World Acceptance Corp Q4 FY2022 Earnings Call

Good morning, and welcome to the World Acceptance Corporation sponsored fourth quarter press release conference call. This call is being recorded. Before we begin, the corporation has requested that I make the following announcement. These comments made during the conference call may contain certain forward-looking statements within the meaning of the Section 21E of the Securities Exchange Act of 1934 that represent the corporation's expectations and beliefs concerning future events. Such forward-looking statements are about matters that are inherently subject to risks and uncertainties. Statements other than those of historical fact as well as those identified by the words anticipate, estimate, intend, plan, expect, believe, may, will and should and any variation of the foregoing similar expressions are forward-looking statements. Additional information regarding forward-looking statements and any factors that could cause actual results or performance to differ from the expectations expressed or implied in such forward-looking statements are included in the paragraph discussing forward-looking statements. In today's earnings press release and in the Risk Factors section of the corporate most recent Form 10-K for the fiscal year ending March 31, 2021, and subsequent reports filed with or furnished to the SEC from time to time. The corporation does not undertake any obligation to update any forward-looking statements it makes. At this time, it is my pleasure to turn the floor over to your host, Chad Prashad, President and Chief Executive Officer.

Good morning, and thank you for joining our fiscal 2022 fourth quarter and year-end earnings call. Before we open up to questions, there are a few areas that I'd like to highlight. First, for the third consecutive quarter, we've experienced record growth in origination volumes. During the fourth quarter, gross originations grew by approximately $220 million more than the prior year fourth quarter. And at over $700 million surpassed our prior strongest fourth quarter originations by approximately 40%. We attribute this record growth to positive customer experiences, increased marketing intelligence, and larger loan offerings, all in the midst of tighter credit underwriting for new customers that we began in the third quarter. Further, we experienced this broad expansion across all customer types and continue to see tremendous increases in new and returning customer loan volumes when compared to last year or even pre-pandemic levels. In particular, new customer originations in the fourth quarter increased from approximately $25 million to over $60 million as new loan applications increased significantly by 64% versus the fourth quarter of fiscal '21 and 41% versus the fourth quarter of fiscal '20. In all, we experienced an exceptional 37.8% year-over-year portfolio growth. We are confident that this extraordinary growth is profitable growth, but recognize that growth at this rate is likely unsustainable. Therefore, we believe our continued and additional credit tightening that we recently began in April will also result in further reduced credit risk and higher profitability as we slow growth and reduce the credit provision in the new year. Another contributing factor was the significantly lower paydowns and lower runoff in the most recent fourth quarter. Traditionally, we see runoff averaging approximately 12% to 12.2%, approximately $200 million for our beginning portfolio size. This quarter's runoff was just over 5% or only $80 million, largely resulting from a move to higher balance loans, which are less subject to lump sum payoffs through tax refunds. In other words, that approximate 7% difference equates to around $150 million of higher performing ledger, going into the new fiscal year. Regarding credit performance, we expect the origination cohort performance to remain relatively consistent in the near term. Based on several factors, including overall economic environment, changes to our credit underwriting and increase of larger loans to retain our most attractive options for our best customers. We continue to expect to hit our long-term incentive EPS target of $25.40 per share before the end of fiscal year 2025, and we are accruing accordingly. Further, delinquencies remain within expectations and when confidence to long-term EVA expectations. It's important to note that with the change to CECL provisioning last year, we expect to grow our provision in real time as our portfolio grows and reduce our provision in real time with any seasonal runoff, which is traditionally during tax season. During periods of rapid growth, this temporarily depresses net income as compared to historical delinquency based provisioning model. The loan growth in day 1 provisioning of CECL should positively impact revenue and income in future quarters, especially in quarters when we begin to decelerate our growth rates. For the entire year, we originated approximately $800 million more than in the prior year with over $200 million of that being unseasonal during the most recent fourth quarter. With this growth, as mentioned before, we've also significantly increased our loan loss reserves under CECL accounting. I'd also like to point out that over the last 5 years, we've achieved over 10% compounded annual growth rate in the portfolio, including the dramatic reduction we experienced throughout the pandemic. Finally, aside from our continued record growth, we have much to be thankful for and excited about at World. First, our branch team and those who support them have done a tremendous job of navigating in the last 2 years and putting our customers' needs and safety first. Second, we continue to win top workplace awards across the country, with over half of our branches being in winning states or regions this year. In addition to the overall company being recognized as the only company to be a top workplaces of USA winner for 2 consecutive years, reflecting the incredible culture that our World family has created and continues to foster. I can't be prouder of them. At this time, Johnny Calmes, our Chief Financial and Strategy Officer; and I would like to open up to questions about our fourth quarter and fiscal year 2022 earnings.

The first question comes from Vincent Caintic of Stephens.

First question, regarding the charge-off rate. It appears that in the past quarter, you had a 19% charge-off rate, which suggests you experienced strong loan growth this quarter. This would indicate that with slower loan growth, charge-offs could exceed 20%. I'm curious about what the normalized annual charge-off rate we should expect over time will be.

Sure. This quarter, the charge-off rate was a little under 20%. Growth has been lower, and while it might have been slightly higher, it aligns with the figures from fiscal 2020, which was the last period with significant growth similar to what we've experienced in the last three quarters, and the delinquencies are also in line with that. We feel good about where we are in relation to our growth, particularly with new borrowers. It's challenging to project future rates since they depend heavily on the portfolio mix. As the portfolio ages, we should see loss rates decrease. However, there is typically a lag, so it may take a quarter or two for the growth from Q2, Q3, and Q4 to reflect in the loss rates. But after that, we anticipate seeing those loss rates decrease quite significantly.

Okay. That's helpful. It seems like it might be hard to say, but do you expect the target losses you're aiming for to be below the current range? Or is this a comfortable level of net charge-offs for your underwriting?

Relative to the growth, we're comfortable where we are, right? But as Chad pointed out, right, as we move forward, we don't expect to maintain the same level of growth that we've seen over the last 9 months, right? So we plan to be a lot more selective, especially around new borrowers going forward, right? So we could see that mix shift in the next couple of quarters.

Yes, that's right. This is Chad, just to provide a little more clarity around that. The net charge-off rate really is dependent, as Johnny mentioned, on the portfolio mix. So as that portfolio mix changes and ages, you would expect that NCO rate to come down as well. And further to Johnny's point about the tightening credit underwriting as we slow down our growth from these extremely high levels, we've already begun reducing our approval rates, especially for new customers. And they were much lower in the fourth quarter, and they'll continue to go down throughout the first quarter of this fiscal year.

Just a little bit of color about where we are today. We are through April now, and the delinquency is trending down from March as we expected. As charge-offs follow delinquencies, the continuing decrease in delinquencies will also lead to a decrease in charge-offs.

Okay. That's a very helpful detailed feedback. And just a second, just a follow-up question on along those lines. So the underwriting changes you made to tighten in April, if you could describe maybe what those are in more detail? And is there any particular surprises you've seen maybe the payment rates slowing down or anything else that was unusual that cost tightening? Or maybe if you could just describe what the kind of the variables on the tightening?

We started tightening our underwriting process in the third quarter primarily because we were receiving a significant number of applications, and we wanted to maintain and enhance our credit quality. This also provided us with a great opportunity to do so. As we shifted towards larger loans, it became crucial for us to ensure that our new customers had a credit risk profile suitable for these larger amounts. When we invest in a customer, we aim to retain them long-term, which means ensuring they are eligible for higher quality credit lines in the future. Regarding the specifics of our credit underwriting changes, we implemented further modifications in April. Before these adjustments, we noticed that the booking rate for new customers dropped by 17% compared to the fourth quarter of 2020, which was prior to the pandemic's impact. Yet, we saw a significant increase in the number of applications; in the fourth quarter, applications rose by 46% compared to pre-pandemic levels and by 68% year-over-year, with most of this growth coming from digital sources. We have effectively leveraged our marketing intelligence and made substantial improvements in our brand and the culture within our branches, resulting in a noticeable increase in overall application flow, allowing us to tighten our underwriting at the same time.

Okay. Got you. And last 1 for me. I think from the last earnings call when you talked about achieving your EPS targets, the $25 by fiscal 2025, you outlined the growth trajectory. I think it was, what, kind of high single digits plus your capital return and your underwriting. Maybe if you talk about that's still in mind, you're still on that path to get there with those 3 variables?

Yes. I mean so I'll start, I'll let Johnny chime in as well. So with the amount of growth we've had this year in the overall ledger, it really does come down to that how rapidly we decelerate the overall growth rate. There's 2 pieces to that. The first is every new customer that we bring in is significantly more risky than existing customers. And we seem provisioning, we have to provision for that upfront. So as you could see in this quarter, we had rapid growth, not just in terms of customer retention, but also record originations. And with that comes a pretty substantial CECL provisioning. As we slow that down, yes, we're still accruing towards $25.40. We believe that a portfolio of the size that we are today can certainly put off that amount of cash. And I think you can see that in the press release as well. It really comes down to making sure that we are prudent for the long term investments for new customers for the company. So we are still looking at the long-term EVA of every applicant to make sure that those are good investments. And we're still very opportunistic. So as we see those, we'll continue to make them. So it's really difficult to say that we're aiming at a specific percent growth rate. We keep our eye towards the overall economy and any influences there that may impact demand, but also influences, we think may impact repayment rates in the future. So all that to say, we aim to be opportunistic. We really aren't setting a certain percent growth rate in order to hit those targets. But we think that the portfolio size we have today certainly allows us to do so in a decelerating growth environment.

The next question comes from John Rowan of Janney.

John, I understand your hesitation to provide a specific NCO rate in a stable environment. However, you are setting a target for substantial earnings growth based on this run rate to achieve your accrual target by fiscal 2025. Historically, your loss rates have ranged from the low single digits to the mid-teens, approaching 20%. Could you possibly clarify which of these ranges you're using to develop your outlook? While you may not want to provide an exact number, a rough estimate of the loss rate you're currently underwriting would help us have a clearer understanding for our assumptions.

I can provide a range. Currently, as we've mentioned, we are becoming more selective with new customers. This should be near the top of the range. As the portfolio matures, we expect the loss rate to decrease. Long term, I believe it could settle in the high single digits, which seems reasonable. However, it's difficult to predict exactly when that will occur. Right now, the mix is likely more weighted towards higher risk than it will be in the future, indicating that the loss rate should begin to trend down. We won't completely eliminate new borrower growth, so there will always be some level of risk in the portfolio that exceeds our existing customer loss rate. We're currently at high single digits, trending toward high single digits over time, but it's challenging to specify the exact timing for that.

No, that's fair enough. I mean, listen, I've covered the stock for a while and you look back in time and high single digit is a lower number than what I remember ever seeing even pre-financial crisis. Is there something kind of just fundamentally different in the credits that you're underwriting with that type of embedded loss rate relative to the history of World?

No, it was just the shift to these larger loans. As the mix of the portfolio changes, with the shift to larger loans, we should retain our best customers for a longer period. As that mix starts to adjust and the portfolio matures, the loss ratio should trend back toward that. However, I'm not saying we'll definitely reach that point because much will depend on our willingness to take risks with new customers. This variability makes it challenging to provide an exact figure since our attitude towards new borrowers may change in the future, influencing the potential loss rate.

John, I hope I don't just repeat what Johnny already said, but we don't target a specific NCO rate at the portfolio level. Instead, we look at the NCO rate for individual customers in relation to their acquisition cost and expected long-term EVA. There are many factors that influence the calculations for new customer acquisition. Once a customer has been with us for a while, their risk significantly decreases, and various elements contribute to the overall portfolio NCO rate. As Johnny mentioned, new customers play a key role. Depending on their appetite and market conditions, we believe the returns will guide our investments, which will impact the overall NCO rate as we invest more in new customers. Additionally, regarding larger loans, there are two factors to consider. First, when underwriting new customers whom we anticipate will become long-term large loan clients, we focus on customers with a higher credit risk profile, which negatively affects the NCO rate. Second, as we transition towards larger loans, we are retaining customers for longer periods, whereas in the past we may have lost them to competitors offering lower interest rates. Our best customers tend to have a lower NCO rate. As the portfolio matures, this is an essential aspect because it constitutes a significant portion of the portfolio. We expect to see NCO rates decline, potentially reaching single digits, as our current portfolio is considerably different from previous ones. The customer base is on track to transform significantly as well. I hope that clarifies things.

No, it is. And I kind of want to attack the topic of the investing hurdles in 2025 with 2 different methods, right? So first is the top down, look at growth and provision via charge-offs. But in the past, World has under prior management teams use the vesting hurdle issue to lever up the balance sheet basically try to buy back stock to meet those hurdles. So maybe if we look at it from the bottom up, is there any appetite to do such a strategy to meet the vesting hurdle in 2025?

So I appreciate the question. I think it's really insightful. But I'll speak first. And Johnny, if you want to chime in, please do. When we first put out the long-term incentive plan, the goal for us as a management team, from the Board, is first I think it's long term as possible. As part of that, we also removed short-term incentives, including bonuses for our executive team. So we don't have any annual bonuses. We're not looking to hit certain quarterly targets or even annual targets. Our goal is to build the most valuable asset we can for our shareholders long term. So as the lead of the executive team, I'm really not interested in manipulating things as we get closer to the vesting cliff to make sure we hit it. Certainly not at the expense of the long-term value of the asset that we've created here. And so that's certainly the perspective that I have going into this. We have bought back a fair amount of the float over the last couple of years. As long as we believe that the stock price is a good investment and accretive for our investors, we'll continue to repurchase. And again, we're very opportunistic, but that's not something that we're looking forward to into the future in terms of trying to, let's say, necessarily hit a certain target to make any decisions that might be short term at the expense of the long-term value of the company.

I appreciate it. The last time there was a clear intention to increase leverage significantly, so it was more apparent. I don’t have an issue with share repurchases being positive. I was commenting on whether there might be a complete shift in the leverage rates we are currently seeing. I appreciate the insight.

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

In closing, we are pleased with the many improvements in our operations and culture that have helped to result in our record growth this year and believe our portfolio will continue to generate significant cash flow in the coming quarters and years. Thanks for taking the time to join us today. This concludes the fiscal year 2022 Earnings Call for World Acceptance Corporation.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.