Regional Management Corp. quarterly report, Q3 FY2018

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Regional Management Corp. — Q3 2018 Form 10-Q

Reporting period: Three and nine months ended September 30, 2018; balance-sheet comparisons are to December 31, 2017 unless otherwise stated. Financial statement amounts are in millions of dollars unless noted.

Business context

Regional Management is a consumer finance company offering small, large, and retail loans and related insurance products, primarily through its 346-branch network in 10 states. Small and large loans are its core growth products. The company ceased originating automobile loans in November 2017 and continues to service its existing portfolio. It opened four net branches in the first nine months of 2018.

Financial performance and position

  • Q3 revenue and earnings: Revenue was $77.9 million, up 12.6% year over year. Net income was $7.4 million, up 40.3%; diluted EPS was $0.61 versus $0.45.
  • First nine months: Revenue was $223.0 million, up 11.3%; net income was $24.6 million, up 28.8%; diluted EPS was $2.03 versus $1.62.
  • Revenue yields and expenses: Total revenue yield on average receivables was 35.9% in Q3 versus 36.7% a year earlier, and 35.6% year to date versus 36.8%. Interest and fee yield was 33.2% in Q3 versus 33.8%. The receivable efficiency ratio improved to 16.5% in Q3 from 18.0%, and to 16.6% year to date from 17.8%.
  • Credit costs: Q3 provision for credit losses was $23.6 million, up 17.3%; annualized provision was 10.9% of average receivables versus 10.7%. Year-to-date provision was $63.4 million, up 9.5%, while its annualized rate declined to 10.1% from 10.6%. Net credit loss rates were 7.7% in Q3 versus 7.8%, and 9.1% year to date versus 9.5%.
  • Portfolio quality and growth: Finance receivables totaled $888.1 million, up 14.6% year over year. Core small and large receivables grew 22.8%; automobile receivables declined 54.9%. Contractual delinquency was 7.1% versus 6.8% a year earlier. The allowance was $55.3 million, or 6.2% of receivables, versus $47.4 million, or 6.1%, at September 2017.
  • Cash flow: Nine-month operating cash flow was $104.8 million, investing cash outflow was $132.0 million, and financing cash inflow was $35.0 million. Cash and restricted cash together ended the period at $29.8 million; unrestricted cash was $0.5 million and restricted cash was $29.3 million.
  • Debt and equity: Long-term debt was $611.6 million gross ($604.4 million net of issuance costs), compared with $571.5 million gross ($566.5 million net) at year-end 2017. Stockholders’ equity was $267.4 million; management reported debt-to-equity of 2.3 to 1. The company completed a $150 million asset-backed securitization in June. It reported compliance with debt covenants.
  • Funding costs and rate risk: Average cost of long-term debt increased to 5.78% in Q3 from 5.17%, and to 5.51% year to date from 4.64%. The company said 94.3% of debt was fixed-rate or covered by interest-rate caps. A 100-basis-point increase in LIBOR was estimated to add approximately $4.3 million of annual interest expense on LIBOR-based borrowings.
  • Taxes: The effective tax rate was 23.1% in Q3 versus 37.9%, and 23.5% year to date versus 32.9%, reflecting the federal corporate tax-rate reduction under the Tax Act.

Material changes and unusual items

  • Q3 interest and fee income rose 13.4%, primarily due to 15.3% growth in average receivables, partly offset by a 0.6% decline in yield. Management expects large-loan growth to continue, while noting that product-mix changes may reduce total interest and fee yield over time.
  • Q3 allowance estimates changed in three ways: excluding reversal of unearned non-refundable fees reduced the allowance and provision by $6.6 million; updated impaired-loan assumptions increased them by $2.8 million; and a non-file insurance policy change increased them by $4.1 million. Together, these three changes increased the allowance and provision by approximately $0.3 million, reducing Q3 net income by about $0.2 million. Separately, a $3.9 million incremental hurricane allowance reduced Q3 net income by $2.9 million.
  • The company plans to reduce non-file insurance claims beginning in Q4 2018. It expects the resulting increase in net credit losses—estimated to reduce the insurance benefit by about 65 basis points over five quarters—to be substantially offset by higher insurance income, with no expected impact on profitability.
  • The 2017 comparison included a $1.0 million recovery from a bulk sale of charged-off accounts. Q3 2018 also included hurricane-related allowance expense; the prior-year quarter had a separate hurricane allowance increase of $3.0 million.
  • Large-loan growth and lower yields on some products contributed to pressure on yields. Automobile lending is in run-off following the cessation of originations.

Outlook, risks, and contingencies

  • Management expects operating cash flow and debt facilities to fund the business for the next 12 months. It anticipates annual spending of approximately $7 million to $10 million on technology infrastructure and branch expansion and sees potential to add as many as 700 branches in favorable markets.
  • Funding and refinancing remain risks: the senior revolving facility matures in June 2020, the warehouse facility’s revolving period ends in February 2020, and the securitization revolving period ends in June 2020. Management intends to address upcoming maturities but cautions that extensions or replacement funding are not assured and may be more costly.
  • The company expects the new expected-credit-loss accounting standard, effective after December 15, 2019, to have a material adverse effect; the impact was still being quantified. The forthcoming lease standard will create balance-sheet lease assets and liabilities and may affect debt covenants; the company was working with lenders on implementation.
  • Results and cash needs are seasonal: loan demand is generally strongest in the second through fourth quarters, while delinquency typically rises through the year. Legal and compliance costs are expected to remain elevated. Management said ordinary-course legal matters were not expected to have a material adverse effect, but outcomes and possible losses can be difficult to estimate.
  • Management reported effective disclosure controls and no material changes in internal control over financial reporting. The filing reported no material changes to previously disclosed risk factors.

Key facts for investors to verify

  • Reconcile the senior revolving facility balance: the debt table and liquidity discussion report approximately $352.7 million, while the market-risk section states $502.9 million outstanding. Confirm the correct balance and related borrowing availability.
  • Assess whether portfolio growth can continue without further deterioration in delinquency, credit losses, or loan yields, particularly as large loans become a greater share of receivables.
  • Track the allowance methodology changes, hurricane-related credit exposure, and the expected transition to the new credit-loss accounting standard.
  • Evaluate refinancing capacity and terms ahead of the 2020 revolving-period and facility maturities, including the restricted nature of securitization collateral and cash.
  • Monitor the expected offset between lower non-file insurance claims and higher net credit losses, and confirm whether the policy change is earnings-neutral in practice.