Earnings Call Transcript - RM Q3 2023

Operator, Operator

Thank you for standing by. This is the conference operator. Welcome to the Regional Management Third Quarter 2023 Earnings Conference Call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Garrett Edson with ICR. Please go ahead.

Garrett Edson, IR Representative

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 2 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 our future operating results and financial condition. Also, our discussion today may include references to certain non-GAAP measures. Reconciliation of these measures to the most comparable GAAP measure can be found within our earnings announcement or earnings presentation posted on our website at regionalmanagement.com. I would now like to introduce Rob Beck, President and CEO of Regional Management Corp.

Rob Beck, CEO

Thanks, Garrett, and welcome to our third quarter 2023 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 current operating environment and loan portfolio performance, and share our expectations for the fourth quarter. We continued our focus on portfolio quality, expense management, and strong execution of our core business in the third quarter. We generated $8.8 million in net income and $0.91 in diluted EPS. Strong loan demand and our conservative underwriting criteria led to high-quality portfolio growth of $62 million, record revenue of $141 million, and a sequential increase in revenue yields of 80 basis points, all of which exceeded our expectations for the quarter. We also continue to closely manage our G&A expenses while investing in our business, driving a 50 basis point improvement in our operating expense ratio from the prior year. We're pleased with our team's ability to deliver consistent, predictable, and superior results for our shareholders quarter after quarter. As you would expect, we're keeping a close eye on the economic environment and its impact on our consumer base. Recent data indicates a strong labor market, moderating inflation, and real wage growth. However, we continue to observe stress in certain segments of our portfolio caused by inflationary pressures. We also remain mindful that the resumption of student loan repayments will impact many consumers' budgets, and we're monitoring whether recent geopolitical events may cause energy prices to increase further. As a result, we remain selective in making loans within our tightened credit box. While we achieved strong high-quality portfolio growth in the third quarter, we slowed our year-over-year growth rate to 9%, down from 22% in the third quarter of last year. We're prepared to lean back into growth when economic conditions are right, but until then we'll maintain a conservative credit posture. Our third quarter originations reflected our selective underwriting. We originated 60% of our volume to our top two risk ranks. We continue to emphasize present and former borrower lending over new borrower lending and we further grew our auto secured portfolio to 8.3% of our total loan portfolio, up from 6% a year ago. We're also seeing the benefit of the machine learning-driven credit and marketing models that we've implemented in recent quarters. We see additional opportunity for improvement as we develop our next-generation models. We ended the third quarter with a 30-plus-day delinquency rate of 7.3%, up 40 basis points from the second quarter but consistent with normal seasonal trends. Our higher quality originations from credit tightening have kept our first payment default and early-stage delinquency rates below 2019 levels. Our July one payment default rate was 50 basis points better than July 2019 rate. Our third quarter one-to-59-day delinquency rate was 110 basis points better than the third quarter of 2019. Notably, we're seeing solid performance in fourth quarter 2022 and 2023 vintages. As of September 30, these vintages represent nearly 70% of our portfolio, a number we expect to increase to nearly 80% by year-end. Macroeconomic conditions, however, have continued to stress mid-and-late-stage delinquencies and loan rates, something we've observed across our industry, particularly for loan vintages originated prior to late 2022. This is causing our delinquency levels and credit losses to be higher than we'd like. We anticipate that this stress will linger into at least the early part of 2024, but we continue to expect that credit tightening actions, strong collections execution, and moderating inflation will gradually bring delinquencies and credit losses back down to more normalized levels over time, subject to the macroeconomic environment. Looking ahead, in the near to midterm, we'll navigate this challenging economic environment in much the same way that we have over the past year. We'll focus on strong execution of our core business, including by maintaining a tight credit box and originating loans only where we can achieve our return hurdles under an assumption of additional credit stress and higher funding costs. As we've discussed in the past, we have a large addressable market that provides us with ample opportunity to take advantage of high levels of consumer demand to drive strong portfolio growth, while still remaining selective in approving borrowers under our conservative underwriting criteria. Where appropriate, we'll also continue to pursue opportunities to increase pricing and expand our margins, a strategy that has been effective in recent quarters in improving our revenue yield. At the same time, we'll keep a firm handle on expenses while continuing to make key investments in technology, digital initiatives, and data analytics, including artificial intelligence. These investments are critical to achieving our strategic objectives and will create additional sustainable growth, improved credit performance, and greater operating efficiency and leverage over the long term. In summary, we're pleased with our results, and we're proud of our team's execution. We're well positioned to operate effectively in the current economic cycle, and with ample liquidity and significant borrowing capacity in a large addressable market, we stand ready to lean back into growth when justified by economic conditions. I'll now turn the call over to Harp, to provide additional color on our financial results.

Harp Rana, CFO

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 $8.8 million and diluted earnings per share of $0.91. Our results were driven once again by high-quality portfolio and revenue growth and careful management of expenses, partially offset by increased funding costs and net credit loss headwinds caused by macroeconomic conditions. Turning to pages four and five, demand remained strong in the quarter but our tighter underwriting standards, emphasis on present and former borrower originations, and collections focus led us to increase total originations by only 2% over the prior year. By channel, direct mail originations were up 12%, while branch and digital originations were down 1% and 10% respectively. As we've consistently noted, we've deliberately reduced originations in recent quarters as we appropriately balance growth with further enhancing the credit quality of our portfolio. Page six displays our portfolio growth and product mix for the quarter. We closed the third quarter with net finance receivables of just over $1.75 billion, up $62 million from June 30 and ahead of our guidance. As of the end of the third quarter, our large loan book comprised 73% of our total portfolio, and 85% of our portfolio carried an APR at or below 36%. Notably, we grew our small loan portfolio by $30 million or 7% in the third quarter. These higher margin loans will support future revenue yield, offsetting increasing funding costs, and meet our return hurdles, despite higher expected net credit losses on these somewhat riskier segments. Looking ahead, we expect our ending net receivables in the fourth quarter to grow by approximately $35 million as we continue to monitor the economic environment and maintain our current underwriting standards. We remain focused on smart controlled growth, particularly given the continued uncertainty around consumer financial health. As circumstances dictate, we're prepared to further tighten our underwriting or lean back into growth, either of which would impact ending net receivables. As shown on page seven, our lighter branch footprint strategy in new states and branch consolidation actions in legacy states continue to drive our receivables per branch to all-time highs coming in at $5 million at the end of the quarter. We believe considerable growth opportunities remain within our existing branch footprint under this more efficient model, particularly in newer branches and newer states. Turning to page eight, total revenue grew 7% to $141 million in the third quarter. Our total revenue yield and interest and fee yield were 32.7% and 29% respectively. The year-over-year decline in yield is primarily attributable to our continued mix shift towards larger, higher quality loans and the impact of the macroeconomic environment. However, we're pleased to see yields move up 80 basis points sequentially, in part from the impact of pricing increases on newer loans and improved credit performance. In the fourth quarter, we expect sequential declines in interest and fee yield, and total revenue yield of 20 basis points and 50 basis points respectively, due to seasonally higher net credit losses and interest reversals, offset in part by the impact of pricing increases. We continue to anticipate that our increased pricing will drive further benefits for yields in future quarters as these actions roll through the portfolio over time. Moving to page nine, our 30-plus-day delinquency rate as of quarter end was 7.3% and our net credit loss rate in the third quarter was 11%. Our tightened underwriting helped ensure that the increase in our delinquency rates stayed in line with seasonal patterns, while net credit losses came off of their second quarter highs as expected. In the fourth quarter, we expect our delinquency rate to increase slightly compared to the third quarter based on normal seasonality. In addition, we anticipate that our net credit losses will be approximately $52 million in the fourth quarter with the sequential increase also being due to normal seasonality. Turning to page ten, our allowance for credit losses increased slightly in the third quarter as we built reserves to support receivables growth that decreased our reserve rate by 10 basis points to 10.6%. As of quarter end, the allowance was $185 million, which continues to compare favorably to our 30-plus-day contractual delinquency of $128 million. We expect to end the year with a reserve rate between 10.4% and 10.6%, subject to macroeconomic conditions. Over the long term, under a normal economic environment, we continue to expect that our net credit loss rate will be in the range of 8.5% to 9%, based on our current product mix and underwriting. We believe, over time, that our reserve rate could drop to as low as 10% with the improvement attributable to our shift to higher quality loans. As we've always done, however, we'll manage the business in a way that maximizes direct contribution margin and bottom line results. Flipping to page eleven, we continue to closely manage our spending while investing in our capabilities and strategic initiatives. G&A expenses for the third quarter were better than our prior guidance, coming in at $62.1 million. Our annualized operating expense ratio was 14.4% in the third quarter, 50 basis points better than the prior year period, and our revenue growth outpaced our expense growth by a factor of 2.4 times. We'll continue to manage our spending closely moving forward. In the fourth quarter, we expect G&A expenses to be approximately $64 million to $65 million to support receivables growth and continued targeted investments in our operations. Turning to pages twelve and thirteen, our interest expense for the third quarter was $16.9 million or 4% of average net receivables on an annualized basis. Despite the sharp increase in benchmark rates since early 2022, we've experienced a comparatively modest increase in interest expense as a percentage of average net receivables, thanks to fixed-rate debt issued through our asset-backed securitization program. As of September 30, 87% of our debt is fixed-rate with a weighted average coupon of 3.6% and a weighted average revolving duration of 1.3 years. In the fourth quarter of 2023, we expect interest expense to be approximately $18 million or 4.1% of average net receivables, with the increase in expense primarily attributable to our expected portfolio growth. As our fixed-rate funding matures and we continue to grow using variable-rate debt, our interest expense will continue to increase as a percentage of average net receivables. We continue to maintain a very strong balance sheet, with low leverage, healthy reserves, and ample liquidity to fund our growth. As of the end of the third quarter, we had $613 million of unused capacity on our credit facility and $179 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 maturity stretching out to 2026. Since 2020, we've maintained a quarter-end unused borrowing capacity of between roughly $400 million and $700 million, demonstrating our ability to protect ourselves against short-term disruptions in the credit market. Our third quarter funded debt-to-equity ratio remains a conservative 4.2:1. We have ample capacity to fund our business, even if access to the securitization market were to become restricted. We incurred an effective tax rate of 19% for the third quarter, lower than guidance due to tax benefits from reestablished deferred tax assets for certain state net operating losses. For the fourth quarter, we expect an effective tax rate of approximately 24% prior to discrete items such as any tax impacts of equity compensation. We also continued to return capital to our shareholders. Our Board of Directors declared a dividend of $0.30 per common share for the fourth quarter. The dividend will be paid on December 13, 2023, to shareholders of record as of the close of business on November 22, 2023. 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.

Rob Beck, CEO

Thanks, Harp. And as always, I'd like to recognize our team for the outstanding results that it's delivered throughout this economic cycle. Looking ahead, we'll remain focused on consistent execution of our core business, including originating high-quality loans within our tightened credit box, closely managing expenses, and maintaining a strong balance sheet. Our geographic expansion over the past few years has greatly increased our addressable market, positioning us well to take advantage of consumer demand while maintaining our conservative credit posture. We're pleased that our early delinquency and first payment default rates continue to outperform 2019 levels, thanks in large part to our credit tightening actions over the last several quarters and the strong performance of our more recent loan vintages. We also remain sharply focused on limiting our G&A expenses while still furthering our key technology, digital, and data analytics initiatives that will create additional growth, improved credit performance, and greater operating leverage in the future. And, of course, we'll continue to monitor the economic environment so that when conditions are right we will need to immediately leverage our substantial balance sheet strength, liquidity, and borrowing capacity to reopen our credit box and lean further into growth. Thank you again for your time and interest. I'll now open up the call for questions. Operator, would you please open the line?

Operator, Operator

Certainly. We will now begin the question-and-answer session. Our first question is from John Hecht with Jefferies. Please go ahead.

John Hecht, Analyst

Good afternoon, guys. Thanks for taking my questions. First question is I think you guys said $52 million of losses charge-offs in the fourth quarter. I'm just wondering, the roll rates you're seeing behind that are they relatively consistent with recent quarters or anything that you're assuming in terms of the migration of roll rates?

Rob Beck, CEO

Hey, John, how are you? Thanks for the question. Yeah, we're assuming consistent roll rates from the prior quarter with the normal seasonal lift that we would see, albeit off of elevated levels still.

John Hecht, Analyst

Okay. And then I think you guys referred a couple of times in the presentation a little bit of focus on recurring customers rather than new customers as part of the tightening. I mean, what is the loss experience like between a recurring customer and a new customer to just get a sense for what that specific focus might do to the loss mix?

Rob Beck, CEO

Yeah. You broke up there John right in the middle of your question. Can I ask you to repeat it because I think we missed the gist of it?

John Hecht, Analyst

I apologize. I'm wondering what the kind of loss experience is between new and recurring customers to get a sense of what that focus might do to losses over the next few quarters?

Rob Beck, CEO

Yeah. And so look, new borrowers and we've never disclosed the difference between a new borrower and an existing borrower in terms of higher losses. But new borrowers do perform worse until they're seasoned. Now, obviously, we've been shifting the mix of our book to present borrowers and former borrowers from new borrowers over a period of time. But when you're in new geographies and the new states we are, we're still going to have a reasonably high percentage of new borrowers and that will naturally take time to season through. But I will tell you though, that our underwriting models adjust for the new borrower effect and assume additional stress on those customers, and we underwrite obviously with the assumption not only of that stress but the incremental cost of funds that we incur today as well as fully loaded expenses to make sure that we achieve our hurdle. So it's factored into our models. But Harp, anything to add to that?

Harp Rana, CFO

Yes. I would just say that our originations continue to be concentrated on programs for present and former borrowers, and we know that they performed better than new borrowers just because of the on-us data that we have on them. And then the other thing that I would probably add to that, in terms of the new borrowers Rob touched on this, but they fit within our risk box. So when we're making loans to new borrowers, we're making sure that they are meeting those internal hurdles that we have.

Rob Beck, CEO

Yes. And John, over 70% of our customers are former and present borrowers this quarter, which has been pretty steady I guess since last year, a little bit up from last year but pretty steady. And again, that's related to the new states we're in. We're going to have some of that new borrowers.

John Hecht, Analyst

Yes. Okay.

Rob Beck, CEO

Yes. It's also important to note that the vintages from the fourth quarter of 2022 and more recent ones are all performing very well. The earliest vintage from the fourth quarter of 2022 is just now reaching 12 months on the books, so we are beginning to see what the peak losses are, while the other vintages are still progressing. Currently, performance looks strong, which reflects the mix of new, present, and former borrowers. We feel positive about the situation given the current macro environment for these vintages.

John Hecht, Analyst

That's a very good context. Thank you. My last question is, you mentioned that the losses experienced seem to be related to income ranges. Are you noticing any variations in credit metrics based on geography? Is there anything else to consider, or do you believe it's primarily driven by income?

Rob Beck, CEO

It's not just one factor. When we tightened our criteria, we reduced the number of lower FICO scores and increased the proportion of higher income brackets. This is a natural outcome of tightening. Employment does play a role, and different states perform differently. We incorporate numerous variables in our underwriting models, analyzing hundreds of segments to assess returns based on factors like loan size, type, and demographics by state. We've been discussing our tightening strategy since the fourth quarter of 2022, where we implemented significant changes, although we were adjusting throughout 2022, particularly as inflation surged to 9%. Since the fourth quarter of 2022, we continuously refine our approach based on the performance of each segment. We are confident in our decisions, focusing on assets that can withstand stress and consistently prioritizing high-confidence assets each quarter.

John Hecht, Analyst

Great. Thank you very much.

Operator, Operator

The next question is from Vincent Caintic. Your line is open.

Unidentified Analyst, Analyst

Hi. Thanks for taking my question. Good afternoon. Thanks for all the detailed guidance that you're giving in the fourth quarter and lay out in the slides. It's really very helpful. And first, just wondering the trends that we're seeing in the fourth quarter, if that's a good jumping off point when we think about 2024 going forward. I know, it's a little bit ways away. But when you think about the revenues, the credit performance, and your expense controls, just wondering if that's a good jumping off point in the fourth quarter? Thank you.

Rob Beck, CEO

Yes. I mean, naturally you've got to look at fourth quarter and project out from there. And we're not giving specific guidance at this point in time for next year. Naturally, we're still in the middle of our budget process. But I think most importantly is, those vintages that we said originated in fourth quarter 2022 and sooner are going to be about 80% of the book by the end of this year. A couple more months of seeing how those vintages perform is going to help give us better guidance for all of you as to what we might expect next year. What we do know is the 20% of the book that is pre fourth quarter 2022, those vintages, and some have called it a back book, those vintages are going to create stress in the early part of next year. By the very nature, they've been matured renewed where they could be renewed, paid off, and there's still a lot of good customers in there, but there's also customers in there probably disproportionately that are under some form of borrower assistance program, which for us is important for them to stay active and engaged, particularly leading up to tax season. So if we sit here right now and say, what does the credit profile look like for next year, I don't think anybody can predict precisely, particularly given some of the macro events. But what I think we can say is, there will be some stress from those earlier vintages, but the more recent vintages are performing well and we haven't seen anything that is causing concern, and I think the things that will make a difference for next year will be what's the tax refund season look like. I think that's always a big help and a lever very beginning of the year, and we will ring-fence those assets and make sure we put everything against collecting against them. And then of course, if there's any other macro stresses that might be out there, probably the one that we're all kind of looking at is, is there any results or contagion from the Middle East that ends up hitting oil prices. So that would be the one thing we would be looking at as we get close to the end of the year and figuring out what next year looks like.

Unidentified Analyst, Analyst

Okay. Great. And then I guess regarding expenses, you've managed to maintain good control over the expense ratio. I'm curious if there's more potential to keep expenses relatively stable for a while.

Rob Beck, CEO

What I would tell you is, that we are laser-like focused on that every dollar we spend helps drive the business forward. And we've been strongly profitable in this environment yet still investing in the business. We will adjust the spending pattern as we need to continue to grow the business where growth is needed or to continue to drive operating leverage that we need to do over time as well. So I can't really give you any more guidance than that right now.

Unidentified Analyst, Analyst

Okay, perfect. And lastly from me, the product mix has changed. You've mentioned that high-quality loans are increasing, particularly those that are auto-secured. Should we expect this trend to continue? Are there specific products you plan to focus on more? Thank you.

Rob Beck, CEO

I believe we will continue to focus on and expand our auto-secured offerings. I see this as one end of our strategy, where we have our large loan products, which currently make up the majority of our business and are performing well, alongside our small loan business. The small loan segment is quite appealing in terms of returns. In fact, we saw sequential growth in this area this quarter, similar to what we experienced last year at the same time. This growth is part of our approach to tightening where we've identified opportunities to offer smaller loans to certain customers while charging a bit more due to perceived higher risk. By employing risk-based pricing, we've managed to create strong returns from our growth in the small loan portfolio. We see ongoing opportunities to engage in this space when small loans are attractive. We have not restricted ourselves to a 36% rate cap, giving us the flexibility to take advantage of these segments, especially in a rising or stable rate environment. This adaptability helps us differentiate ourselves from our competitors.

Unidentified Analyst, Analyst

Great. Very helpful. Thank you.

Rob Beck, CEO

Great. Appreciate it.

Operator, Operator

This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Beck for any closing remarks.

Rob Beck, CEO

Thanks, Operator, and thanks everyone for joining the call. Look, as we close out this year and approach 2024, as I said, we're going to continue to monitor the changing macro conditions and the overall health of the consumer. And let me just say again, and I know we had it in our prepared remarks, but we're focused on the fundamentals, strong underwriting. We're adjusting our underwriting as needed. We're focused on disciplined growth and growth as appropriate, as we put on our highest confidence assets. We're always focused on tight expense management and investing in those initiatives that drive growth and improve our operating leverage, and of course maintaining a strong balance sheet and liquidity. And those are the mantras in which we manage the business and we'll continue to do so. And I think like everybody, we're hoping for a brighter 2024, and we're prepared to – we're positioned well for 2024, regardless of the environment, but we're hoping for a very strong environment.

Operator, Operator

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