Regional Management Corp. (RM) Q3 2018 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Regional Management Corp. Q3 2018 Earnings Conference 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 conference over to Garrett Edson, Senior Vice President of ICR. Please go ahead, Mr. Edson.

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 Web site 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. 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 comparable GAAP measure can be found within our earnings announcement and presentation deck posted on our Web site at regionalmanagement.com. I would now like to introduce Peter Knitzer, President and CEO of Regional Management Corp.

Thanks, Garrett, and welcome to our third 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, who will speak later on the call. For those of you with access to a computer or mobile device, we've once again posted a supplemental presentation on our Web site at regionalmanagement.com to provide additional color to our remarks. We had a terrific third quarter. Our underlying business once again performed very well, and we continue to execute on our long-term growth strategy. It was another quarter of double-digit top and bottom-line growth, stable credit performance and strong expense management. For the third quarter, we reported diluted EPS of $0.61 with net income growth of 40% versus the prior year period. We estimate that Hurricane Florence caused $2.9 million or $0.24 per share after tax negative impact. Absent the hurricane, we generated diluted earnings per share of $0.85 on a non-GAAP basis. Let me take a few minutes to talk about where we see the company heading over the next 2 to 3 years and how our strategy and key initiatives will continue to improve our business performance. Our hybrid growth model combines increasing receivables per branch in our existing footprint with building out de novo branches. The third quarter was the fourteenth consecutive quarter that this strategy delivered double-digit receivable growth, which has driven nine consecutive quarters of double-digit revenue growth. As I've said on previous calls, the credit quality of our growth is front and center. We began to implement custom scorecards this quarter to further improve our credit profile. We expect to continue and enhance our hybrid growth model going forward. Importantly, we continue to see considerable receivable growth in our more mature branches. In branches more than 24 months old, our average financial receivables increased 13.6% year-over-year. There remains significant room to increase average receivables in existing branches over time with our well-established sales and marketing programs. Improved response and risk target models for our mail campaigns continue to make our marketing dollars more efficient, allowing us to improve our acquisition rates and target customers with healthier credit profiles. These efficiencies should free up additional dollars to invest in our digital channels, which continue to become a larger part of our marketing mix. Furthermore, we have a proven strategy of offering our more credit-qualified small loan customers who have the capacity to repay us, the opportunity to borrow more money at lower rates with our large loan product as their needs evolve. This provides Regional with a strong point of differentiation versus competition to continue to grow with greater insight into our customers' payment and credit performance prior to increasing the size of their loans and graduating qualified customers to larger loans is much more cost effective than soliciting new customers in the open market. We are also pleased to have officially entered Missouri, our tenth state during the third quarter, with plans to enter our eleventh state, Wisconsin, in the fourth quarter. Both of these states have REIT structures that support our small and large loan strategy. We are still on target to open approximately 25 branches this year, although a couple of branches may fall into early 2019. And we plan to open an additional 25 to 30 branches in 2019 with more opportunity to expand into new states over time. Along with this outlook for growth, we continue to enhance our capabilities to drive further improvements in credit quality. In the third quarter, we deployed our custom scorecards in 5 states and plan to roll them out to our entire branch network by the first quarter of 2019. Once the scorecards are fully implemented, we expect they should contribute to lower net credit losses beginning in the second half of 2019 and beyond. We are cognizant of cycle concerns, but from what we can see, our customers' credit profile remains stable, evidenced by our continued strong performance. We think our credit performance demonstrates the value of community-based lending and the impact of our branch network. While we do compete with online players in the non-prime space, our APRs are usually lower and our credit performance is typically much better. That said, we are always monitoring new entrants into the marketplace and thus far, have not seen any impact on our business. As for our operating expenses, we continue to manage them prudently while making appropriate investments in the business. Our annualized G&A expenses as a percentage of average finance receivables declined 150 basis points over the prior year period from 18% to 16.5%. As we grow and achieve more scale, we believe our operating expense ratio has the potential to improve an additional 150 to 200 basis points by the end of 2021. Finally, a quick update on the hurricane impact in the quarter. We provided free deferrals and waived late fees for impacted customers. Fortunately, it was minimal damage to our branches and we have been fully back up and running for some time. The hurricanes will have no effect on our long-term business performance. I think you can tell why we are so excited about our company and plans for the future. There is so much opportunity to deliver long-term shareholder value. 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 3 in the supplemental presentation. I'll start with some highlights for the quarter. Peter already touched on our strong year-over-year increases in net income and EPS from both a GAAP and non-GAAP perspective. Picking up on Peter's comments about our strategic plans, our hybrid growth strategy produced $113 million or 15% increase in our finance receivables in the third quarter of 2018 compared to the prior year period. The streak of consecutive double-digit growth quarters now stands at 14. The finance receivable growth drove a 13% increase in our revenues and brings us to 9 quarters with double-digit revenue increases. Our provision for credit losses moved up 17% year-over-year. However, absent any hurricane impacts and the benefit from the bulk sale of previously charged-off bankrupt accounts last year, the increase in the provision for credit losses would have been lower than the growth in our portfolio reflecting our stable credit profile. G&A expenses were up 6% in the quarter, but annualized as a percent of average finance receivables; we saw a very nice improvement from 18% in the third quarter of 2017 to 16.5% in the third quarter of this year. Flipping to Slide 4. Our core small and large loan business grew 23% or $153 million versus the prior year period. Year-over-year, growth in small loans was $51 million or 14% and our large loans grew $102 million or 33%. At the end of the third quarter, approximately 50% of our small loan customers qualified to apply for a large loan offer, which represents a significant incremental lending opportunity in our existing book of business. Turning to Slide 5. Driven by a 15% increase in finance receivables, interest and fee income was up 13% year-over-year. As we noted on our prior call, we saw our interest and fee yield in the third quarter of 2018 rise 50 basis points sequentially based on a number of factors, including certain discrete pricing actions we took earlier this year. While our interest and fee income yield has moved around some over the past 3 years, the third quarter 2018 interest and fee yield is exactly the same as it was in the first quarter of 2016. As we grow our business in Missouri and Wisconsin, we will see some support for our interest and fee yield due to change in state mix, which should help to partially offset the increasing interest rate environment that we expect for the next couple of years. Beyond the state mix support and the potential for additional pricing actions, we have other levers to offset higher interest rates, including custom scorecards and operating expense improvement that Peter discussed. Moving to Slide 6. Our annualized net credit loss rate as a percentage of average finance receivables for the third quarter of 2018 was 7.7%, an improvement of 10 basis points from the prior year period. We expect to incur net credit losses related to Hurricane Florence in the first half of 2019, but we believe the $3.9 million additional allowance we took in the quarter has fully reserved us for those impending losses. On Slide 7, on the delinquency front, our 30-plus day and 90-plus day delinquency levels at September 30, 2018, stood at 7.1% and 2.9%, respectively. Our 30-plus day delinquencies were up 30 basis points on a year-over-year basis, but in October, our 30-plus day delinquency returned to the same level as the prior year period. Overall, we are pleased that our credit performance has remained relatively stable. Turning now to Slide 8. G&A expenses of $35.9 million in the third quarter of 2018 rose $2 million from the prior year period. Approximately $1.8 million of the increase was for personnel expense split fairly evenly between home office and branches. We expect our total G&A expenses for the fourth quarter of 2018 will be about $3 million greater than the fourth quarter of 2017, which means we expect our full year 2018 G&A expenses as a percentage of average finance receivables, will improve about 100 basis points on a year-over-year basis. And as Peter noted in his remarks, we also see opportunity for continued improvement in our operating expense ratio over the longer term. Interest expense of $8.7 million was higher in the third quarter of 2018 compared to the prior year period due to increases in interest rates and higher long-term debt amounts outstanding from our finance receivable growth. Interest expense was lower than our expectations due to lower mark-to-market adjustments on our rate caps. For the fourth quarter of 2018, we expect interest expense to be about $0.6 million to $0.7 million higher than it was in the third quarter of 2018, driven by higher interest rates and our growing loan portfolio. We are currently working towards launching our second asset-backed securitization deal in the fourth quarter of 2018. That concludes my remarks, and I'll now turn the call back to Peter to wrap up.

Thanks, Don. To sum up, our hybrid strategy of increasing receivables per branch, coupled with de novo expansion, continues to drive double-digit top-line growth. Credit remains stable with new credit tools being rolled out to further improve our risk profile. Strong focus on expense management is driving improved operating leverage and continued diversification of our funding sources and optimization of our capital structure all provide us with increased opportunity to deliver long-term shareholder value. Thanks for your time and interest and I'd like to now open up the call for questions. Operator, could you please open the line?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question is from Sanjay Sakhrani with KBW.

Hi. This is Maya in for Sanjay. Thanks for taking my question. I just had a quick -- my question was on the originations growth this quarter and how much it was impacted by the hurricanes. And then, do you expect that to rally in the fourth quarter and then heading into 2019?

Yes. Our growth was pretty solid in the quarter and we continue to see growth in the fourth quarter starting in October. So we really weren't impacted on a total basis. Obviously, in the affected areas growth slowed down, things have returned to normal from a growth standpoint in those affected areas. So given the timing, we really feel that our growth has been solid across the network.

Okay. And then on the delinquency rate, it was higher this quarter. I know you usually do see an increase in that. I imagine some -- a portion of that from the hurricanes. How do you expect that to trend into the fourth quarter given the hurricane impact?

Yes. As Don said, we returned in October to levels on par with year ago, so some of it is just quarter-to-quarter shifting, I'm sorry, month-to-month shifting. So we feel that our delinquency levels are stable. And again, month-to-month, sometimes you have small variations.

Yes. Obviously, if we move to the end of the year, then certain of the delinquency buckets from the hurricane will push up delinquency a little bit at the end of the year just like we saw last year.

Great. Thanks for taking my question.

[Operator Instructions] The next question is from Bill Dezellem with Tieton Capital Management. Please go ahead.

Thank you. Actually, I want to come back to the delinquencies and hurricane. Can you reconcile for us the charge that you took for the hurricane delinquencies, which makes great sense? And yet, delinquencies actually returned to normal as of the end of October, which just seems better than what we would have anticipated. Would you please tie those two together?

Hi, Bill, this is Don. Listen, the reserve for the hurricane really comes from some of the early delinquency buckets, and those delinquencies will roll through across a period of time here. We'll see some rise in delinquency to the fourth quarter, and then, some charge-offs in Q1 and Q2 show the improvement really in October somewhat across the board but not quite as much in the early buckets where it's coming from the hurricane areas. That help you a little bit?

It does help a little bit. And then the custom scorecard, would you please talk to the implementation of that process, you mentioned five states -- additional states are going to be coming on. What's involved with that implementation, how easy or difficult is that for the branches to bring on especially in light of the new system that they now have?

Bill, its Peter. Hi. Actually, we're treating this very similarly to the rollout of NLS. The system, each -- we have custom scorecards for each state. So we test each scorecard and roll them out over time, over several month period. And this way, just as with any other release, you make sure that things are operating before we put it into production. So it's gone just fine. And we haven't skipped a beat. We're on track with where we plan to be, and we don't see any issues implementing the balance of these scorecards. In fact, we will have two more scorecards -- two more states up and running in the fourth quarter, somewhat before the end of the year.

And is the scorecard in the NLS system, is it a new system? How does it interact with the branch staff?

So, it is in the system. And just like any other origination capability, it happens all behind the scenes. And it's much more effective at predicting risk than the matrices that we've been using, which are also programmed into NLS, but you've got a logistic regression model that takes a lot more variables in to assess someone's credit worthiness, on top of which we obviously look at debt-income ratios, et cetera, based on what consumers present as proof of income. So it really is a much more effective way of underwriting our customers and we expect benefits in the second half of '19 because we're just rolling it out. And so most of the vintages on our books are not originated using these scorecards, but as we roll into the second half of '19, a greater proportion would have been originated utilizing this tool.

And would you care to make a prediction on how many basis points improvements in charge-offs that you are hoping this will make?

We don't provide that level of detail at this juncture. We think we'll get some improvements on our overall loss rates.

Thank you. And then, lastly, regulatory. Would you update what you're seeing on that front, what you're hearing and how you feel like the election this week may or may not impact the Federal level?

Well, it's a hard one to predict. Let me answer the question a little differently than what the administration may bring. We run a very compliant shop and I think I've said this on multiple calls. I took this job in part because of the compliant culture of Regional Management. So, we take a lot of pride in making sure that we fully disclose all the terms and conditions to our customers that we're in compliance with not just Federal, but state regulations. And we've built up a team of compliance folks who really do a great job.

And the regulatory changes that you're seeing at the state level or just an update there for us, please.

We haven't seen a lot of talk. As the Federal government may be easing with the CFPB, the states may be picking some of that up and we haven't seen that in our states materially. We haven't seen it in our states, but we're prepared for it. Again, irrespective of where the pendulum swings, we're not changing our culture of compliance, which we began in previous administrations.

Thank you, both.

Thanks Bill.

[Operator Instructions] There appear to be no further questions at this time. I'd like to hand the conference back over to Mr. Knitzer for any closing remarks.

Thank you, operator. Thank you all very much for joining us on this call today. We look forward to future calls and to continue running Regional Management the way we have on a steady, progressive, consistent manner. So 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.