our large loan receivables, and we just need to continue to grow and fund that using securitizations. And I think that if rates continue to go up, you'll continue to see the securitization market with fixed rates be at slightly better overall cost than where we are with our bank group today.

Okay. Great. That's helpful. And then separately, I think, it's maybe a little related to a prior question about the yields. I'm just kind of wondering as you're -- you've been growing quite a bit on each of the core products. Just wondering when -- if you think you have some pricing power or is that may be that way you think or maybe you don't think that way in terms of thinking about yield expansion as you grow and as you roll out also with more stores?

Well, I think, this is Peter, that there is some pricing power as we look at competitive landscape. And as interest rates rise, we've already taken some opportunity, which is helping our yield in the second quarter going into the third quarter, we may see more opportunity over time as the Fed continues to increase rates and our competitors raise their pricing as well.

Our next question comes from Mike Del Grosso with Jefferies.

I want to see if you could briefly comment on some of the credit trends experienced this quarter. There was a nice benefit both on charge-offs and DQs. Is this better underwriting of the new customers predominantly or is there also a component of repeat borrowers or maybe they aren't experiencing as much stress, any commentary there?

Sure. Mike, we continue to look at our credit underwriting that we've tightened consistently over the past several years, which has not impacted our volume, we've been able to grow nicely. So what you're seeing is some of the benefits from Centralized Collections and a little tighter underwriting that occurred last year flowing through in our business. Yes, the consumer, we find healthy. We're always mindful and we try to say ahead of the curve on credit because that's just what you have to manage in asset business. As we move into the second half of the year, we're going to be introducing credit scorecards. Those credit scorecards will not only be resident in our branches for underwriting in the branches, but will also be utilized in our live check campaigns and our mail programs such that in the mail, we'll have better predictors of goods and bads as those who are likely to go bad. We'll also have augmented response rate models. So we hope to get higher response rate, better credit quality. So we're constantly looking at ways to improve our credit profile.

Great. So given that, how should we be thinking about the overall allowance levels? Should there be a commensurate improvement in that given the improvement -- potential improvement in charge-offs going forward?

We're growing -- provision grows with -- as we grow. And so that's part of the function of what we're going to see.

Yes. The allowance itself is tied into the specific portfolios. And as we continue to see lengthening of the lives of our larger loan portfolio, it does increase the need for allowance. And so you have a little bit of upward pressure at the same time that we have lower losses coming from the large loan portfolio itself. So I would see them staying at the 5.7% or possibly moving up to 5.75% as we move forward as opposed to moving them.

[Operator Instructions]. Our next question comes from Matt Dhane with Tieton Capital Management.

I wanted to delve a little deeper into the pricing actions. And is the pricing actions that you're taking, are those across all loan types? And would you also expect this to just continue to be part of your strategy going forward where according to interest rate increases that you probably would look at increasing your AT charge as well across your loans?

Yes. Matt, our large loans are really where we feel that we have more pricing power. And it's not like quantum leaps where we're edging up as interest rates rise. So as that occurs and competitors move, we feel comfortable in that space raising our rates. So depending upon competitive actions and interest rates rising, we will continue to look to increase our prices while not deteriorating the quality of customer and the credit profile of customers that we bring in.

Great. I wanted to also ask about the operating system -- the new operating system. How much of a role has that played in really supporting your strong growth here recently since that's been rolled out?

Well, today, in our NLS platform, we have all of our credit matrices programmed into the system. So the ability for errors that could happen through manual underwriting as we've had prior to NLS has really been eliminated. So that helps from an overall credit perspective. We also have the opportunity to spend more time with the customer because our key members are not sitting there, pulling credit bureaus out of the system and making manual calculations. Going forward, we anticipate -- we couldn't use credit scorecards in our old platform. With NLS now completely built out from a functionality standpoint across our network, we're able to put in these scorecards, which will help us from that underwriting perspective.

At this time, seeing no more questions. I would like to turn the conference back over to Peter Knitzer for any closing remarks.

Thank you, Operator. I want to thank all of you for your interest in Regional Management, and we look forward to continue to stay in touch as we go through the third quarter and appreciate the questions that were asked. Thanks so much. Have a good day.

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