Q1 2023 Regional Management Corp Earnings Call
Participants
Harpreet Rana; Executive VP & CFO; Regional Management Corp.
Robert William Beck; President, CEO & Director; Regional Management Corp.
John Hecht; MD & Equity Analyst; Jefferies LLC, Research Division
Garrett Edson
Presentation
Operator
Thank you for standing by. This is the conference operator. Welcome to the Regional Management First Quarter 2023 Earnings Call. (Operator Instructions) The conference is being recorded. (Operator Instructions)
I would now like to turn the conference over to Garrett Edson, ICR. Please go ahead.
Garrett Edson
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. A reconciliation of these 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 would now like to introduce Rob Beck, President and CEO of Regional Management Corp.
Robert William Beck
Thanks, Garrett, and welcome to our first quarter 2023 earnings call. I'm joined today by Harp Rana, our Chief Financial Officer. Harp and I will take you through our first quarter results, discuss the actions we're taking to maintain the credit quality of our portfolio and share our expectations for the second quarter and beyond, including our plans for continued quality growth.
We had a strong start to 2023 as our team ably navigated a challenging economic environment. We earned $8.7 million in net income and $0.90 of diluted EPS in the first quarter by maintaining our focus on portfolio quality, expense management and strong execution of our core business. We continue to be highly selective in making loans within our tightened credit box, and we further tightened our new borrowers in the first quarter. As a result, and in part due to first quarter seasonality, we liquidated our portfolio by $23 million in the quarter. We intentionally slowed our year-over-year portfolio growth rate to 16%, down from year-over-year growth rates of 19% in the fourth quarter and 31% in the first quarter of 2022. In light of the uncertain macroeconomic environment, we continue to be comfortable trading loan growth for credit quality, but we're well positioned to lean back into growth when warranted by the economic conditions and overall performance of our portfolio.
Our credit tightening actions over the past several quarters have improved our credit profile and benefited early stage delinquencies and roll rates. The percentage of originations in our top 2 risk rates has steadily increased in recent years, up to 61% in the first quarter of 2023 from 43% in the first quarter of 2019 and 53% from a year ago. Our auto secured portfolio has also continued to grow as a percentage of our overall portfolio. And the credit performance of those loans has been very strong with a 30-plus day delinquency rate of only 2.2% as of the end of the first quarter.
We've also continued to moderate new borrower acquisition, while sharpening our focus on originations to present and former borrowers. New borrower originations declined to 26% of all first quarter originations, down from 31% in the third quarter and 28% in the fourth quarter of 2022. As we've highlighted on prior calls, new borrowers initially perform worse on average than our seasoned present borrowers who remain in our portfolio following loan refinancing and our former borrowers with whom we have extensive honest credit experience. The higher credit losses on our new borrower portfolio reflect a component of our investment in growth. But by tightening credit on new borrowers over the past year, we believe we're striking the right balance between growth and credit quality. We'll remain conservative on our new borrower lending until the conditions are appropriate to reaccelerate our growth.
As more time has passed since the execution of our credit tightening actions, a greater percentage of our portfolio has benefited from those actions. Our second half 2022 and 2023 vintages are some of the strongest in our portfolio and are currently performing in line with our expectations. As of the end of the first quarter, roughly 60% of our portfolio consisted of second half 2022 and 2023 vintages, a number that we expect to increase to roughly 85% by year-end. Only 17% of our portfolio as of the end of the quarter was originated in 2021, and we expect that number to decline to under 10% over the next 6 months.
A healthier credit profile and our heightened collections focus have led to continued early indications of improved credit performance. Our 30-plus day delinquency rate at the end of the first quarter was 7.2%, up 10 basis points from 7.1% at the end of the year. However, when adjusting for the non-performing loan sale that we executed in the fourth quarter, our 30-plus day delinquency rate was 80 basis points better compared to year-end, improving from 8% to 7.2%. In addition, our first quarter 30-plus day delinquency rate was only 30 basis points, or 4% higher than the first quarter of 2019.
We also continued to see significant improvements in first payment default rates in the first quarter compared to 2019. Our first payment default rate in February was 6.8%, or 170 basis points better than February 2019. In addition, our early delinquency performance compares favorably to 2019 levels, a byproduct of the strong first payment spot rates that we observed at the end of last year. The delinquency rate of accounts 1 to 59 days past due was 8.6% at the end of the first quarter, a 230 basis point improvement from the fourth quarter of 2022 and 270 basis points better than the first quarter of 2019. Our 60- to 89-day delinquency rate improved by 30 basis points from the fourth quarter to the first quarter and is now flat to 2019 levels. Our 90-plus day delinquency rate was 70 basis points higher than 2019 levels. These late stage buckets remain sticky as our older vintages continue to flow through, a process which we expect to occur throughout the balance of the year.
Monthly Rho rates across all delinquency buckets improved sequentially within the first quarter. And in all but the latest stage buckets, they improved at a faster rate than we experienced in the first quarter of 2019. While our late stage delinquencies continue to be elevated, we're encouraged by the green shoots that we're observing in early delinquency buckets and the performance of our more recent loan vintages.
Looking ahead, we're optimistic that our conservative underwriting, a declining inflation rate and continued strength in the labor market, particularly for our customer base, will drive credit improvement in our portfolio. We're expecting that our net credit loss rate will peak in the second quarter as late stage delinquent accounts roll through to loss. Improvement in our early delinquency buckets and ongoing credit tightening will drive improvement in our net credit loss rate in the second half of the year, barring any further deterioration in the macro environment.
In terms of growth, we'll continue to place our focus on our highest confidence originations, those where we can achieve our return hurdles under an assumption of additional credit stress and higher future funding costs. We'll continue to emphasize present and former borrower originations with new borrower lending disproportionately skewed to our newest states, including Arizona, where we commenced operations in the first quarter. We continue to expect receivable growth in the mid-single digits in 2023 compared to 19% in 2022. Our current credit box is the tightest in our company's history. But as macro conditions warrant, we will lean into growth where appropriate, guided by the underlying performance of our portfolio.
We also clearly recognize the need to closely manage expenses, something we've always done, while still investing in our capabilities and strategic initiatives, including geographic expansion. As we discussed on the last call, we'll largely limit expense growth in 2023 to the carryover impact of 2022 investments as we seek to complete several important technology, digital and data analytics projects that are critical to the modernization and evolution of our omnichannel business to drive further productivity and efficiency.
In addition, having entered 8 new states, with the addition of Arizona, and increased our addressable market by over 80% since 2020, we'll slow our pace of new state entry in 2023 while capitalizing on the infrastructure investments from prior years. We currently expect to open 5 to 7 new branches in 2023 and perhaps 1 additional state late in the year, if justified by the economic conditions.
Based on current expectations and macro conditions, we continue to anticipate that our net income will be the strongest in the second half of the year due to stronger credit performance and higher revenues beginning in the third quarter. The second quarter will be the low point in profitability for the year as our revenue will decline sequentially due to first quarter portfolio liquidation, and our net credit loss rate will reach its peak as late stage delinquencies roll to loss.
As we've done in the past, we'll make adjustments to our underwriting and growth strategy based on changes in our credit performance and the macroeconomic environment. With ample borrowing capacity and a large addressable market, we have the ability to quickly lean back into growth should we observe improving economic conditions.
In summary, we continue to operate based on a few important guiding principles. First, we're committed to our core business of small and large loan installment lending, and we have a long runway of controlled profitable growth with these products. This is where our focus remains for the foreseeable future as we seek to improve the customer experience and optimize results for our shareholders.
Second, we'll continue to originate loans where we have a high degree of confidence in meeting our return hurdles in a stressed macroeconomic environment.
Third, we'll continue to tightly manage expenses while also investing in our core business in a way that improves our operating efficiency over time and ensures long-term success and profitability.
And fourth, we'll maintain a strong balance sheet, ample liquidity and borrowing capacity, diversified and staggered funding sources and a sensible interest rate management strategy. We'll continue to stay focused on making sound business decisions in line with these principles, which will allow us to drive attractive results over the long term for our customers, team members, communities and shareholders.
I'll now turn the call over to Harp to provide additional color on our financial results.
Harpreet Rana
Thank you, Rob, and hello, everyone. I'll now take you through our first quarter results in more detail. On Page 3 of the supplemental presentation, we provide our first quarter financial highlights.
We generated GAAP net income of $8.7 million and diluted earnings per share of $0.90. Our core results were driven by high quality portfolio and revenue growth and careful management of expenses, partially offset by increased funding costs and macroeconomic impacts on net credit losses and revenue.
Turning to Pages 4 and 5. While our loan products continued to experience strong demand, our credit tightening actions and collections focus had the intended effect of reducing total originations by 7% from the prior year. By channel, digital, direct mail and branch originations were down by 15%, 12% and 3%, respectively. We're very comfortable with this result as it reflects our short-term strategy of reducing our growth rate in favor of a higher credit quality portfolio.
Page 6 displays our portfolio growth and product mix through the first quarter. We closed the quarter with net finance receivables of just under $1.7 billion, down $23 million from year-end from credit tightening and first quarter seasonality. While our portfolio is up $230 million, or 16% year-over-year, most of the annual growth rate is attributable to strong origination activity from early 2022. As of the end of the first quarter, our large loan book comprised 72% of our total portfolio, and 86% of our portfolio carried an APR at or below 36%. We'll continue to prioritize growth of our highest confidence originations in a way that optimizes our return.
Looking ahead, we expect our ending net receivables in the second quarter to grow by approximately $5 million as we continue to monitor the macro environment and maintain our tightened underwriting. As we've noted before, we've remained focused on smart controlled growth. If circumstances dictate, we're prepared to further tighten our underwriting or lean back into growth, either of which would impact ending net receivables in the second quarter.
As shown on Page 7, our lighter branch footprint and strategy in new states and branch consolidation actions in legacy states contributed to another strong same-store year-over-year growth rate of 12% in the first quarter. Our receivables per branch remained near an all-time high, coming in at $4.9 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 8. Total revenue grew 12% to $135 million in the first quarter. Our total revenue yield and interest and fee yield were 32% and 28.5%, respectively, in line with our expectations. Compared to the first quarter of last year, our total revenue yield and interest and fee yield declined 170 basis points and 150 basis points, respectively. These declines are attributable primarily to our continued mix shift towards larger, higher quality loans and revenue reversals from credit impacted macroeconomic conditions. In the second quarter, we expect total revenue yield and interest and fee yield to be down 40 basis points and 30 basis points, respectively, compared to the first quarter. Over time, we anticipate that an improving credit environment and increased pricing on our newer loans will benefit our yield.
Moving to Page 9. Our 30-plus day delinquency rate as of quarter end was 7.2%, and our net credit loss rate in the first quarter was 10.1%. As a reminder, net credit losses in the first quarter benefited from the fourth quarter non-performing loan sale. In the second quarter, we expect delinquencies to improve gradually and net credit losses to be approximately $55 million as our net credit loss rate reaches its peak for the year.
Turning to Page 10. Our allowance for credit losses rose slightly in the first quarter. We built reserves by $5 million because the composition of our portfolio changed as late stage delinquency buckets refilled following the fourth quarter non-performing loan sale. As of quarter end, the allowance was $184 million, or 11% of net finance receivables, up from 10.5% of net finance receivables at year-end. The allowance continues to compare favorably to our 30-plus day contractual delinquency of $121 million.
We expect to end the second quarter with a reserve rate between 10.6% and 10.7%, subject to macroeconomic conditions. Assuming credit improves as the year progresses, we still expect our reserve rate to decline further by year-end. 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. And we believe that our reserve rate can 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 11. We continue to manage G&A expenses tightly in the face of normalizing credit. G&A expenses for the first quarter were $59.3 million, better than our prior guidance. Our annualized operating expense ratio was 14% in the first quarter, a 140 basis point improvement from the prior year period. We remain very pleased with our disciplined expense management in this challenging economic environment. We 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 second quarter, we expect G&A expenses to remain flat to the first quarter at approximately $59 million.
Turning to Pages 12 and 13. Our interest expense for the first quarter was $16.8 million, or 4% of average net receivables. As a reminder, in the first quarter of last year, we experienced a $10.2 million mark-to-market benefit to interest expense and pre-tax income from our interest rate cap. In the second quarter of 2023, we expect interest expense to be approximately $16.3 million, or 3.9% of average net receivables.
We continue to aggressively manage our exposure to rising interest rates as 89% of our debt is fixed rate as of March 31 with a weighted average coupon of 3.6% and a weighted average revolving duration of 1.8 years. As a result, despite the sharp increase in benchmark rates over the past year, we expect only a modest increase in interest expense as a percentage of average net receivables throughout the balance of the year.
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. As of the end of the first quarter, we had $581 million of unused capacity on our credit facilities and $182 million of available liquidity, consisting of unrestricted cash on hand and immediate availability to draw down on our revolving credit facilities. Since the beginning of the year, we've also added 2 new $75 million warehouse facilities and terminated our prior $75 million warehouse facility with Credit Suisse. Our debt has staggered revolving duration stretching out to 2026. And 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 first quarter funded debt-to-equity ratio was a conservative 4.2:1. We have ample capacity to fund our business, even if further access to the securitization market were to become restricted. We incurred an effective tax rate of 25% for the first quarter. For the second quarter, we expect an effective tax rate of approximately 26%.
We also continue to return capital to our shareholders. Our Board of Directors declared a dividend of $0.30 per common share for the second quarter. The dividend will be paid on June 14, 2023, to shareholders of record as of the close of business on May 24, 2023.
We're pleased with our first 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.
Robert William Beck
Thanks, Harp. And as always, I'd like to thank our dedicated team for their outstanding work and the best-in-class service they provide to our customers. As I discussed earlier, in this challenging economic environment, we remain focused on strong execution of our core business, including originating high quality loans within our tightened credit box, mostly managing expenses and maintaining a strong balance sheet. This straightforward approach allows us to concentrate our efforts on the key drivers of our results. At the same time, we're continuing to advance our long-term strategies of geographic expansion and key investments in technology, digital initiatives and data and analytics. We expect to emerge from this economic cycle as a stronger company with a larger, higher quality portfolio and improved operating efficiencies, well positioned to deliver attractive returns to our shareholders.
Thank you again for your time and interest. I'll now open up the call for questions. Operator, could you please open the line?
Question and Answer Session
Operator
(Operator Instructions) The first question comes from John Hecht from Jefferies.
John Hecht
You guys gave some really good detail for the upcoming quarter, and that's helpful, and it's some detail over the course of the year. But I'm just wondering, given the mix and the tightening going on, how do we think about yield trends kind of later this year and into next year overall?
Robert William Beck
Yes, John, how are you? Thanks for joining the call. Yes. We expect yields to modestly improve over the course of this year. I'm not going to give you guidance for next year because obviously the mix of our portfolio may change depending on the macro conditions, and we may lean back into growth in higher yielding products later this year. But we do expect modest increase in yields in the second half of the year. And that comes from 2 points of view. One, the improving credit that we expect in the second half of the year, so you have less interest reversals. And then also, we are repricing parts of our portfolio, and it just takes a while for that to really materialize through your portfolio because it's only on new originations.
John Hecht
Okay. That makes sense. And then maybe can you give us kind of with the ALL guidance you've given -- or where the ALL is and what the discussion on ALL is. Like what are kind of your macro assumptions and your unemployment assumptions? In your guys' opinion, if there's a major shift in unemployment, is there some sort of relationship we could think about with the ALL changes tied to changes in unemployment relative to expectations?
Robert William Beck
Yes. And so we've guided to 11.6% to 11.7% here in the second quarter. Actually, no.
Harpreet Rana
No, no, no. We guided to 10.6%, 10 --
Robert William Beck
I'm sorry.
Harpreet Rana
Yes, 10.6% to 10.7% in the second quarter. And in terms of -- there was a number of different variables that go into the allowance calculations that you specifically asked about the unemployment. So our model has unemployment in fourth quarter going to 6.3%. Previously, last quarter, we had talked about it going to 6.7%. And we do know that that may be a little bit higher than what others have assumed. But given the macro headwinds, we think that that's a prudent place to be. And we're very comfortable with our reserves at 11%.
John Hecht
Yes. That makes sense. And then final question is, you've done some branch optimization. You're opening branches in new markets. What do we -- just given other opportunities for consolidation and market expansion, do you kind of envision having more stores than current at the end of the year? Similar amount of stores? Or any guidance you can give us there just in terms of the store tenancy, store trends?
Robert William Beck
Yes. We're expecting to open up 5 to 7 new branches over the course of the year. There may be some consolidations that happen, but it's really kind of BAU activity as leases come up for renewals. So we're really not giving a lot of guidance there. What I will tell you, and it's in the supplement. We are seeing much higher ENR per branch, which is driving more efficiency. And that's a result of the larger branches that we're putting in the new states. In fact, I think if you look at the 1- to 3-year cohort, which includes some of the new markets as well as the 1-year cohort, they're up substantially. And so we're now averaging for the entire footprint, $4.9 million average balance per branch. But I will tell you, in some new states, and really don't want to get into what those states are, we have averages per branch that are north of $6 million. So our larger branch model is working well.
Operator
(Operator Instructions) There are no more questions in the queue, and this concludes the question-and-answer session. I would like to turn the conference back over to Mr. Beck for any closing remarks.
Robert William Beck
Thank you, operator, and thanks, everyone, again for joining the call. As we all know, the macroeconomic environment remains challenging, but we are a resilient business. Our focus remains on strong execution of our core business. And as I've said in the prepared remarks, that means originating high quality loans within our tightened credit box, closely managing our expenses and maintaining a strong balance sheet. All the while investing in kind of our longer-term growth initiatives, which is geographic expansion and then key investments in technology, digital and data analytics. And we believe that these investments and the way we're ably managing through this period of time positions us to be an even stronger company through the economic cycle and deliver attractive returns to shareholders in the future. So thanks again for joining and have a good evening.
Operator
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.
