Regional Management Corp. (RM) Q3 2019 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Regional Management Corp’s Third 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.

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 and which may also be found on our website at regionalmanagement.com. Before we begin our formal remarks, I need to remind everyone that part of our discussion today may include forward-looking statements, which are based on the expectations, estimates and projections of management as of today. The forward-looking statements in our discussion are subject to various assumptions, risks, uncertainties and other factors that are difficult to predict and which could cause actual results to differ materially from those expressed or implied in the forward-looking statements. These statements are not guarantees of future performance and therefore, undue reliance should not be placed upon them. We refer all of you to our recent filings with the SEC for 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 Third Quarter 2019 Earnings Call. As always, I want to thank everyone for participating this afternoon and for your continued interest in the company. I am here with Rob Beck, our Executive Vice President and CFO, who will speak later on the call. For those of you with access to a computer or mobile device, we once again posted a supplemental presentation on our website at regionalmanagement.com to provide additional color to our remarks. Overall, we had a very strong third quarter. Diluted EPS was $1.08, $0.47 better than the prior year period. Net income of $12.6 million was up 69% versus the third quarter of 2018. Net income and diluted EPS for the prior year period included Hurricane-related impact of $2.9 million and $0.24, respectively. We also generated year-over-year revenue growth of 18%, driven by a 17% or $154 million increase in finance receivables. Our third quarter represents a milestone in the history of Regional as we surpassed the $1 billion mark in finance receivables. On a year-over-year basis, we have now grown revenues double digits for 13 consecutive quarters and have achieved double-digit growth in finance receivables for 18 consecutive quarters. Furthermore, our receivable growth of $69 million represents the highest quarterly growth in the history of the company. While we don’t anticipate record receivable growth in the fourth quarter, we expect to achieve year-over-year double-digit receivable revenue and earnings growth. Let me turn to our credit performance in the quarter. As I said on the second quarter call, we are beginning to see the positive impact of our new custom underwriting scorecard. 30-plus-day delinquency improved 50 basis points from 7.1% in the prior year period to 6.6% as of September 30, 2019. This improvement demonstrates that our scorecards are working and that we’re turning the corner on improving our loss profile. 90-plus-day delinquency also improved slightly to 2.8% versus the 2.9% in the prior year period. This is exactly what we expected as the benefits of our scorecard show up in the early-stage bucket sooner than in the late-stage delinquencies. Since 90-plus-day delinquencies are the leading indicator of the following quarter’s losses, we expect that our fourth quarter loss rate will be comparable with the prior year period, with the full benefits of the scorecards being realized in 2020 and beyond. To-date, approximately 60% of our core loan portfolio has passed our new scorecard underwriting criteria. We expect this to increase to over two-third of our portfolio by the end of the year. As we have consistently noted, our customers remain financially healthy and the scorecards will serve us well in any macroeconomic environment. Our hybrid strategy of growing receivables per branch and opening new branches remain central to our success. Year-over-year receivables per branch grew double digits. We expect this trend to continue in the fourth quarter. We opened 4 branches in the third quarter and have opened 20 de novo branches since the end of the third quarter of 2018. We are now on pace to open approximately 9 additional branches in the fourth quarter and expect to open approximately 25 to 30 new branches in 2020. As a reminder, our typical de novo branch breaks even in less than 1 year. As I discussed on our second quarter call, we continue to transform Regional into a true omni-channel provider by leveraging our NLS platform. We saw steady year-over-year increases in the percentage of new borrower originations. The 21% of our new originations sourced through digital channels, up from 16% in the third quarter of 2018, with all of our digitally sourced loans underwritten in the branches. Additionally, our goal is to provide our customers with best-in-class service whenever and wherever they choose. Feedback from our new customer-facing website has been positive. Both our new website and 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 employee’s work. This should lead to higher sales productivity and improve our expense profile, which will ultimately lead to margin expansion. Looking to the future, our investment in digital will continue to rise. Our Chief Technology Officer continues to build out our digital team, and you can expect a greater emphasis on this important channel in 2020 as we focus on better serving our customers and gaining efficiencies over the long term. Even with the investments we are making in digital and other parts of the business, our operating expense ratio improved 60 basis points from 16.5% in the third quarter of 2018 to 15.9% in the third quarter of 2019, and our efficiency ratio, which measures our expense as a percentage of revenue, improved 220 basis points from 46% to 43.8%. On the funding side, our capital structure remains very strong. We increased our senior revolver to $640 million and extended its term to September of 2022. We also renewed our $125 million warehouse facility in October and extended its term to April of 2022. Further, we once again accessed the securitization market in October with $130 million asset-backed securitization. As of September 30, we had $311 million of unused capacity on our credit lines to support our growth objectives, and the $130 million securitization will further increase our capacity in the fourth quarter. As you know, the Board of Directors authorized a $25 million share repurchase program this past May, as we continue to believe that our current market price for our stocks significantly understates the value of our company given our strong financial performance, capital position and future prospects. We have now completed the program having repurchased 938,000 shares at a weighted average price of $26.65. I will now turn the call over to Rob to provide additional color on our financials.

Thank you, Peter and hello everyone. Turning to Slide 3 in the supplemental presentation, we provide you with an overview of our earnings for the quarter. As you can see, we generated third quarter net income of $12.6 million or diluted EPS of $1.08, well above last year’s performance, even excluding last year’s Hurricane impact. As Peter mentioned, our revenues were up 17.7% over the prior year period, primarily driven by the 16.3% increase in average finance receivables. The remainder of the revenue increase was largely due to the change in business practice to lower our utilization of non-file insurance, which we’ve noted on prior earnings call. This change grosses up our insurance income and net credit losses with no impact on net income. Our provision for credit losses rose $900,000 or 3.7% year-over-year. This increase was primarily driven by $154 million portfolio growth and approximately $1.2 million of incremental net credit losses due to the change in business practices related to the non-file line swing I just mentioned. This year-over-year increase in provision was mostly offset by the $3.9 million of Hurricane-related reserve billed in the third quarter of last year and by an improvement in this quarter’s allowance due to lower delinquencies resulting from our new credits scorecards. As Peter noted, we expect that our fourth quarter loss rate to be comparable with prior year period with the full benefits of the scorecards being realized in 2020 and beyond. Looking to Slide 4, our core loan products grew 21.7% or $179 million versus the prior year period. Large loans grew 35% and now represent 53% of our total loan portfolio, while small loans grew by 8% and make up 43% of our total portfolio. In the fourth quarter, we expect sequential portfolio growth to be strong, but less than the record pace we saw in the third quarter. Turning to Slide 5, interest and fee yield declined 30 basis points from the prior year period, primarily due to the change in the mix of our products. However, total revenue yield in the third quarter of 2019 increased 40 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 fourth quarter of 2019, we expect interest and fee yield will be approximately 40 to 45 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 third quarter of 2019 was 8.2%, an increase of 50 basis points from the prior year period. Approximately 40 basis points of the increase was attributable to the business practice change to lower our utilization of non-file insurance. Flipping to Slide 7, our allowance as a percentage of finance receivables ticked down 10 basis points sequentially in the third quarter. The record receivable growth drove an increase in allowance, but as I indicated earlier, the improvement in our delinquencies from the new customer credit scorecards offset the impact of our receivables growth. As you know, we will implement the new CECL accounting standard on January 1, 2020. During the third quarter, we continue to fine-tune our models to, among other things, reflect the impact of our new scorecard and run them parallel to our existing model for current and historical time periods. As Peter mentioned, approximately 60% of our portfolio is now underwritten with the new scorecard, and it’s important that we take the time to appropriately reflect the benefits of these scorecards in our CECL calculation. Our implementation of the new accounting standard will result in the initial CECL adjustment being charged directly to equity, effectively a shift from equity to higher reserves on the balance sheet. We expect to provide you with more details in early January. 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. As we’ve mentioned before, this is strictly an accounting change. The new standard will not present any issues with respect to our debt covenants, funding our growth, 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 September 30, 2019, stood at 6.6% and 2.8%, respectively. Our 30 plus day delinquencies improved 50 basis points versus a year ago, while our 90 plus delinquencies were down 10 basis points. The elevated delinquency levels we saw at the end of the second quarter, which were primarily caused by not lingering to high-risk customers, are improving as more of the portfolio is underwritten by the new scorecards. Flipping to Slide 9 and 10, G&A expenses of $40.2 million in the third quarter of 2019 rose $4.3 million from the prior year period, in line with our expectations, de novo expenses from branches opened since September 30, 2018, accounted for $1.1 million of the year-over-year increase in operating expenses and existing branch expenses to support loan growth accounted for an additional $2.4 million. For the fourth quarter of 2019, we expect G&A expenses 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 and some additional digital investments. Peter mentioned a number of initiatives in his remarks. We have invested and expect to continue to invest in growing our business, largely driven by de novo branch expansion, digital investments and the corresponding account growth. Even with these investments during the quarter, our operating expense ratio improved 60 basis points from 16.5% to 15.9% in the third quarter versus the prior year period. Additionally, our efficiency ratio improved 220 basis points from 46% to 43.8%. It is our goal to continue to control expense growth to improve our efficiency and returns while still investing in our business. Seasonally, our efficiency ratio and operating expense ratios are generally better in the second half of the year than in the first half of the year, as receivable growth is stronger in the latter half of the year. In the fourth quarter, we expect to see approximately 125 basis point improvement on our efficiency ratio and an approximately 60 basis point improvement on our operating ratio from the prior year period. As I noted previously, we expect to drive our ratios lower again next year despite new investments as we continue to control expenses and grow revenue and receivables. Turning to Slide 11, interest expense of $10.3 million was $1.6 million higher in the third quarter of 2019 compared to the prior year period, primarily driven by higher interest rates and larger long-term debt amounts outstanding due to strong growth in finance receivables. We expect interest expense in the first quarter of 2019 will be $1.5 million higher than the prior year period, primarily driven by receivable growth. As shown on Slide 12, we have continued to enhance our funding profile. As Peter mentioned, we amended our senior revolver, extending its maturity to September 2022 and providing additional flexibility in our covenants including the ability to execute on small loans securitization and/or warehouse if we choose to do so. We also renewed our large loan warehouse facility extending the maturity to April 2022 with a slight reduction in funding costs. We also completed a $130 million asset-backed securitization in October, adding fixed-rate funding at a weighted average coupon rate of 3.17%. On Slide 13, you can see that as of September 30, 2019, we have $311 million of available funding and 39% of the company’s outstanding long-term debt was at a fixed rate. The impact of our recent $130 million securitization will increase our funding capacity in the fourth quarter and moves the $130 million to fixed rate debt. Lastly, our third quarter total equity ratio was 2.5, which includes the repurchase of 558,000 shares through the end of the third quarter. As Peter mentioned, we completed the $25 million stock repurchase program in October. We are still in our planning stages for 2020, but we are looking to add approximately 25 to 30 new branches next year. As discussed previously, our typical de novo branch breaks even in less than a year. Slide 14 shows our strong same-store sales growth and the importance of our de novo strategy. In our branches, more than one-year-old, same-store sales are up 15.9% versus 14.4% last year due to record receivable growth over the past two quarters. And even our most mature branches, over 5 years, are growing at double-digit rates. Our branches continue to grow as we shift our product mix towards large loans, and we expect this growth to continue at double-digit levels. This chart also shows the importance of de novos in our growth strategy. We currently have 26 branches that are less than a year old with average receivable balance of $800,000 versus an average of $3 million after 3 years when branches begin to reach maturity. As Peter noted, we are planning to increase our investment in digital and to continue to drive and generate both front-end and back-end efficiencies. As you can see on Slide 15, digitally sourced originations have become an increasing part of our new loan growth, accounting for 20.8% of new loan origination in the third quarter of 2019, up from 16.5% during the same period last year. These loans, while sourced digitally, are fully underwritten in our branches. That concludes my remarks and I’ll now turn the call back to Peter to wrap up.

Thanks, Rob. To sum up, we are very pleased with our third quarter results. We continue to invest in the business, deliver double-digit top line and bottom line growth, custom scorecards are performing as expected, we managed our operating expenses effectively. Our third quarter performance sets us up well to deliver double-digit net income growth in the fourth quarter and further positions us to generate additional long-term shareholder value. Thanks for your time and interest. I’d like to now open the call up for questions. Operator, could you please open the line?

Certainly. [Operator Instructions] Your first question comes from David Scharf of JMP Securities.

Hi, yes. Thanks for taking my questions. Just curious, not sure I really asked this before, it’s more on the product side, but we have seen a few online lenders see a lot of consumer preference for a line of credit product in addition to sort of a core fixed installment product. Is that something that you are exploring at all? And if not, are there materially different either kind of regulatory return requirements they just don’t hit?

David thanks for the question. We have not looked into the line of credit product. We have our small and large core loan products. And our growth has been steady consistent, and we see a lot of Greenfields going forward, going from $1 billion to over time to $2 billion. So we’re still a very small player in the market. The market is about $66 billion, $70 billion. So we just see a lot of opportunity. We may at some point look at it, but at this juncture, we haven’t.

Got it. And then one final question, it looks like the yield on the large loan product picked up I think at the highest level, we’ve seen in quite some time and with delinquencies falling especially lately. I would imagine, along with that, I was a little surprised. Were there any pricing changes, any state-mix factors that may have contributed to that?

Yes, David. This is Rob. Yes, that’s largely just a state mix that you are seeing flow through.

Got it. Thanks very much.

Our next question comes from John Rowan of Janney.

I am sure we have the guidance numbers correct. So the 4Q, you gave a store number. Can you just repeat that for me?

The store number for 4Q...

Yes. The number of stores you’re going to open in 4Q?

They are 9.

9 in the fourth quarter.

Okay. And then G&A expense, you said up or – I think it’s $4.2 million or $4.4 million, that was year-over-year, correct?

That’s year-over-year, yes.

Okay. And then interest expense, I know you gave a number. I think it was like $1.5 million. Is that sequential or year-over-year?

Year-over-year.

Okay. And then – so the other guidance that you gave about the 4Q loss rates being consistent with prior year, is that inclusive of a higher rate because of the non-file or is there just going to be higher because of the non-file?

No, that’s inclusive.

So exclusive of the non-file, the changes in non-file, then your net charge-off rate would actually be lower in 4Q than last year?

Well, there is non-file in both 4Q of last year and 4Q of this year, so what we do is, we’ll show you on a comparable basis. It’s a line swing as you know from insurance down to NCL. So insurance goes up from an income standpoint and NCL goes up in the corresponding way.

Okay, that’s fine. And then CECL, you guys obviously said you’re not going to comment until January. Is there any lifetime loss figure that you guys can provide us so that we can maybe start modeling in some type of CECL impact?

John, not this time as I indicated in the comments, with 60% of our portfolio now underwritten with the new scorecards, we don’t have a lot of historical data on the performance of those scorecards. So we really feel it’s prudent to wait a few more months to get a little bit more in terms of data points and then we’ll be providing that in early January.

Okay, and then just lastly, is there any flow-through into the diluted share count into Q4 from repurchases made this quarter? I’m just trying to figure out or ask another way, is there a way you can handicap the diluted share count was at the end of the quarter?

No. I don’t think there’s any flow-through on a diluted basis. Let me just doublecheck that, but I don’t think there is...

I should know the timing of repurchases in the quarter, and how that might impact the average count going forward.

Yes. It was minimal. So...

Alright. Thank you.

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

Thank you. I was hoping to talk with you folks about operating expense leverage. You folks have obviously done a great job leveraging those. And you talked about further expense leverage that you foresee. I was curious, as you look out over the next 1 to 2 years, how are you thinking about the future expense leverage potential? And just any help there would be great.

As we said a couple of quarters ago, we anticipate over the next several years, I think it was 150 basis points decline in our overall OpEx ratio. And we’ve seen that on a nice trajectory. We’re down this quarter, 60 basis points year-over-year. Now that fluctuates based on the seasonal nature of the business. But I think it’s fair to say that looking out into the future, that translates, and it’s not linear, but one might say 50 basis points a year if you just look at it over a 3-year horizon.

Yes. And Peter, the only thing I would add to that is obviously we’re growing fast on both the receivable side and the revenue side, but as we invest in digitizing the business, both on the front-end from a sales and service standpoint and in the back-end, we’re going to realize some operating efficiencies from that as well.

Okay. That’s helpful. And talking about the digitally sourced originations, that’s been working up nicely as well. I mean how should we think about this longer term? Is there sort of a number that you think about as being really a sweet place or a sweet point that you would like to see that get to? Or how much upside to this is there over time?

Well, Matt, what we do is we optimize our entire marketing mix and our marketing spend, and we invest dollars in the next best return on our investment. So what we’re finding is that the digital channels are becoming more efficient as we learn more. So we’re willing to invest more money, we also have a better user experience, which also makes it easier for consumers to deal with us. So those customers who want to deal with us digitally may seek us more so than those who want to deal coming into the branch or receiving a direct mail package from us. But we’re constantly optimizing it so that the last dollar we spend is spent in the most effective and efficient manner. But yes, we will see -- as the world changes, we will see a continuation of an increased share of our new account originations coming from digital.

That’s helpful thank you gentleman.

Sure. Thanks, Matt.

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

Thank you, operator. Thanks everybody for your attention today and appreciate your support, and we will be talking to you 3 months from now. Take care. Bye now.

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