Regional Management Corp. Q3 FY2022 Earnings Call

Thank you for waiting. This is the conference operator. Welcome to Regional Management’s Third Quarter 2022 Earnings Call. Please remember that all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be a chance for questions. I will now hand the conference over to Garrett Edson of ICR. Please proceed.

Thank you, and good afternoon. By now, everyone should have access to our earnings announcement and supplemental presentation, which were released prior to this call and may be found on our website at regionalmanagement.com. Before we begin our formal remarks, I will direct you to page two of our supplemental presentation, which contains important disclosures concerning forward-looking statements and the use of non-GAAP financial measures. Part of our discussion today may include forward-looking statements, which are based on management's current expectations, estimates and projections about the company's future financial performance and business prospects. These forward-looking statements speak only as of today and are subject to various assumptions, risks, uncertainties and other factors that are difficult to predict and that 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 you should not place undue reliance upon them. We refer all of you to our press release, presentation and recent filings with the SEC for a more detailed discussion of our forward-looking statements and the risks and uncertainties that could impact the future operating results and financial condition of Regional Management Corp. Also, our discussion today may include references to certain non-GAAP measures. A reconciliation of those measures to the most comparable GAAP measure can be found within our earnings announcement or earnings presentation and posted on our website at regionalmanagement.com. I'd now like to introduce Rob Beck, President and CEO of Regional Management Corp.

Thanks, Garrett, and welcome to our third quarter 2022 earnings call. I'm joined today by Harp Rana, our Chief Financial Officer. Harp and I will take you through our third quarter results, discuss the economic environment, update you on our strategic initiatives and share our expectations for the fourth quarter. We're pleased with our third quarter results. We produced $10.1 million of net income and $1.06 of diluted EPS. Demand for our loan products remained strong in the quarter. We expanded our operations to California and Louisiana, increased our account base by 16% from the prior year to more than 500,000 and grew our loan portfolio to an all-time high of $1.6 billion. Quarterly origination volume of $419 million was comparable to the prior year period, despite recent credit tightening actions and reallocation of labor to collections, both of which impacted origination levels in the quarter. For the sixth straight quarter, we saw double-digit year-over-year growth in our net finance receivables and quarterly revenue, which were up 22% and 18%, respectively. We continue to demonstrate our ability to grow our company and portfolio in a controlled and profitable manner while also maintaining a tightened credit box. Regarding the economic environment, as we've discussed on prior calls, we continue to take a cautious approach as we monitor the health of the consumer. The strong demand for labor and low unemployment levels have continued to benefit moderate and low-income consumers, and our customers tend to be remarkably resilient in difficult economic conditions. However, as the benefits of government stimulus declined and inflation accelerated earlier this year, the pressure on consumers' personal finances increased, particularly for those consumers in higher risk credit segments. As a result, the delinquency rates for many non-prime lenders reverted to pre-pandemic levels during the second quarter. And in the third quarter, the delinquency rates of our own loan portfolio also normalized to pre-pandemic levels. As of the end of the quarter, our 30-plus day delinquency rate was 7.2% and our annualized net credit loss rate during the third quarter was 9.1%. The sequential increase in delinquency was due to normal seasonal patterns, the continuing impact of certain segments that we eliminated earlier this year, and the lag effect of inflation, particularly high gas and food prices. The lag effect was most apparent in the month of July, but in August and September, we observed a slowdown in the rate of increase in delinquencies to what we would ordinarily expect from normal seasonal trends. Encouragingly, as of quarter end, a 1 to 29-day delinquency bucket was performing 120 basis points better than September 30, 2019, pre-pandemic levels. We attribute the strong performance in the early stage bucket to our credit tightening actions and our focused collection efforts, both of which are benefiting our more recent 2022 vintages. The late-stage buckets are performing worse compared to 2019, largely due to weak performance in our 2021 vintages. As of September 30, 32% of our portfolio was originated in 2021, and we expect that number to decline to roughly 25% by year-end and 10% by the end of 2023. As we previously discussed, we began tightening credit in the fourth quarter of last year, principally focused on certain higher risk, higher rate customer segments that had been most adversely impacted by inflation. On our last call, we noted that we had eliminated one higher risk, higher rate digital affiliate and two higher risk, higher rate segments within our direct mail program. Loans originated through the eliminated affiliate and direct mail segments contributed 30 basis points to our 30-plus day delinquency rates as of September 30, and 60 basis points to our net credit loss rate in the third quarter, despite only representing 1.9% or $31 million of our total portfolio as of quarter-end. We expect that this stress portion of our portfolio will run off by the middle of next year. Our remaining portfolio continues to perform well considering the current environment with delinquency and net credit loss rates just above pre-pandemic levels. While our credit tightening actions slowed our year-over-year receivables growth to 22% in the third quarter, we believe that the trade-off between credit and growth is appropriate. New borrowers represented 31% of our 2022 originations, compared to 23% in 2019 originations. New borrowers naturally perform worse on average than our incumbent present borrowers, who remain in our portfolio following a loan refinancing. The higher credit losses on our new borrower portfolio reflect a component of our investment in growth. By tightening credit over the past year, we believe we continue to strike the right balance between growth investment and credit quality. As I'll discuss later, it's worth highlighting that we're achieving our growth principally through geographic expansion, not from credit box expansion. Given the uncertainty presented by persistently high inflation and rising interest rates, we prudently increased our allowance for credit losses to 11.2% of net finance receivables at the end of the quarter, including $19 million of macro-related reserves. We feel very comfortable with our current credit posture and are well positioned for an economic downturn. As a reminder, we design our loan products to remain profitable under stressed economic scenarios. We believe that our investments in improved credit models and collection capabilities, years-long shift to large and sub-36% loans, and recent credit tightening actions have contributed to an overall higher quality portfolio, compared to pre-pandemic levels. Average FICO scores on originations in the third quarter were 15 points higher than the average in the third quarter of 2019. In the third quarter, 83% of new originations had a FICO score at or above 600, compared to 72% in the third quarter of 2019. In the third quarter, 96% of our new borrowers had a FICO score at or above 600. In light of the evolving economic environment, our primary focus remains on maintaining the credit quality of our loan portfolio, supporting our customers and controlling expenses. In August, we began rolling out our next generation custom credit scorecard, and we remain on track to complete the rollout by the end of the year. The new advanced model evaluates more than 5,000 attributes, including alternative data, and has more complex segmentations that will allow us to further fine-tune our underwriting strategies, swap in incremental loans at the margin, increase origination volume and drive higher revenues, all while keeping losses stable. We also continue to increase the size of our centralized collection staff, incentivize branch labor towards collection activities and improve our collection tools and training. Last quarter, we began leveraging a third-party collector to augment our in-house collection efforts. For customers who fall behind on their payments, we offer borrower assistance programs that enable them to manage their debt obligations, cure their accounts, resume repayment and maintain their creditworthiness. These borrower assistance programs have been a part of our business for decades. They act as an important bridge for our customers while requiring them to remain engaged and active in repaying their accounts. We know from past experience that these programs reduce credit losses for those customers who utilize the programs. In the third quarter, we began offering new digital solutions to ease access to these programs for our customers. We will continue to monitor economic conditions in all segments of our portfolio closely. For example, we are carefully tracking the performance of renters and have tightened in this segment this year. Rents have remained elevated over the past year, but it appears that rents nationally may have hit an inflection point in September as the U.S. median rental price declined sequentially in the month. There are also segments of our portfolio that could experience benefits in the coming year. For example, roughly 21% of our portfolio is outstanding to fixed income borrowers, who will be receiving an 8.7% increase in benefits in 2023, providing much-needed relief to this segment. Similarly, we estimate that roughly 18% of our portfolio is outstanding to borrowers who also carry student loan debt. As the federal student loan forgiveness plan begins to move forward, we believe that it could wipe away as much as $780 million in student debt for the borrowers in our portfolio. Lastly, we will continue to monitor labor market trends. There remain millions of job openings for our lower and moderate-income customers in their respective industries, along with strong wage growth including 7.3% annual wage growth in the lowest quartile wage earners in the third quarter. The strong labor market and robust wage growth may help protect the lower-income segment as the economy slows. In sum, we'll remain conservative on credit even as we continue to grow our business, and we'll adapt our underwriting models quickly whenever we observe either risks or opportunities in the market. In recent months, we've also taken additional steps to strengthen our balance sheet and liquidity, protect ourselves against rising rates, lower our expense base and focus our operations on our core product offerings. In September, we made the decision to discontinue our retail loan product offering effective in November. As of the end of the third quarter, the retail portfolio stood at only $11 million or less than 1% of our total portfolio. We concluded that our capital was better invested in our core loan portfolio, which continues to experience strong growth and profitability. Along with the retail portfolio discontinuation, we completed a small reduction in force in our corporate offices and we moved to new office space in the Dallas area, necessitating an acceleration of expense on the prior lease. These actions resulted in general and administrative expenses of $600,000 in the third quarter. The retail product discontinuation will generate approximately $1.1 million in annual general and administrative expenses moving forward, which will be used to fund our growth initiatives, including our geographic expansion that I'll touch upon in a moment. In October, we closed a $200 million asset-backed securitization. The transaction has a two-year revolving period, and the Class A notes received AAA ratings from both S&P and DBRS. Following the transaction, nearly 100% of our debt was fixed with a weighted average coupon of 3.6% and a weighted average revolving duration of 2.3 years. Despite a challenging market environment, we experienced solid investor interest in that transaction, and as a regular issuer in the ABS market with an established investor base, we feel very comfortable in our continued ability to access funding to fuel our growth. We also continue to optimize pricing across all segments of our loan portfolio. In several of our states, we have substantial pricing opportunities, in part because we do not self-impose a 36% rate cap. We believe that we have opportunities to increase our revenue yield and improve our margins to offset some of the inflationary pressure and increasing funding costs. Despite the economic uncertainty, we continue to invest in our growth initiatives and execute on our long-term strategic plans. In the third quarter, we entered California and Louisiana, and within the next three to four months, we plan to enter another two new states. Since the outset of the pandemic, we have entered six new states and increased our total addressable market by nearly 75%. Our geographic expansion provides us with new market opportunities to create growth without necessitating an expansion of our credit box. We also continue to experience success in deploying our lighter footprint model in new states. Through October, these branches on average exceeded $3 million in receivables within six months and exceeded $5 million within 12 months. Looking ahead, we'll continue to utilize a lighter footprint model in our newer states and further optimize our footprint in our legacy states. There remains substantial opportunity to continue growing in states that we've entered since 2020 and in new states. On the digital front, we continue to gain experience with our new end-to-end lending pilot, which is underway in one of our states. Meanwhile, our prequalification channel continues to produce strong high-quality volume. We originated a record $56 million of digitally sourced loans in the third quarter, up 17% from the prior year period. New digital volumes represented 32% of our total new borrower volume in the quarter. As a reminder, other than the loans originated through our end-to-end digital panel pilot, digitally sourced loans are fully underwritten by our brand's personnel. In conclusion, I'm proud of our team's execution in the third quarter. We've continued to protect our portfolio company as we move through a difficult macroeconomic environment. At the same time, we maintained our execution on our long-term strategic plans of controlled, disciplined growth. I'll now turn the call over to Harp to provide additional color on our financial results.

Thank you, Rob, and hello, everyone. I'll now take you through our third quarter results in more detail. On page three of the supplemental presentation, we provide our third quarter financial highlights. We generated net income of $10.1 million, and diluted earnings per share of $1.06. Our results were driven once again by high-quality portfolio and revenue growth and careful management of expenses, partially offset by our base reserve build for portfolio growth, a $4.1 million increase in our macro-related reserve and the $0.6 million restructuring charge that Rob discussed earlier. Year-to-date, we produced annualized returns of 4.3% ROA and 21.7% ROE. Turning to page four, we once again experienced solid demand for our loan products as we continue to focus our efforts on larger high-quality loans. We had $419 million of total originations in the quarter, which is on par with the prior year period. We were pleased with our ability to maintain robust origination activity despite recent credit tightening actions and a shift in focus in our branches to collection activities. Direct mail and digital originations were up 11% and 17%, respectively, compared to the prior year, while branch originations trailed the prior year by 8%. As you can see on page five, we continue to grow our digital channel through affiliate partnership expansion. In the third quarter, digitally sourced originations ended at a record of $56 million, representing 32% of our new borrower volume in the quarter. We continue to meet the needs of our customers through our multichannel marketing strategy. Page six displays our portfolio growth and product mix through the third quarter. We closed the quarter with net finance receivables of just over $1.6 billion, up $82 million from the prior quarter and up $293 million year-over-year. On a product basis, we continued our shift to large loans and loans at or below 36% APR. As of the end of the third quarter, our large loan book comprised 69% of our total portfolio, and 85% of our portfolio carried an APR at or below 36%. As we noted on our prior call, it was possible that we would miss our portfolio growth guidance if we elected to tighten credit in light of the volatile economic environment. This tightening actions in our shift in branch labor attention to collection efforts caused us to miss guidance, but we believe that our intention of slowing growth in favor of a focus on credit and collection is appropriate. Year-over-year, we grew our ending net receivables by 22% in the third quarter, compared to year-over-year growth rates of 31% and 29%, respectively, in the first and second quarters of this year. Looking ahead, we anticipate similar sequential portfolio growth in the fourth quarter as we continue to watch the macroeconomic environment and keep a close eye on our underwriting. In the fourth quarter, we expect to grow our net finance receivables by approximately $70 million. We are focused on smart controlled growth and, as dictated by the circumstances, we will further tighten our underwriting, which would impact our estimated fourth-quarter growth. As shown on page seven, our growth initiatives, lighter branch footprint strategy in new states, and recent branch consolidation actions in legacy states contributed to another strong same-store year-over-year growth rate of 19% in the third quarter. Our receivables per branch were at an all-time high of $4.8 million at the end of the third quarter. We believe considerable growth opportunities remain within our existing branch footprint, particularly in newer branches. Turning to page eight, total revenue grew 18% to a record $131 million in the third quarter. Due to a continued mix shift towards larger, higher quality loans and the impact of credit normalization, our total revenue yield declined 230 basis points and our interest and fee yield declined 240 basis points year-over-year. We continue to believe that the tightening of underwriting on higher risk, higher yield segments and the shift in our portfolio towards higher quality large loans is appropriate in light of the uncertain macroeconomic environment. In the fourth quarter, we expect sequential declines of 100 basis points in total revenue yield and 80 basis points in interest and fee yield primarily due to credit normalization. As the credit environment improves, our yields will increase. And as Rob noted earlier, we had significant pricing power in parts of our portfolio that will enable us to recapture some of the decline in yields in the future. Moving to page nine, our 30-plus day delinquency rate as of quarter-end was 7.2%, up 100 basis points sequentially and up 70 basis points compared to September 30, 2019, inclusive of the 30 basis points of impact from the eliminated Digital Affiliate and Direct Mail segment that Rob discussed earlier. Our net credit loss rate in the third quarter came in at 9.1%, up 100 basis points compared to the third quarter of 2019, inclusive of the 60 basis points of impact from the eliminated Digital Affiliates and Direct Mail segment. We expect delinquencies to increase gradually in the fourth quarter consistent with normal seasonal trends and the challenging economic environment. Likewise, we anticipate that fourth quarter net credit losses will be approximately $11.6 million higher than the third quarter, as late-stage delinquency buckets flow through to loss, including approximately $2 million of the segments we eliminated. Turning to page 10, we built our allowance for credit losses by $12.3 million in the third quarter, including an incremental $4.1 million in macro-related reserves related to potential future macroeconomic impacts on credit losses. As of quarter-end, the allowance was $180 million or 11.2% of net finance receivables. Our allowance model contemplates that the unemployment rate will peak at 6.4% in the third quarter of next year and then gradually decline. The allowance continues to compare favorably to our 30-plus day contractual delinquency of $116 million and includes a macro-related reserve of $19 million. These macro-related reserves amount to 11% of our total allowance for credit losses, a strong position as we continue to monitor the health of the economy and the consumer. In the fourth quarter, we're expecting to build our base reserves by approximately $7.6 million to support portfolio growth in the quarter, and we expect to end the year with a reserve rate of approximately 11.2%, subject to macroeconomic conditions. Over the long term, we continue to believe that our reserve rate could drop to as low as 10% once the macroeconomic environment stabilizes, which would be lower than our day one CECL reserve rate of 10.8%, with the improvement attributable to our shift to higher quality loans. Looking to page 11, we continue to manage general and administrative expenses tightly in the face of normalizing credit. General and administrative expenses for the third quarter were $58.2 million. Relative to the guidance we provided on our prior call, G&A expenses came in $1.2 million higher than our expectations, primarily due to one-time restructuring costs of $0.6 million and increased incentive accruals for our 2022 long-term incentive program, which was based upon our pre-provision net income and EPS performance over a three-year period, compared to our peers. Our strong performance relative to our periods during the performance period necessitated an increase in the 2020 long-term incentive accrual. Our annualized operating expense ratio was 14.9% in the third quarter, a 50 basis point improvement from the prior year period. The expense ratio includes a 20 basis point impact from the one-time restructuring costs. Moving forward, we will continue to manage our expenses tightly and prioritize those investments that are most critical to achieving our strategic objectives. Over the long term, we believe that our investments in our digital capabilities, geographic expansion, data and analytics, and personnel will drive additional sustainable growth, improved credit performance, and greater operating leverage. In the fourth quarter, we expect G&A expenses to be approximately $59.1 million. Turning to page 12, our interest rate expense for the third quarter was $11.9 million, better than initially expected due to slower growth in our receivables. We sold our remaining $100 million of interest rate caps in August, enabling us to lock in $2.3 million of lifetime market value gains on the cap. In total, we recognized $15.1 million of lifetime gains on the $550 million of interest rate caps, including $13.1 million in gains in 2022. In the fourth quarter, we expect interest expense to be approximately $14.6 million. Page 13 displays our strong funding profile and healthy balance sheet. Over the last several years, we have diversified our types and sources of funding, enabling us to mitigate interest rate risk and maintain access to liquidity throughout the economic cycles. As of the end of the third quarter, we had $565 million of unused capacity on our credit facilities and $181 million of available liquidity consisting of unrestricted cash on hand and immediate availability to draw down on our revolving credit facility. Our debt has staggered revolving duration stretching out to 2026, providing protection against short-term disruption in the credit market. We have ample capacity to fund our business even if further access to the securitization market were to become restricted. We have also aggressively managed our exposure to rising interest rates by increasing the level of our fixed-rate debt to nearly 100% of total debt, following the closing of our most recent securitization transaction in October. As of the closing, our fixed-rate debt had a weighted average coupon of 3.6% and a weighted average revolving duration of 2.3 years. As a reminder, our future portfolio growth would be funded in part by variable-rate debt on our revolving credit facility. Our third quarter funded debt to equity ratio remained at a conservative 4 to 1. We continue to maintain a very strong balance sheet with low leverage, healthy reserves, ample liquidity to fund our growth and substantial protection against rising interest rates. Our effective tax rate during the third quarter was 24.6%, compared to 22.8% in the prior year period. For the fourth quarter, we expect an effective tax rate of approximately 24.5%, prior to discrete items such as any tax impacts of equity compensation. During the quarter, we also continued our return of capital to our shareholders. Our Board of Directors declared a dividend of $0.30 per common share for the fourth quarter of 2022. The dividend will be paid on December 14, 2022, to shareholders of record as of the close of business on November 23, 2022. We're pleased with our third quarter results, our strong balance sheet and our near and long-term prospects for controlled sustainable growth. That concludes my remarks. I'll now turn the call back over to Rob.

Thanks, Harp. As always, I'd like to thank our team for their hard work and strong execution. We're proud of our third quarter results, but our attention is now on what lies ahead. The economic environment will remain challenging to the end of the year and into 2023. Our focus will continue to be on maintaining the credit quality of our loan portfolio, while at the same time executing on our long-term strategic plans of controlled, disciplined growth and digital innovation. Thank you again for your time and interest. I'll 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. The first question comes from David Scharf with JMP Securities. Please go ahead.

Good afternoon. Thank you for taking my questions, Rob and Harp. I promised myself I would steer clear of the usual macro questions about inflation that we hear every earnings call. However, you mentioned something, Rob, and I want to clarify to ensure I got this right. Did you indicate that the reserve rate, among other factors, was based on unemployment peaking at 6.4% or 4.4%?

No. Hey, David. Thanks for the question. Yes, we have it factored in peaking at 6.4%, I think in the third quarter of next year.

Third quarter of 2023 and then it gradually

Right. Okay, so I wrote it down correctly. I was just wondering if that forecast is perhaps more conservative than what others might expect regarding where the Fed might ultimately allow things to go. Are there specific benchmarks you have in mind, either for year-end or by March, at which you believe the reserve rate might be too high? If things stabilize around the 5% range, I am trying to understand what that might mean for returning to that initial CECL level.

Yes. No, appreciate that, David. So when we look at our reserve rate, going back to COVID, we built up obviously a macro reserve for that environment. We did bring down that reserve rate as you know, I think, maybe not as much as maybe others in the industry. And so we haven't had the need to build as much. But as we're sitting here right now and inflation is still high, although it's hopefully turned the corner, we felt it prudent to bump the reserve up a little bit and assume a more stressed environment next year. I sure hope that unemployment is in 6.4% next year and inflation comes down. Look, I'm very encouraged by the job market today. There was an increase in the number of available jobs that went from 10.3 million to 10.7 million, which is roughly two open jobs for every person seeking a job. And I think based on the industries where those open jobs are, I think that's even indexed higher towards low and moderate-income consumers such as our customers. So look, we're hoping for a good outcome next year on the economy, but we're being prudent and making sure we're protected if things were to deteriorate.

Got it, got it. Hey, shifting to just competition, I mean, mindful you've been very prudent and cautious in taking your foot off the accelerator. But we've heard on some other calls from some other non-prime lenders, specifically Enova and OneMain, that they've sensed a material pullback in lending volumes and conversions in marketing from a number of near-prime competitors, some of them all digital, some otherwise. Are you seeing the same thing? Trying to get a sense for, obviously, you're getting a lot of growth from just geographic expansion. But even though the last thing anybody wants to see is, as you know, is growing needlessly when there's so much economic certainty, but at the same time. Are you sensing an opportunity given all your excess liquidity and so forth that now might be the time to sort of pounce?

It's a great question and something we discuss regularly. I believe some companies may be pulling back for liquidity reasons or because they took on too much risk last year without tightening their approach quickly enough. I'm confident that we started tightening our underwriting late last year and have continued to do so this year. There's plenty of demand out there, allowing us to choose where we want to grow and where we prefer not to. You’re correct that we have slowed our growth by focusing more on collections. The 22% year-over-year growth we achieved this quarter was the slowest in the last five quarters, but we see that as a prudent choice given the current economic cycle. This approach enables us to selectively target growth areas and prioritize segments that provide the best risk-return balance. As of this quarter, 83% of our originations are to customers with FICO scores above 600, and roughly 60% of our originations in the third quarter came from our top two risk categories. We're originating solid credit and are pleased with our position as the economic environment evolves. We aim to stay flexible, ready to cut back if conditions worsen, while also being opportunistic should the situation improve.

Terrific. Great, thanks so much for taking my questions.

Great. Appreciate it, David, as always. Thanks.

The next question comes from John Hecht with Jefferies. Please go ahead.

Hey, thanks guys. Actually, Dave asked another question I was going to ask but I wanted to resubmit into the California and some other new geographies it sounds like that gives you the opportunity to kind of continue to tighten, but also expand into new markets at the same time. Maybe give us a sense of the characteristics of the loans you're doing in California and where you think you are in that geographical ramp?

Yes, California is a new market for us with our first branch. Everything is currently under 36%, and we are just beginning to scale up. It's a large state with significant potential. Since the pandemic, the new states we have entered, especially California, have allowed us to increase our addressable market by 75%. This growth is possible without changing our credit standards, as we are expanding geographically and targeting the best customers in these areas. We are still in the early stages in California, and we made the tough choice to exit the retail business for various reasons, including supply chain issues and competitive pricing. This decision frees up over $1 million in expenses, which could fund four new branches. Typically, after 12 months in new states, each branch generates around $5 million in receivables. Therefore, there is significant potential for growth by expanding in these states with a streamlined approach and utilizing our digital capabilities to serve our customers. This model has proven to be effective, and we plan to continue pursuing this growth, as it is fundamentally sound.

Okay. I understand you're not providing guidance for next year yet, but considering current trends, the tightening, and the increased focus on larger loans, how should we view the potential range for that mix? I believe you mentioned it’s around 69% or 70% now. What are your thoughts on where that might head and how that could impact the consolidated yields as the mix shifts?

Well, so we're 70% large, but more importantly on the yield, we're at 85% below 36%. What's great about our position, particularly in an inflationary environment is unlike some competitors, we haven't self-imposed the 36% rate cap. There's been a lot of people leave that market. So depending on where we see the business here at the end of the year, we have the opportunity to pivot right or pivot left. We can increase the percentage of sub-36% or we could slow that and maybe stabilize it or go the other way. It really depends on all the variables that we have to look at in terms of the credit environment, performance of the customers and the like. But from a yield standpoint, there's two components of the yield. One, when you're in a rising environment of net credit losses, you have a higher reversal on interest revenue. And so as you see credit normalize and stabilize and come down, then your yield is going to adjust accordingly. And we'll get some improvement. And today, the deterioration in yield of about 200 basis points from prior years, half of that is due to the normalizing credit. The other half is due to mix. And as I said, we may choose to address some of the mix issues depending on how the credit environment is. But ultimately, what we do is we price for our risk, we look for risk-adjusted returns. And if we do that, then we're going to deliver the bottom line that we expect to deliver.

Alright. And then forgive, but Harp mentioned this, but you did mention the $600,000 of elevated expenses towards restructuring. And then you mentioned the wind down of the retail loans. What I guess take this just all else equal what would the run rate of expenses be at this point?

You're referring to the savings of $1.1 million from the actions we took. However, if you're seeking guidance on run rate expenses for next year, we are currently in the planning process and assessing our investment strategies and amounts, so we will provide updates on that as we approach the end of the year.

Sorry.

Yes. We did give guidance in terms of right fourth quarter expenses.

And what was that?

$59.1 million.

Okay, I missed it. Sounds good. Okay, go ahead.

Thanks, John.

The next question comes from Sanjay Sakhrani with KBW. Please go ahead.

Hi, this is actually Steven Kwok filling in for Sanjay. Thanks for taking my questions. The first one I have is just around the yield and where we are today relative to pre-pandemic from the impact of credit normalization? Are we back to where it should be? Or could there be further pressure on the yield as a result of that?

Yes, when you reach a 90-day delinquency, the account stops accruing interest. Then, when it goes into charge-off at 180 days, you begin to see interest reversals. The changes we've observed in the past two quarters, when compared year-over-year, are mainly attributed to credit normalization. We need to monitor when credit will normalize. We provided guidance in the prepared remarks about the expected net credit losses for the next quarter. You can expect continued impact on yield from credit normalization. However, it's important to note that as credit normalizes, the reversals and non-accruals will improve, which will enhance yields as well.

And then I think just, you know, I said to John, if we decide to slow the shift to sub-36% business, because there are some attractive risk-return segments that we can go after greater than 36%, then that's been part of the mix shift in the last year or so as we've tightened it. It's taken away some high-yield parts of our portfolio. We certainly can lean into that in an appropriate way once we're comfortable with the risk environment.

Got it, understood. And then just from a sensitivity perspective on your reserve rate, the 11.2% you call out is relative to a 6.4% peak unemployment rate. If we were to stress that unemployment rate in either direction, say 100 basis points, how much would the reserve rate have to change to accommodate for that?

Yes, Steven, not something I can really give you at this point in time, because the model is not just sensitive to unemployment. It's the delinquency performance of the portfolio, other qualitative factors that we might put in. And again, the 6.4% is a full unemployment rate. I'm still somewhat of the opinion and we'll see if it bears out that given the 10.7 million open jobs and how they're correlated with industries where our customers are and low and moderate-income employees. And there's been some market indications saying this that this could be more of a white-collar downturn than something that's going to hit the lower-income band. So we'll just have to see how that all plays out. Hopefully, employment stays strong for low and moderate-income folks. Certainly, wage growth recently, about 7.3% for that segment. So we'll have to see how that plays out. But to try to give you sensitivity on one variable, it's just not something we can do at this point.

Yes, Steven, the only other thing I would add to that is, right, lots of variables in there, including some of the ones that Rob mentioned, right, portfolio mix and growth. Our credit loss trends, contractual life, loss ratio, et cetera. So there's many things that go into coming up with that reserve amount. But a reminder that we actually look at that quarterly. So every quarter we look and we reassess where unemployment is going to be. And then we reassess that reserve rate. So that's just something to keep in mind that as the macroeconomic environment improves, we'll take that into account in assessing our reserves.

Understood. Great, thanks for taking my questions.

The next question comes from Vincent Caintic with Stephens. Please go ahead.

Thank you for taking my question. I want to follow up on the relationship between the net charge-off rate and the yield. First, regarding the net charge-off rate, I understand that the 2021 vintages were higher, which may be contributing to the increased losses compared to 2019 levels. If we were to exclude the 2021 figures and focus on normalizing that, should we expect the rate to be 10% or less by the end of 2023? What net loss rate should we keep in mind, and should we reference the 2019 levels? That's my first question about charge-offs. For the second question on yield, I realize that it has been declining, with part of that decline due to increased losses or non-accruals, and the other part due to a mix shift. Can you elaborate on whether it's possible to add price within each of the components of the mix? Should we anticipate yield expansion across the different categories? Thank you.

Yes, that's a great question. Regarding the outlook for net credit loss rates, it's difficult to predict due to the current macro environment and the impact of the 2021 portfolio. Our loss rate this quarter was 9.2%, with 60 basis points attributed to eliminated segments, which represent about 1.9% of our portfolio or $31 million. Adjusting for this, our rate is approximately 40 basis points higher compared to pre-pandemic levels, reflecting the inflationary pressures on our customers. We noticed a rise in credit delinquencies in July, influenced by increased gas prices and seasonal trends in August and September. While I can't provide estimates for next year, it's important to consider the various factors at play, including inflation, strong job numbers, a potential 8.7% increase for fixed income customers, and possible student loan forgiveness. Despite the macro risks, there could also be beneficial offsets. We incorporate all this information into our underwriting models to prepare for a stressed environment, and if conditions improve, that would be favorable. Regarding yields, I can say that over half of the decrease is due to credit deterioration, with the remainder related to mix shifts. We still possess strong pricing power; we haven’t self-imposed a 36% interest rate cap and can continue profitable business above that threshold. We also have pricing opportunities below 36%, so the extent to which we can improve yields depends on our comfort with the macro environment and our willingness to take on additional credit risk while ensuring we meet our return objectives.

Okay. That's very helpful. Thanks very much.

Yes, appreciate the question.

The next question comes from Matt Dhane with Tieton Capital Management. Please go ahead.

Thank you. I wanted to touch on the end-to-end digital originations pilot that you folks have been working on here for a while. I was just curious what key learnings have you had to date? And what are your current expectations on when you may roll that out a little bit more widely here?

Thank you, Matt, for that important question regarding our direction for next year. We aim to enhance our efficiency and digital capabilities. While I need to be cautious about revealing too much from a competitive perspective, I can share that the insights from our pilot have highlighted areas in the end-to-end experience that lead to customer drop-off. We are focused on improving that experience and adapting our strategy to achieve a meaningful pull-through rate. I won't specify what meaningful entails at this moment, but achieving a better pull-through for customers without relying solely on branch staff for loan origination will boost our productivity. This shift will enable branch staff to either originate more loans or focus on collections. We are enthusiastic about this initiative and will update you on the rollout pace soon. We've gained valuable lessons from the pilot and are ready to advance to the next phase.

Great. That's helpful. Thank you, Rob.

No, great. Appreciate it, Matt.

At this time, there are no further questions. I would like to turn the conference back over to Rob Beck for any closing remarks.

Thank you, operator, and thank you everyone for joining us. We're pleased with our quarterly results despite the challenging economic environment, and we're maintaining our strength. Our focus remains on preserving credit quality, supporting our customers, and managing our expenses while continuing to pursue our long-term growth strategies, which emphasize controlled and disciplined growth along with digital innovation. I want to highlight the steps we've taken to navigate the credit landscape, as mentioned in our prepared remarks. It's worth reiterating our actions: we tightened credit last year, eliminated three segments, and intentionally slowed our growth along with charge-off growth over the past five quarters. The growth we are experiencing is not due to increased risk but primarily from our geographic expansion. We are currently rolling out our next-generation scorecard. We have expanded our centralized collection team, adjusted the incentives for our branch staff towards collections, and enhanced our collection tools and training. We also brought in a third-party collector to support our team and are utilizing our well-established assistance programs to improve access for customers through various digital channels. We've been proactive and engaged in these efforts throughout the year. We will continue to monitor our portfolio, employment, and inflation, and adjust our underwriting models to align with changing macroeconomic conditions. Thank you for your time and your questions, and have a good evening.

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