Regional Management Corp. (RM) Q2 2019 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Regional Management Second Quarter 2019 Earnings Conference Call. [Operator instructions]. I would now like to turn the conference over to Garrett Edson, Senior Vice President of ICR. Please go ahead, sir.

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. 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 2019 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 outgoing 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 website at regionalmanagement.com to provide additional color to our remarks. Before we take you through our second-quarter highlights, it's my pleasure to introduce Rob Beck, Regional's new Executive Vice President and CFO. After a comprehensive search process, it became clear that Rob's 30-plus years of consumer finance experience and success in multiple leadership roles while at Citigroup made him the right choice to succeed Don. I look forward to Rob being a key member of Regional's leadership team. Don and Rob will work together over the next several weeks to ensure a smooth transaction. Rob is with us on today's call, and I'm now going to turn it over to him for a few remarks.

Thank you, Peter, and thank you to the board at Regional for this wonderful opportunity. First, I want to congratulate Don on the great job he's done as CFO in helping transform Regional into the company that it is today. We are very well positioned to profitably grow over the long term. I wish him only the best in his next chapter. Since officially joining last week, I've had the chance to meet with our entire finance team, as well as much of our management team. I'm excited to be working with such a talented group of professionals. I look forward to being a key contributor to continue the success that Regional has experienced over the past several years. I also look forward to working with our shareholders in the investment community on an ongoing basis. With that, I'll turn the call back to Peter.

Thanks, Rob. Overall, we had a strong second quarter. Diluted EPS was $0.70, comparable with the prior-year period. We generated year-over-year revenue growth of 16%, driven by a 15%, or $126 million increase in finance receivables. On a year-over-year basis, we've now grown revenue by double digits for 12 consecutive quarters and have achieved double-digit growth in finance receivables for 17 consecutive quarters. Our sequential receivable growth of $61 million represents the highest quarterly growth in the history of the company. Let me turn to our credit performance in the quarter. As I said on our first-quarter call, the implementation of our new custom underwriting scorecards has resulted in us not renewing customers who we expect to charge off over time. This led to elevated late-stage delinquencies at the end of the first quarter and, as expected, a higher annualized net credit loss rate in the second quarter versus the prior-year period. This short-term pain in net credit losses will be offset by long-term gain, as we should start to see the benefits from the scorecard in the latter part of 2019, and the full-year benefits in 2020 and beyond. As I said on our first-quarter call, our customers remain financially healthy, and the scorecards will serve us well in any macroeconomic environment. At quarter-end, approximately half of our core loans on our books were underwritten with the new scorecard. We expect that the vast majority of our loans in our portfolio will be underwritten utilizing these scorecards by the end of 2019. Our hybrid strategy of growing receivables per branch and opening new branches remains central to our success. We have opened 22 de novo branches since the end of the second quarter of 2018, and expect to open approximately 15 more in the second half of 2019, with an eye toward potentially more de novo openings in 2020 and beyond. It's important to note that a typical de novo branch breaks even between six and eight months. As I discussed on our first-quarter call, we continue to transform Regional into a true omnichannel provider by leveraging our NOS platform. We saw steady year-over-year increases in the percentage of new borrower originations coming through digital channels, with all digitally sourced loans underwritten in the branches. Additionally, with our goal to provide our customers with best-in-class service whenever and wherever they choose, we are pleased to have just launched our new customer-facing website this week at regionalfinance.com. Both our new website and our customer portal can be accessed on mobile devices. In addition to providing our customers with better service, our investment in digital technology also simplifies our employees' work. This will lead to higher sales productivity and improve our expense profile, which will ultimately lead to margin expansion. On the funding side, our capital structure is very strong. We have $368 million of unused capacity on our credit lines to support our growth objectives. In addition, we plan to continue to access the securitization markets. As you know, the board of directors authorized a share repurchase program this past May, as we continue to believe that the current market price of our stock significantly understates the value of our company, given our strong financial performance, capital position, and future prospects. To date, we have purchased just under 490,000 shares at a weighted average price of $25.54. We have repurchased $12.5 million of shares of our common stock under the program, which leaves us with $12.5 million of shares available for repurchase. Importantly, on our last earnings call we said we expect to achieve solid double-digit growth in net income in the second half of 2019, compared to the second half of 2018, excluding the impact of hurricanes. Given our growth in the second quarter, along with our normalized delinquency levels and the custom scorecards working as intended, we remain confident in our expectations. Before I conclude, I want to once again express my deepest gratitude to Don for all of his contributions to Regional. I and the entire Regional team wish him only the best on his well-deserved retirement. With that, I will now turn the call over to Don to provide additional color on our financials.

Thank you, Peter. I am grateful to you for the fantastic partnership we've had over the last three years. I will certainly miss that as I move on. I appreciate everyone's well wishes. I have enjoyed working with all of you, and I'm looking forward to a more relaxed schedule, of course. Now let's move on to my comments on the quarter. Turning to Slide 3 in the supplemental presentation, we provide you with an overview of earnings for the quarter. Our second-quarter net income of $8.4 million, or diluted EPS of $0.70, was slightly higher than we expected at the end of the first quarter. As Peter mentioned, our revenues were up more than 16% over the prior-year period, and while most of the increase in revenues was driven by the more than 14% increase in average financed receivables, the remainder of the increase was due to the change in business practice to lower our utilization of non-file insurance that we've noted on prior earnings calls. This change grosses up our insurance income and net credit losses, with no impact on net income, and will cycle over the change in the fourth quarter of this year. Our provision for credit losses rose $5.5 million, or 27%, year over year. This increase includes approximately $1.4 million of net credit losses, due to the change in business practice I just mentioned. In addition, the provision was higher, due to the record portfolio growth during the quarter. With new credit tools in place, we should see some improvement in our credit metrics starting later this year, and continuing into 2020 and beyond. Peter mentioned a number of initiatives in his remarks. Those are some of the many ongoing investments we are making in our growing business, and therefore, our dollars of operating cost are expected to increase some over time, largely driven by branch expansion and account growth. It is our goal to continue to control expense, though, such that operating costs are low enough to contribute to improving returns. In the second quarter versus the prior-year period, G&A expenses rose 14%, but remained flat as an annualized percentage of average financed receivables, at 16.2%. De novo expenses from branches opened in the second half of 2018 accounted for $1.3 million of year-over-year increase, and existing branch expenses to support loan growth accounted for an additional $2.3 million. I'll talk more about G&A expense later in my comments. Flipping to Slide 4, our core loan products grew 20%, or $153 million versus the prior-year period, with small loans growing 12% and large loans growing 27%. From a mix perspective, the small and large loan portfolios are 44% and 51% of the total portfolio respectively. We expect large loans will continue to increase as a percentage of the total portfolio over the next few years. Total portfolio growth of 15% was less than core loan growth of 20%, as it was dampened by the continuing liquidation of the auto portfolio, which is now less than $16 million in receivables. For the rest of 2019, we expect sequential portfolio growth to be strong, but somewhat less than the record pace we saw in the second quarter. Turning to Slide 5, interest and fee yield declined 20 basis points from the prior-year period, primarily due to the change in the mix of our product. However, total revenue yield in the second quarter of 2019 actually increased 70 basis points from the prior-year period, primarily as a result of the increase in insurance income, due to the lower utilization of non-file insurance. In the third quarter of 2019, we expect interest and fee yield will be approximately 50 basis points lower than the prior-year period, based on the ongoing change in mix of our loan products. Moving to Slide 6, our annualized net credit loss rate as a percentage of average finance receivables for the second quarter of 2019 was 10.7%, an increase of 120 basis points from the prior-year period. The higher annualized net credit loss rate this quarter was expected, given the elevated levels of our late-stage delinquency bucket at the end of the prior quarter, from the introduction of new custom scorecards. The late-stage delinquencies have since returned to a more normalized level, which I'll talk more about shortly. In addition, approximately 0.6 percent of the increase in net credit loss rate was attributable to the business practice change to lower our utilization of non-file insurance. Flipping to Slide 7, the allowance as a percentage of finance receivables came down 0.3% sequentially in the second quarter, as the hurricane portion of the reserve has now been fully depleted. With improved loss results from the new marketing risk-and-response model we discussed on the prior call, as well as from the custom credit scorecard, we see the potential for further reductions in the reserve in the latter part of the year. With respect to CECL, which RM has to implement on January 1, 2020, we have run some initial models. During the third quarter, we will perform more analyses and make adjustments to the initial models, and run them parallel to our existing model for current and historical time period. My implementation of the new accounting standard will result in the initial CECL adjustment being charged directly to equity. After the initial adjustment of our allowance for credit losses, any increase or decrease to the ongoing reserve rate for new originations will flow through the 2020 income statement. We will provide further disclosure as the implementation process progresses. As I mentioned before, the new standard will not present any issues with respect to our debt covenant, funding the growth of our business, the cash flow of our operations, or our ability to return capital to shareholders. Turning to Slide 8, on the delinquency front, our 30-plus-day and 90-plus-day delinquency levels at June 30, 2019, stood at 6.4% and 2.7% respectively. Our 30-plus-day delinquencies increased 10 basis points on a year-over-year basis, while improving 60 basis points sequentially. Ninety-plus-day delinquencies increased 10 basis points on a year-over-year basis, while improving 80 basis points sequentially. The elevated delinquency levels we saw at the end of the first quarter that were primarily caused by not renewing higher-risk customers have almost returned to normalized levels. G&A expenses of $37.7 million in the second quarter of 2019 rose $4.5 million from the prior-year period, a little higher than our expectation. For the third quarter of 2019, we expect G&A expense to be about $4.2 million to $4.4 million higher year over year, with most of the increase related to branch expenses associated with increased loan growth. On a year-over-year basis in the second quarter, our G&A expense as a percentage of average finance receivables was 16.2%, comparable with the prior-year period. Our 2019 year-to-date operating expense ratio is 30 basis points lower than the prior-year period. Seasonally, our operating expense ratio is generally better in the second half of the year than in the first half of the year, and we expect the full-year 2019 ratio will decline by roughly 45 to 60 basis points. As we've noted previously, we expect to gain more operating leverage as we continue to control expenses and grow receivables. Turning to Slide 10, interest expense of $9.8 million was $1.9 million higher in the second quarter of 2019 compared to the prior-year period, primarily driven by higher interest rates and greater long-term debt amounts outstanding due to finance receivable growth. We expect interest expense in the third quarter of 2019 will be about $2 million higher than the prior-year period, primarily driven by receivable growth. As of June 30, 2019, 42% of the company's outstanding debt was fixed-rate debt. That concludes my remarks, and I'll now to turn the call back to Peter to wrap up.

Thanks, Don. To sum up, we accomplished exactly what we set out to do in the second quarter. We continued to deliver double-digit top-line growth, driven by record growth in our core loan portfolio. Our custom scorecards are performing as expected, and we kept our operating expense ratio consistent. Our second quarter performance sets us up well to deliver double-digit net income growth in the second half of the year, and further positions us to generate additional 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 up the line?

[Operator Instructions]. The first question comes from the line of David Scharf, who's with JMP Securities. Please go ahead, sir.

All right. Thank you and good afternoon. Thanks for taking my questions. Welcome aboard, Rob and Don, I'm sure you'll be enjoying all your new endeavors.

Yes, I will. We're glad to have Rob on board, and I'm probably the gladdest of all.

And thanks for the welcome. Appreciate it.

I'm pretty happy, too, for both of them.

That's the clear sense we got. Hey, Pete, you know what? The results were almost entirely in line with kind of all of our estimates up and down the P&L, and the message you're delivering seems to be pretty consistent with kind of what you talked about last quarter, so maybe I'm -- veer off into a few other directions. You know, and one question is, despite the company's name, Regional, and the region you typically operate in, is California an opportunity for you if the -- for the large loan product if AB-539 passes there? Certainly, other sub-36% lenders have viewed it as potentially an opportunity to pick up market share.

David, yes, I mean, California is a huge state and a huge market, and that's certainly going to be on our list for consideration. Right now, we still have opportunity to build out our new states, Wisconsin and Missouri, but we're constantly looking at geographies to expand to and California would be on the consideration list.

Got it. Hey, shifting just to some of the forward guidance and commentary, in terms of thinking about loss rates, is it fair to say that the late-stage delinquency ramp associated with, you know, the scorecards and not renewing a certain segment of borrower, has that largely run its course, and therefore, in the second half we should maybe be just looking at a year-over-year increase in loss rate of 50, 60 basis points, that it's more in line just with the accounting change form the nonfile or are there other moving items that we should think about?

Yes, David, I'll take that one real quick. Yes, the non-file swing will continue until we roll over in the fourth quarter. And, you know, if there's still a little bit of noise from the scorecards, then that will come through maybe in the third quarter. But it looks like that the vast majority of that has played out, and so we'd just leave you with those thoughts.

Yes, and David, you said 50, 60 basis points. Don, correct me, 70 basis points is sort of where we are on the line swing from the nonfile?

Yes, the increase from year over year this time was in the 500, 60-basis-point arena, so I think David may have been talking about the increase as opposed to the absolute.

Right. Yes, perfect. No, that's helpful. And then, just lastly, can you repeat, there were some comments about digital investments and exposure, not so much the launch of the website, but are there metrics about application volume, perhaps, that are done digitally versus in-store? I didn't catch exactly what you were referring to.

Yes, David, we've seen a nice increase year over year on application volume, and it's, you know, in the mid to upper teens relative to a couple years ago, where it was in the very low single digits. So we're seeing nice growth there, and as I mentioned in my remarks, all of these loans are underwritten in the branches, so we have full underwriting, similar to other loans that are originating in the branches.

The next question comes from John Hecht, who's with Jefferies. Please go ahead, sir.

Welcome, Rob, and enjoyed working with you, Don, and hope to keep in touch. With the new card, you know, so you're working through it. It seems like the effects of this migration are happening exactly as you expected. What should we think about, you know, once this is fully move through the portfolio? What's the kind of overall impact on yields and your expected impact on long-term loss rates, relative to the average loss rate right now?

Well, in the first quarter, we saw the elevated late-stage delinquencies and even the early buckets. It's going to all roll through, you know, in third and fourth quarter, where we'll see the full benefits of the scorecards. From the standpoint of we'll see the benefits then, and then 2020.

Yes, on the yield side, we do have a policy of accruing up to 90 days of interest on an account, and when it's charged off, then we'll reverse it. So to the extent that we see lower charge-offs materializing in the future, John, then there will be some slight improvement opportunity within yield.

And do you have some expectation of potential magnitude of charge-off reduction?

We do, but we've not been public with it.

Yes, we're just working through the process and trying to maximize the benefit as much as we can.

Okay. Okay. You also talked about more activity coming through the digital channel. Maybe, can you give us a little bit more color on your total capabilities there, and loans being originated and serviced completely through that channel yet?

No, no, we still have those leads go to the branches. And with respect to, digital underwriting, you know, that's into the future, and as you know from all of our conversations, we would want to test and learn a lot in that arena, because we don't want to have a misstep in either current losses or fraud. So that's not on the near-term horizon, but it's something that, you know, many companies are getting into, and we want to make sure we're not left behind. Some of the other benefits that we've talked about in the past are electronic payments. They're now over 60% of all payments that we take, and that's either debit card or ACH. We use texting for reminders to consumers that, either prior to their due date or on their due date or if they're delinquent, to remind them to come into the store, into a branch, or use their electronic payment to make electronic capabilities to make a payment.

Okay. And then my final question is, maybe just curious, is there any kind of change to the competitive environment? You seeing any new capital come into this sector, any commentary there?

We haven't seen any influx of competitors. You know, one of the things that's good about our position in the marketplace, you know, we're relatively small compared to the opportunity out there. So while we keep an eye on competition and we're always tracking what's going on with competitors, and we still see a lot of greenfields for us and opportunity to grow. You know, as we're around $1 billion and the category is $70 billion to $100 billion, there's just so much opportunity for us to grow.

The next question comes from Sanjay Sakhrani, who's with KBW. Please go ahead, sir.

Thanks. Good afternoon. It's actually Eric on for Sanjay. Can you just remind us what kind of data you're picking up on the scorecards, specifically that suggest to you that a borrower would potentially charge off maybe sooner, or even at all, if they were renewed? Thanks.

So we use a method called logistic regression, where we take hundreds of variables, even more than that, and we run them through a regression model. And we come up with 15 to 20 variables that are most predictive of loss, and we overlay FICO on top of that. Now, that's a far cry from the matrices that we've used in the past, where we took six or seven variables, and we used those without the analytics of a logistic regression capability. And so, this is a really vast improvement, and what the models do is they help separate the goods from the bads -- the bads, obviously the likely to get a charge off, and the goods that will perform well. So that's sort of the way we see it, and obviously, as we mentioned earlier, there's a short-term bubble as we go through not renewing customers that we would have renewed in the past, that we've now identified as more likely to go bad or go to charge-off.

Got it. Okay, thanks. That's interesting about the FICO overlay. Thank you. Then the strong loan growth quarter over quarter looked at least maybe partially due to the pick-up in larger loans versus smaller. Wondering if you can just give any color around the reasoning behind larger loans. I mean, I imagine it's something that you're targeting, and you've made those comments before, but is something changing with the borrower as well that would lead them to taking out a larger loan, that you guys are seeing generally across the market? Thanks.

Yes, just a couple thoughts on that, Eric. One is, you know our graduation strategy. We bring customers in via check or via small loan, and we look at their performance, which is -- their performance as a customer is the best indication of their creditworthiness, because they're actually paying you versus looking at their payments on other assets. So our graduation strategy has not changed, but what we're finding is that we're able to do more debt consolidations and help consumers save more money by consolidating some of their loans at other institutions, and so we're able to give large loans to creditworthy customers. Plus, the scorecards give us confidence that, in making large loans, that the credit performance will be strong on these customers.

[Operator instructions]. The next question comes from Bill Dezellem, who's with Tieton Capital. Please go ahead, sir.

Thank you, it's Tieton Capital. I have a group of questions, and let me start, if I may, relative to that strong portfolio growth. Would you talk in a bit more detail as to why you think this quarter was as strong as it was?

Well, Bill, seasonally, the second quarter is very strong for us, and there was good demand in the marketplace. Plus, you know, I think we had very good execution in the branches. As I mentioned before, we've had strong small loan growth, a 12% increase, and that is a good feeder for those who are creditworthy into large loans. And with our new credit tools, we feel confident that giving these larger loans will provide a good loss profile for the larger loans. So part of it's seasonal, part of its really good execution, part of it's scorecards, and consumer demand remains strong. And as I mention consumer demand, I have to always say the health of the consumer, because demand on its own, it's sort of like talking about growth without profit. We look at demand as we only want to make a loan to someone who's creditworthy, and we look at growth only in the context of how that's going to set us up for profit.

Great, thank you. And then, you have, as you noted at the cover of the press release, had 17 quarters of double-digit receivable growth, 12 quarters of double-digit revenue growth, and now you're talking on this call about double-digit earnings growth in the second half of the year. Is the implication that we are now at the inflection point, where you have built enough of the foundation that we're at the point where we should be able to have consistent income growth, in line with that revenue and receivable growth that we have been having?

Yeah, that's our goal. We like consistency. We're not looking to hit home runs, and I think that what you saw in the first and second quarter was a transition period, where we wanted to implement our scorecards. Execution was really good, but there's always that short-term pain, because if you're turning down folks that you would have previously renewed, it makes good business sense. You're not prolonging the inevitable, so you're taking the up-front hit. And as we cycle through, about half of our portfolio has now been underwritten by these scorecards. Of course there's a lead lag, so it will take time to go through the entire portfolio, which we expect to cycle through by the end of the year. So we really do feel as though we'll be on a good trajectory going forward.

Great, thank you. And then I'm going to ask a question that I normally would not ask, however, I'm going to dive into the next couple quarters. The third-quarter estimate is $0.96, fourth-quarter estimate is $1.02. And if I look at the last couple of years, the fourth quarter has been meaningfully higher than the third quarter, whereas the estimates right now would be more modest in terms of that rate of growth. So on the surface, it makes me wonder if the third-quarter estimates are too high, and the fourth quarter is too low. And if in fact you are feeling that way, I was just going to give you this public forum to clear the air on that or maybe I'm just missing something here.

Well, Bill, as you know, we don't give guidance. Typically, the third and fourth quarter are higher income than the first and second quarter, where we see first and second quarter pretty flat, so we expect to earn more money in the third and fourth quarter. As we build receivables, the two strongest quarters are second and third quarter, so there's a natural opportunity in the fourth quarter to be slightly higher than the third quarter. But in terms of being a little more specific, we don't provide that guidance, as you know.

Okay, great. I do want to ask one more, if you would allow. I'm curious, are you seeing a difference or a discrepancy in delinquencies between those customers that pay you online versus those that would pay you versus a more traditional method?

No. We're not seeing any difference between those who pay us electronically or those who come into the store with cash or check. So, no, it has performed very well. We're not seeing any difference.

There are no more questions at this time. I would like to turn the conference back over to Peter Knitzer for any closing comments.

I thank you everyone. I really appreciate your time and interest in the company, and I think we're in a good place to deliver value in the second half to shareholders and over the long haul, particularly with the investment that we're making in digital, our credit custom scorecards, and our capital structure to be able to grow nicely into the future. So thank you for your time and interest, and have a good afternoon.

This concludes today's conference call. You may disconnect your line. Thank you for participating. Have a pleasant day.