Regional Management Corp (RM) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Regional Management Corporation Second Quarter 2017 Earnings Conference Call. (Operator Instructions) Now I would like to turn the call to Mr. Garrett Edson, Senior Vice President of ICR.

Thank you, Carmen. 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 a more detailed discussion of the risks and uncertainties that could impact the future operating results and financial condition of Regional Management Corp. We disclaim any intentions or obligations to update or revise any forward looking statements except to the extent required by applicable law.

I would now like to introduce Peter Knitzer, CEO of Regional Management Corp.

Thanks, Garrett, and welcome to our second quarter 2017 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 CFO, Don Thomas, who will speak later on the call. I'm also here with some members of our financial team. 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. Our second quarter was strong on a variety of fronts as we continue to execute on our top priorities. We recorded double-digit year-over-year revenue growth for the fourth consecutive quarter. We further stabilized credit. And we remain on track to complete our loan platform conversion by the end of the year. Importantly, in the second quarter, we entered into a $125 million warehouse facility and extended a committed line under our current revolving credit facility to $638 million. Both of which are critical milestones in terms of executing a successful long-term growth plan and our testament to the strength of our company. All in all, our team is accomplishing exactly what we need to do to set up Regional for long-term profitable growth.

As you can see on Slide 3, for the second quarter, we recorded net income of $6.1 million, an increase from $5.9 million in this prior year period. Our net income excluded a $300,000 or after-tax expense for COO transition costs. Including this nonoperating expense, net income was up 3.8% in the second quarter of '17. Diluted EPS for the quarter was $0.52 versus $0.49 in the prior-year period. Our top-line performance remains strong with revenue up 14% versus second quarter of 2016. This was primarily driven by an increase in our finance receivables to $727 million, up $81 million or 12.5% versus the prior year. Approximately $1 million of our revenue increase was due to the temporary shift of certain insurance claims expense into the provision for credit losses that we mentioned on our last earnings call. With respect to credit, we continue to see our credit metrics stabilize in the quarter. Our provision for credit losses was $5.2 million higher on a year-over-year basis, primarily due to the $81 million increase in finance receivables, the temporary shift of $1 million in insurance claims expense of which $1.6 million is an increase in net credit losses, offset by a $600,000 reserve release and a $1 million bill in allowance for credit losses this year compared to a slight decrease in the second quarter of 2016. As we noted last quarter, this shift of insurance plan from revenue to provision is a temporary line swing that will normalize by the end of 2017, and has 0 impact on our net income. We also said on our first quarter call that we expected our net credit losses to improve in the second quarter. We are pleased that we achieved a substantial decrease in our net credit losses. Looking ahead, we expect net credit losses to continue to improve somewhat in the third quarter versus the second quarter.

Turning to Slide 4. On our last call, we discussed the expansion of our centralized collection capabilities. We are very pleased with how the centralized collection performance is going. And as we continue to expand it, we will realize an increase in our G&A expense run rate. Don will provide more details on our expectations for our G&A run rate in his comments later on in the call. We believe investing now in centralized collections will ultimately pay long-term dividends for Regional with respect to improved collections; lower, fewer net credit losses and higher loan growth; all of which should lead to an enhanced bottom line. On the systems front, we successfully converted our branches in Oklahoma to the new system on June 1. And on July 1, we completed the conversion of our branches in South Carolina, the largest conversion to date. About half of our total portfolio is now on this new system. As with any conversion, it takes operations a short time to get used to the new software. So as with the other states that we previously converted, we expect and have planned for a temporary slowdown in production and a temporary increase in delinquencies.

That said, I'm happy to report that the system is performing well, and that we are on track to fully convert all of our branches to the new platform by the end of the year. We continue our hybrid approach to growth through increasing receivables in our current branches and targeted de novo expansion. Our same-store receivable growth remains strong at 12% in the second quarter, while adding 3 net new branches in Virginia. We expect to add a few more de novo branches in the second half of 2017 as we complete our system conversion. Once the conversion is completed, we anticipate moving back to an increased level of de novo branch openings.

We continue to make progress in our marketing efforts. As we stated on previous calls, we had expected to spend a couple of million dollars more on marketing in 2017 versus 2016. In the first half of 2017, we're actually able to spend less than planned through a combination of efficiencies, reducing non-campaign costs and by consolidating campaigns. Through further improvements in our targeting on segmentation, we now anticipate an increase in marketing expense in the second half of 2017 versus the second half of 2016, in the range of $1.2 million to $1.6 million. In addition, we continue to make steady progress on the digital front. Through our disciplined test-and-learn approach, we have expanded our LendingTree partnership from a few states to our entire network. We also expect to enhance our online user experience in the second half through investments in our website redesign and search engine optimization, standardization of our online branch listings and deployment of online customer portal.

Finally, as I touched on earlier, in order for our long-term growth strategy to succeed, we obviously need to continue to increase and diversify our funding sources. By increasing our committed line under our senior revolver from $585 million to $638 million and implementing $125 million revolving warehouse facility, which will be secured by large loan receivables, and provide us with the opportunity to conduct securitizations, we have significantly enhanced our funding capabilities and are now well positioned to carry out our long-term strategic initiatives.

I'll now turn the call over to Don to provide a little more color on the financials.

Thank you, Peter and hello to everyone on the call. Please turn to Slide 5 in the presentation. Ending net receivables increased double digits from the prior-year period for the ninth consecutive quarter, increasing 12.5% to $727 million, net income increased to $6.1 million in the second quarter of 2017 from $5.9 million in the second quarter of 2016. The 2017 net income figure includes an after-tax expense of $300,000 for COO transition cost, which is a nonoperating cost that did not occur last year. It is important to know there was not a typical build of allowance in the second quarter of 2016, which makes the comparison less favorable than it otherwise would've been.

Moving to Slide 6. You can see our product category trends. Core loan receivables at June 30, 2017 stood at $617 million, growing 19.8% from the prior-year period. Our large loan portfolio continues to be our growth engine as we saw a $73 million or 37.5% increase from the prior year, and it was up 10.5% from the end of the first quarter.

The large loan portfolio now stands at $268 million, and accounts for nearly 37% of our total portfolio. Meanwhile, our small loan category saw a $29 million or 9% increase from the prior year and was up 4% from the end of the first quarter. Our other loan categories were down $7 million sequentially and $21 million from the prior year, primarily due to the continued liquidation in our automobile loan category. As noted previously, we do not expect the origination volume associated with our auto loan product to stem the current liquidation during 2017.

Turning to Slides 7 and 8, the first of which is for total revenues and the second of which is for interest and fee income, we break them down at average net receivables and yield. The 14% year-over-year revenue growth rate was primarily driven by a 13.3% increase in our average net receivables. This is the seventh consecutive quarter where average net receivables have been up double digits.

Still on Slide 7, total revenue yield in the second quarter of 2017 increased 20 basis points year-over-year due to the benefit of the line swing between revenues and provision for credit losses. Sequentially, the second quarter 2017 benefit from the line swing was less than what it was in the first quarter. Therefore, we saw a 20 basis point decline in our total revenue yield despite a 40 basis point improvement in our interest and fee yield, which you can see on Slide 8.

Improved credit metrics or specifically lower dollars of accounts and nonaccrual status boosted our interest and fee yield in the second quarter.

Moving to the top of Slide 9. Our provision for credit losses of $18.6 million in the second quarter was up $5.2 million from the prior year period, but down $0.5 million on a sequential basis. Of the year-over-year increase, $1 million was due to our insurance carrier change and the related line swing between revenues and provision for credit losses. Another portion of the year-over-year increase in the provision for credit losses comes from the allowance for credit losses.

In 2016, we had a small release of $30,000 of allowance versus a build of $1 million of allowance in 2Q '17, which increased the provision for credit losses this quarter by $1 million versus the prior year period. The balance of the increase in provision for credit losses is due to portfolio growth. Net credit losses were up $4.2 million over the second quarter of 2016, but down $1.8 million sequentially.

As we had discussed previously, we had expected our net credit losses to decline sequentially from the elevated first quarter levels. At the bottom of Slide 9, we show the trend of our net credit loss rate. Our annualized net credit loss rate as a percentage of average net receivables for the second quarter of 2017 was 9.9%, which is a 100 basis point sequential improvement. Year-over-year, the annualized net credit loss rate is up 130 basis points. I'd note that 90 basis points or most of the 130 basis points year-over-year increase was due to claims from the insurance line in the second quarter of 2017.

Turning to Slide 10. We show our seasonal pattern of delinquency. Our 30-plus day delinquency level stood at 6.5%, an improvement from 6.8% in the second quarter of 2016 and flat with the first quarter of 2017. Importantly, our 90-plus day delinquency level stood at 2.7%, equal to our second quarter 2016 level, and below the 3% level from the first quarter of 2017. With an improved delinquency profile, we would expect our net credit losses to be somewhat lower in the third quarter than in the second quarter and we would expect our net credit loss rate to also move down from the second quarter level.

Moving on to Slide 11. G&A expenses as a percentage of average net receivables declined 100 basis points year-over-year. That said, our G&A expense of $31.6 million in the second quarter of 2017 was up $2.1 million from the prior year period. Sequentially, G&A expense was up only slightly from the first quarter of 2017, as the increases in personnel, occupancy and marketing were offset by a decrease in other expenses.

However, we do expect our G&A expenses will move up in the third quarter for a number of reasons. We anticipate a sequential increase in our personnel expense run rate in the third quarter of approximately $1.6 million to $1.8 million, primarily from the incremental cost of building out centralized collections, that Peter described, from an increase in branch labor cost due to higher average wages and additional staff to support account growth and from higher incentive expenses in the quarter. Some of the G&A increases also relate to our NLS loan-management system. Lastly, we also planned to spend approximately $0.7 million to $0.9 million more in marketing in the third quarter. As a result, we expect our G&A expenses will increase between $2.3 million and $2.7 million in the third quarter from the level reported in the second quarter of 2017.

Looking at it on a full year basis, we believe G&A expenses as a percentage of average net receivables will be slightly down in 2017 compared to 2016. We're confident that these investments [will] enable us to continue to grow, reduce our cost of credit and improve our long-term earnings performance. That concludes my remarks.

And I'll now turn the call back to Peter to wrap up.

Thanks, Don. To sum up, we believe that we had a solid performance in all facets of our business in the second quarter. On the top line, we saw another quarter of double-digit revenue growth. On the credit side, we further stabilized our delinquencies and reduced our net credit losses. The critical build-out of our loan platform remains on track with the successful conversion of Oklahoma and South Carolina. And last but certainly not least, in order to fund our growth, we significantly increased our funding capacity as well as further diversified our funding sources. All in, we are continuing to position Regional to achieve ongoing long-term profitable growth.

Thanks for your time and interest, I'd like to now open up the call for questions.

(Operator Instructions) And our first question is from the line of John Hecht with Jefferies.

Just real quick on the expense [thus as Don you just covered yourself]. You said if I heard you right, about $2.3 million of incremental total SG&A expense in the second half versus the first half?

That's sequentially from second quarter to third quarter, John.

Okay. And then would that -- I guess base increase in the third quarter persistent into the fourth quarter?

Most of it will, some of it will not. Look at our trend from 2016, you see we had a bump in the third quarter and it fell back down some in the fourth quarter. And incentives are a portion of the reason why we see some increase in the third quarter every year. Our incentive costs are aligned around our profitability. So it's not just straight line across the year.

Okay. And I understand some of this investment growth as well, any thoughts just in terms of that trend as you go into 2018?

We expect continued growth on our top line as well as bottom line, John. We have, in addition to the build-out of our digital channels, improved targeting and segmentation, which will continue to improve in 2018, enabling us to be both more efficient and more effective, plus as I mentioned earlier in my remarks, we expect to build out more de novo branches in 2018 once we can complete the system conversion.

Okay. And then I guess some of that was related to delinquency trends and so forth that your installment below both (inaudible) -- yield growth quarter-to-quarter here. I'm wondering, if you could maybe discuss the competitive market? Or any kind of mix shift in what that might mean for yields into the near term, I guess, near to intermediate term?

Well, as you can see, we continue to grow our large loan portfolio significantly, it's now 37% of our overall portfolio. And a lot of that comes from a shift or an up-sell from small to large. While in the short term, we might see a slight decrease in yield from that shift, we've been able to maintain the overall yield by increasing our small loans as well as our large loans. But over time, it may shift somewhat lower, but we believe and our models indicate that we'll make it up on volume.

Okay. And then final question on credit, I mean in the aggregate, you look at delinquency trends seasonal factors and so forth, your credit has been pretty stable, and I'm wondering, is that just -- is that reflective of just a really I guess stable end market trends in terms of your borrower's ability to repay their debt? Or is it just fine tuning underwriting as the end markets change? I'm wondering, kind of what you're seeing in terms of patterns and behavior from that perspective.

Well, it's a combination of a lot of things, John. We have tightened credit in certain pockets, as I've discussed on previous quarter calls. We have also increased our emphasis with centralized collections. And we do have that [lip] that I discussed at the end of the fourth quarter where we found certain cohorts that we needed to tighten down and that's helped improve both delinquencies and our losses. As I just mentioned, we expect that to continue into the third quarter.

And our next question comes from the line of David Scharf with JMP securities.

Maybe follow-up on just the last question on credit. I was looking at my notes from the Q1 call and I think when you were providing guidance at the time in early May, you'd indicated that the loss rate would improve a bit seasonally into Q2, but that we shouldn't expect it to be down by as much as 100 basis points and in fact, it came in that much lower. And I think when I back out those insurance moves, it looks like it was down almost 150 basis points. I'm just curious, if there was anything you could pinpoint in the quarter in terms of payment patterns? Or whether it's large versus small loan category? Where the outperformance on credit came from? And also based on that observation, how we ought to think about the allowance rate in the back half of the year?

Well, in terms of -- you're 100% right. I was asked a question. We're expected to decrease 100 basis points. I thought it would be somewhere in the middle, we actually outperformed that. A part of it is centralized collections even though it only covered a small portion of our overall branch network, the portion of our receivables. We also just -- we're able through the tightening that -- on that cohort that was not doing as well as we anticipated. It got much better in the second quarter than we anticipated. So overall, the combination of our centralized collections doing better than we anticipated. The cohort loans grew a little faster. The higher delinquency and higher [net code] losses led us through the 100 basis point decrease.

Got it. Can you remind us on the centralized collections effort and that was highlighted as one of the areas of increased investment? Is the goal to have this ultimately completely replace branch-level collections? Or is it a supplement?

It is absolutely not to replace our branch collections efforts. Rather, what we have found is we see a lift in our later stage delinquency buckets by centralizing our efforts. And we also see a lift, we've seen this in the test-and-learn approach we've taken with centralized collections. We see improvement on the 1 to 59, because that's what the branches are focusing on. We also see an improvement in the 60-plus delinquencies because that's what our centralized collections is focused on. So all in all, it improves us on all ends of the delinquency section.

Got it. And what percentage of the branches is it covering right now? You mentioned it's still early stages.

Still early stages and I don't have that number in front of me. We're still building it out, which is part of our third quarter increase in our G&A. So we've been in somewhat of a test and learn mode, though we've gotten better results than we anticipated, as I mentioned. I don't recall exactly what percentage it is, but we're still in a build-out mode, John.

It's David.

Got it. We'll obviously keep an eye on those developments. I guess, last question and then I'll get back in queue. Any commentary on -- this relates to John's question on just consumer health and what you are witnessing, but anything you can add about maybe the quality of loan apps you're getting, maybe approval rates whether you're finding that it's not just not that one cohort you've been highlighting. I'm wondering, are you seeing greater household debt now and perhaps having to improve fewer loans or focus more on repeat borrowers as opposed to new customers? Just any background on sort of that end market mix would be helpful.

Sure David. So one of the shortcomings of our old ParaData system is we only see what comes through as a booked loan. In the NLS system, we will actually have those that are applied, those that are approved, those that are booked. We just don't have insight, and we just converted Oklahoma and South Carolina, South Carolina being our largest state to date. So we don't really have a good view on those applied versus -- to those booked. In terms of the overall consumer, we've seen in other segments of the consumer financing and consumer loan business, some pressure. Credit card companies was reported in the Journal that they've seen pressure on the credit losses. We've been relatively steady and as we've mentioned, we've tightened our criteria where we've seen pockets of potential weakness. So far so good. And our consumers have really not built up that we've seen an over-levered position.

And our next question comes from the line of Sanjay Sakhrani with KBW.

This is Maja Feenick filling in for Sanjay. You had mentioned before that similar to other states that'd previously been converted, you planned for a temporary slowdown in production and then an increase in delinquencies. Could you perhaps size that impact on delinquencies? And then how should we see that flowing through into future charge-offs?

Sure. We saw the same behavior in North Carolina and New Mexico when we converted those states. We have planned for it, let me just comment on any conversion that I've experienced and I think anyone in the industry has experienced. It takes 1 to 2 months for our employees to really get familiar with the new software. We're going from manual decisioning on credit to actually automated decisioning and even if it's better, which this is, change is difficult and change takes time for people to get accustomed to it. So we do anticipate couple 1 to 2 months of these temporary decreases and increases. And we don't anticipate it lasting beyond that, nor do we foresee material overall increases in our delinquencies and charge-offs. One of the things also that we've done in our conversion schedule is we've derisked it by spreading it out across the year so that we were not going to see a major impact because of the way we've scattered each state on conversions.

And our next question is from the line of Arren Cyganovich with D.A. Davidson.

Just following up on the last question, so when you start talking about the 1 or 2 months of slower production as you get your employees used to the new systems, that's not expected to cause material slow down in your overall receivables growth?

No, we really haven't seen that in our prior conversions. There will be a slight dip, which if we didn't plan for it, I got to be honest, would be irresponsible on our part. We're still anticipating strong growth and have planned for that. So 1 state or 2 states, even if they are large, are not going to have a significant impact on our overall growth.

Okay, great. And then I guess in terms of the overall conversion, this is now -- you are through 5 states and you've 4 remaining, is that correct?

That's correct.

Okay. I guess shifting over to the funding side, yet you have a new warehouse facility that you sort of drawn, maybe you just talk a little bit about the intended use for that, assuming asset back financing over time? And maybe the timeframe you expect to build a pool before you enter that market.

As we mentioned, this facility will be funded by large loans only, which as we mentioned on the call, has been a huge portion of our growth. And I'll let Don take the latter part, he's probably more familiar with that than -- and more capable of answering that.

Yes, today we have $268 million of large loans on the books, plenty enough for securitization transaction. We're going to gradually fund the warehouse over some period of time, maybe 9 to 12 months before we do our first transaction.

Okay, great. And then just lastly, could you remind me the seasonality of delinquencies and charge-offs over the next couple of quarters and the seasonality for -- if there's any material seasonality for yields as well?

Yes, delinquency typically rises in the second half of the year. It's usually lower at March 31 and then over time, with a move-up some to the end of the year and peak again before moving down in the first quarter. Losses would follow that in the normal schedule of falling off the back end of your delinquency schedule. As far as yield goes, we see some decline in yield late in the first quarter, early in the second quarter because a lot of the income tax pay downs that we receive are paying off some of our higher rate loans. And so we do see a little dip usually in the first half of the year.

(Operator Instructions) And our next question is from the line of John Rowan with Janney.

The guidance on net charge-offs and the net charge-off rate, obviously are for lower numbers sequentially. But I'm assuming that, that doesn't translate necessarily into lower provision guidance just given the growth in the portfolio [while all else held equal]?

Yes, John, the provision itself has to include the allowance billed. So it won't go down quite as much as just NCOs by themselves. So you're right on that.

I'm sorry, just one more quick question on the G&A. So obviously we know the guidance for G&A going up a little over $2 million sequentially, and good chunk of that is in advertising. I just want to make sure I understood the guidance correctly, the rest of the build is for a higher operating cost relating to the centralized collection facility,? I just want to make sure that I kind of had the right relationship there.

Yes, centralized collections is a portion of the increase, John. Branch higher average wages is another portion of it. We've seen specific portions of the country, where we've had some wage pressure and we responded to that and have some higher wage cost. And in addition to that is the third quarter, we have growth and so we respond by hiring a few more people to handle the additional accounts. And then we've hired a few people in our IT group to continue to handle our NLS conversion. And then incentives was the other item I mentioned. So collectively, $2.3 million to $2.7 million.

Okay, and then last question for me. You guys obviously said that next year once you [wrap] kind of the system conversion, you're going to open more than 15 stores for the year was the guidance, I mean can you give us a ballpark? Is it 20 stores, 40, 50? I mean just some type of guidance if you will on [the de novo] outlook for '18?

Yes, John, at this point, we're still formulating plans for '18. We feel very confident that it's going to be an increase versus 2017. We're not really ready yet because we haven't gone through our planning cycle to provide more than that from a guidance standpoint, but it will definitely be more than 2017. And we'll come back to you when we get our plans formulated and locked in with more specificity on that front.

And I'm not showing any further questions in the queue. I would like to turn the call back to Peter Knitzer with his final remarks.

Well, I want to thank everybody for your interest and for participating today. Really, we're excited about the trajectory that we're on as you can tell from our remarks we feel that we had a pretty solid second quarter. And we look to continue to build our foundation in our loan management system, centralized collections and overall portfolio growth into the second half of this year. Thank you all very much, and we look forward to speaking with you later on.

And with that, ladies and gentlemen, we thank you for participating in today's program. You may all disconnect. Have a wonderful day.