ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Information
This Quarterly Report on Form 10-Q contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are based on management’s current beliefs and assumptions, as well as information currently available to management. When used in this document, the words “anticipate”, “estimate”, “expect”, “will”, “may”, “plan,” “believe”, “intend” and similar expressions are intended to identify forward-looking statements. Although Nicholas Financial, Inc., including its subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) believes that the expectations reflected or implied in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. As a result, actual results could differ materially from those indicated in these forward-looking statements. Forward-looking statements in this Quarterly Report may include, without limitation: (1) the projected impact of the novel coronavirus disease (“COVID-19”) outbreak on our customers and our business, (2) projections of revenue, income, and other items relating to our financial position and results of operations, (3) statements of our plans, objectives, strategies, goals and intentions, (4) statements regarding the capabilities, capacities, market position and expected development of our business operations, and (5) statements of expected industry and general economic trends. These statements are subject to certain risks, uncertainties and assumptions that may cause results to differ materially from those expressed or implied in forward-looking statements, including without limitation:
•the ongoing impact on us, our employees, our customers and the overall economy of the COVID-19 pandemic and measures taken in response thereto, including without limitation the successful delivery of vaccines effective against the different variants of the virus, for which future developments are highly uncertain and difficult to predict;
•availability of capital (including the ability to access bank financing);
•recently enacted, proposed or future legislation and the manner in which it is implemented, including tax legislation initiatives or challenges to our tax positions and/or interpretations, and state sales tax rules and regulations;
•fluctuations in the economy;
•the degree and nature of competition and its effects on the Company’s financial results;
•fluctuations in interest rates;
•effectiveness of our risk management processes and procedures, including the effectiveness of the Company’s internal control over financial reporting and disclosure controls and procedures;
•demand for consumer financing in the markets served by the Company;
•our ability to successfully develop and commercialize new or enhanced products and services;
•the sufficiency of our allowance for credit losses and the accuracy of the assumptions or estimates used in preparing our financial statements;
•increases in the default rates experienced on automobile finance installment contracts (“Contracts”);
•higher borrowing costs and adverse financial market conditions impacting our funding and liquidity;
•our ability to securitize our loan receivables, occurrence of an early amortization of our securitization facilities, loss of the right to service or subservice our securitized loan receivables, and lower payment rates on our securitized loan receivables;
•regulation, supervision, examination and enforcement of our business by governmental authorities, and adverse regulatory changes in the Company’s existing and future markets, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and other legislative and regulatory developments, including regulations relating to privacy, information security and data protection and the impact of the Consumer Financial Protection Bureau's (the “CFPB”) regulation of our business;
•fraudulent activity, employee misconduct or misconduct by third parties;
•media and public characterization of consumer installment loans;
•failure of third parties to provide various services that are important to our operations;
•alleged infringement of intellectual property rights of others and our ability to protect our intellectual property;
•litigation and regulatory actions;
•our ability to attract, retain and motivate key officers and employees;
15
•use of third-party vendors and ongoing third-party business relationships;
•cyber-attacks or other security breaches;
•disruptions in the operations of our computer systems and data centers;
•the impact of changes in accounting rules and regulations, or their interpretation or application, which could materially and adversely affect the Company’s reported consolidated financial statements or necessitate material delays or changes in the issuance of the Company’s audited consolidated financial statements;
•uncertainties associated with management turnover and the effective succession of senior management;
•our ability to realize our intentions regarding strategic alternatives, including the failure to achieve anticipated synergies;
•our ability to expand our business, including our ability to complete acquisitions and integrate the operations of acquired businesses and to expand into new markets; and
•the risk factors discussed under “Item 1A – Risk Factors” in our Annual Report on Form 10-K, and our other filings made with the U.S. Securities and Exchange Commission (“SEC”).
Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or expected. All forward-looking statements included in this Quarterly Report are based on information available to the Company as the date of filing of this Quarterly Report, and the Company assumes no obligation to update any such forward-looking statement. Prospective investors should also consult the risk factors described from time to time in the Company’s other filings made with the SEC, including its reports on Forms 10-K, 10-Q, 8-K and annual reports to shareholders.
Litigation and Legal Matters
See “Item 1. Legal Proceedings” in Part II of this Quarterly Report below.
COVID-19
The expansion of unemployment benefits by the CARES Act, the Coronavirus Response and Relief Supplemental Appropriations Act of 2021 and the American Rescue Plan Act of 2021 to eligible individuals collectively had a beneficial effect on the Company. While pandemic unemployment assistance had been extended through September 6, 2021, the beneficial impact these benefits have had on the Company largely disappeared once its customers no longer qualified for such benefits. The Company continued to experience normal cash collections and experienced positive trending on net charge-off balances for the three months ended June 30, 2022.
In accordance with our policies and procedures, certain borrowers qualify for, and the Company offers, one-month principal payment deferrals on Contracts and Direct Loans. Due to COVID-19, the Company allowed an additional deferment during fiscal year 2021, as a result the number of deferments increased at the beginning of the pandemic. For the three months ended June 30, 2022 and 2021 the Company experienced an average monthly number of deferments of 324 and 153, respectively, which would represent approximately 1.2% and 0.6% of total Contracts and Direct Loans, as of June 30, 2022 and 2021, respectively. The number of deferrals is also influenced by portfolio performance, including but not limited to, inflation, credit quality of loans purchased, competition at the time of Contract acquisition, and general economic conditions.
The Company believes the number of one-month principal payments deferrals is now largely consistent with pre-pandemic levels.
However, the extent to which the COVID-19 pandemic eventually impacts our business, financial condition, results of operations or cash flows will depend on numerous evolving factors that we are unable to accurately predict at this time. The length and scope of the restrictions imposed by various governments, success of vaccination efforts, and scope and duration of special government benefits to be unemployed, among other factors, will determine the ultimate severity of the COVID-19 impact on our business. It is likely that prolonged periods of difficult market conditions could have material adverse impacts on our business, financial condition, results of operations and cash flows.
Risks Related to Regulation
In 2017, the CFPB adopted rules applicable to payday, title and certain high cost installment loans. The rules address the underwriting of covered short-term loans and longer-term balloon-payment loans, including payday and vehicle title loans, as well as related reporting and recordkeeping provisions. These provisions have become known as the “mandatory underwriting provisions” and include rules for lenders to follow to determine whether or not consumers have the ability to repay the loans according to their
16
terms. Implementation of the rule’s payment requirements may require changes to the Company’s practices and procedures for such loans, which could materially and adversely affect the Company’s ability to make such loans, the cost of making such loans, the Company’s ability to, or frequency with which it could, refinance any such loans, and the profitability of such loans. Additionally, the CFPB may target specific features of loans by rulemaking that could cause us to cease offering certain products, or adopt rules imposing new and potentially burdensome requirements and limitations with respect to any of our current or future lines of business, which could have a material adverse effect on our operations and financial performance. The CFPB could also implement rules that limit our ability to continue servicing our financial products and services.
The CFPB has broad authority to pursue administrative proceedings and litigation for violations of federal consumer financing laws.
The CFPB has the authority to obtain cease and desist orders (which can include orders for restitution or rescission of contracts, as well as other kinds of affirmative relief) and monetary penalties ranging from $5,000 per day for minor violations of federal consumer financial laws (including the CFPB’s own rules) to $25,000 per day for reckless violations and $1 million per day for knowing violations. If we are subject to such administrative proceedings, litigation, orders or monetary penalties in the future, this could have a material adverse effect on our operations and financial performance. Also, where a company has violated Title X of the Dodd-Frank Act or CFPB regulations under Title X, the Dodd-Frank Act empowers state attorneys general and state regulators to bring civil actions for the kind of cease and desist orders available to the CFPB (but not for civil penalties). If the CFPB or one or more state officials believe we have violated the foregoing laws, they could exercise their enforcement powers in ways that would have a material adverse effect on us. See “Item 1. Business – Regulation” for additional information.
Pursuant to the authority granted to it under the Dodd-Frank Act, the CFPB adopted rules that subject larger nonbank automobile finance companies to supervision and examination by the CFPB. Any such examination by the CFPB likely would have a material adverse effect on our operations and financial performance.
The CFPB defines a “larger participant” of automobile financing if it has at least 10,000 aggregate annual originations. The Company does not meet the threshold of at least 10,000 aggregate annual direct loan originations, and therefore would not fall under the CFPB’s supervisory authority. The CFPB issued rules regarding the supervision and examination of non-depository “larger participants” in the automobile finance business. The CFPB’s stated objectives of such examinations are: to assess the quality of a larger participant’s compliance management systems for preventing violations of federal consumer financial laws; to identify acts or practices that materially increase the risk of violations of federal consumer finance laws and associated harm to consumers; and to gather facts that help determine whether the larger participant engages in acts or practices that are likely to violate federal consumer financial laws in connection with its automobile finance business. At such time, as we become or the CFPB defines us as a larger participant, we will be subject to examination by the CFPB for, among other things, ECOA compliance; unfair, deceptive or abusive acts or practices (“UDAAP”) compliance; and the adequacy of our compliance management systems.
We have continued to evaluate our existing compliance management systems. We expect this process to continue as the CFPB promulgates new and evolving rules and interpretations. Given the time and effort needed to establish, implement and maintain adequate compliance management systems and the resources and costs associated with being examined by the CFPB, such an examination could likely have a material adverse effect on our business, financial condition and profitability. Moreover, any such examination by the CFPB could result in the assessment of penalties, including fines, and other remedies which could, in turn, have a material effect on our business, financial condition, and profitability.
In July 2020, the CFPB rescinded provisions of the Rule governing the ability to repay requirements. Currently, the payment requirements are scheduled to take effect in June 2022. Any regulatory changes could have effects beyond those currently contemplated that could further materially and adversely impact our business and operations. Unless rescinded or otherwise amended, the Company will have to comply with the Rule’s payment requirements if it continues to allow consumers to set up future recurring payments online for certain covered loans such that it meets the definition of having a “leveraged payment mechanism” under the Rule. If the payment provisions of the Rule apply, the Company will have to modify its loan payment procedures to comply with the required notices and mandated timeframes set forth in the final rule.
17
We are subject to many other laws and governmental regulations, and any material violations of or changes in these laws or regulations could have a material adverse effect on our financial condition and business operations.
Our financing operations are subject to regulation, supervision, and licensing under various other federal, state and local statutes and ordinances. Additionally, the procedures that we must follow in connection with the repossession of vehicles securing Contracts are regulated by each of the states in which we do business. The various federal, state and local statutes, regulations, and ordinances applicable to our business govern, among other things:
•requirements for maintenance of proper records;
•payment of required fees to certain states;
•maximum interest rates that may be charged on loans to finance used and new vehicles;
•debt collection practices;
•proper disclosure to customers regarding financing terms;
•privacy regarding certain customer data;
•interest rates on loans to customers;
•late fees and insufficient fees charged;
•telephone solicitation of Direct Loan customers; and
•collection of debts from loan customers who have filed bankruptcy.
We believe that we maintain all material licenses and permits required for our current operations and are in substantial compliance with all applicable local, state and federal regulations. Our failure, or the failure by dealers who originate the Contracts we purchase, to maintain all requisite licenses and permits, and to comply with other regulatory requirements, could result in consumers having rights of rescission and other remedies that could have a material adverse effect on our financial condition. Furthermore, any changes in applicable laws, rules and regulations, such as the passage of the Dodd-Frank Act and the creation of the CFPB, may make our compliance therewith more difficult or expensive or otherwise materially adversely affect our business and financial condition.
Some litigation against us could take the form of class action complaints by consumers. As the assignee of contracts originated by dealers, we may also be named as a co-defendant in lawsuits filed by consumers principally against dealers. The damages and penalties claimed by consumers in these types of actions can be substantial. The relief requested by the plaintiffs varies but may include requests for compensatory, statutory, and punitive damages. We also are periodically subject to other kinds of litigation typically experienced by businesses such as ours, including employment disputes and breach of contract claims. No assurances can be given that we will not experience material financial losses in the future as a result of litigation or other legal proceedings.
Critical Accounting Estimates
A critical accounting estimate is an estimate that: (i) is made in accordance with generally accepted accounting principles, (ii) involves a significant level of estimation uncertainty and (iii) has had or is reasonably likely to have a material impact on the Company’s financial condition or results of operations.
The Company’s critical accounting estimate relates to the allowance for credit losses. It is based on management’s opinion of an amount that is adequate to absorb losses incurred in the existing portfolio. Because of the nature of the customers under the Company’s Contracts and Direct Loan program, the Company considers the establishment of adequate reserves for credit losses to be imperative.
The Company takes into consideration the composition of the portfolio, current economic conditions, the estimated net realizable value of the underlying collateral, historical loan loss experience, delinquency, non-performing assets, and bankrupt accounts when determining management’s estimate of probable credit losses and the adequacy of the allowance for credit losses. Management utilizes significant judgment in determining probable incurred losses and in identifying and evaluating qualitative factors. This
18
approach aligns with the Company’s lending policies and underwriting standards. If the allowance for credit losses is determined to be inadequate, then an additional charge to the provision is recorded to maintain adequate reserves based on management’s evaluation of the risk inherent in the loan portfolio. During the fourth quarter of the fiscal year ended March 31, 2022, the Company made a change in the accounting estimate and began using a trailing twelve-month net charge-offs as a percentage of average finance receivables, and applying this percentage to ending finance receivables to estimate future probable credit losses. This approach better reflects the current trends of incurred losses within the portfolio and more closely aligns the allowance for credit losses with the portfolio’s performance indicators. Prior to the fourth quarter of the fiscal year ended March 31, 2022, the Company used a trailing six-month net charge-offs as a percentage of average finance receivables, annualized, and applied this percentage to ending finance receivables to estimate future probable losses for purposes of determining the allowance for credit losses. Management believes that estimating the allowance for credit losses using the trailing twelve-month charge-off analysis more accurately reflects portfolio performance adjusted for seasonality and encompasses historical collection practices. Under the current methodology management continues to evaluate qualitative factors to support its allowance for credit losses. The Company examines the impact of macro-economic factors, such as inflation, and changes in the value of underlying collateral and as a result incorporated an additional $0.2 million as a qualitative component amount to its current estimate of adequate reserves.
Contracts are purchased from many different dealers and are all purchased on an individual Contract-by-Contract basis. Individual Contract pricing is determined by the automobile dealerships and is generally the lesser of the applicable state maximum interest rate, if any, or the maximum interest rate which the customer will accept. In most markets, competitive forces will drive down Contract rates from the maximum rate to a level where an individual competitor is willing to buy an individual Contract. The Company generally purchases Contracts on an individual basis.
The Company utilizes the branch model, which allows for Contract purchasing to be done at the branch level. The Company has detailed underwriting guidelines it utilizes to determine which Contracts to purchase. These guidelines are specific and are designed to provide reasonable assurance that the Contracts that the Company purchases have common risk characteristics. The Company utilizes its District Managers to evaluate their respective branch locations for adherence to these underwriting guidelines, as well as approve underwriting exceptions. Any Contract that does not meet the Company’s underwriting guidelines can be submitted by a branch manager for approval from the Company’s District Managers or senior management.
Introduction
For the three months ended June 30, 2022, the net dilutive loss per share decreased to $0.24 as compared to net dilutive earnings per share of $0.22 for the three months ended June 30, 2021. Net loss was $1.8 million for the three months ended June 30, 2022 as compared to a net income of $1.7 million for the three months ended June 30, 2021. Revenue decreased 10.5% to $11.3 million for the three months ended June 30, 2022, as compared to $12.6 million for the three months ended June 30, 2021, mainly due to an unrealized loss of $0.8 million on equity investments in the current year quarter.
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The Company finances primary transportation to and from work for the subprime borrower. The Company does not finance luxury cars, second units or recreational vehicles, which are the first payments customers tend to skip in time of economic insecurity. The Company finances the main and often only vehicle in the household that is needed to get our customers to and from work. The amounts we finance are much lower than most of our competitors, and therefore the payments are significantly lower, too. The combination of financing a “need” over a “want” and making that loan on comparatively affordable terms incentivizes our customers to prioritize their account with us.
|
|
|
|
|
|
|
|
|
|
|
Three months ended
June 30,
(In thousands) |
|
|
|
2022 |
|
|
2021 |
|
Portfolio Summary |
|
|
|
|
|
|
Average finance receivables (1) |
|
$ |
179,455 |
|
|
$ |
181,970 |
|
Average indebtedness (2) |
|
$ |
60,829 |
|
|
$ |
79,217 |
|
Interest and fee income on finance receivables |
|
$ |
12,064 |
|
|
$ |
12,594 |
|
Interest expense |
|
|
568 |
|
|
|
1,188 |
|
Net interest and fee income on finance receivables |
|
$ |
11,496 |
|
|
$ |
11,406 |
|
Gross portfolio yield (3) |
|
|
26.89 |
% |
|
|
27.68 |
% |
Interest expense as a percentage of average finance receivables |
|
|
1.27 |
% |
|
|
2.61 |
% |
Provision for credit losses as a percentage of average finance
receivables |
|
|
8.12 |
% |
|
|
1.60 |
% |
Net portfolio yield (3) |
|
|
17.50 |
% |
|
|
23.47 |
% |
Operating expenses as a percentage of average finance receivables |
|
|
21.11 |
% |
|
|
18.35 |
% |
Pre-tax yield as a percentage of average finance receivables (4) |
|
|
(3.61 |
)% |
|
|
5.12 |
% |
Net charge-off percentage (5) |
|
|
6.48 |
% |
|
|
3.59 |
% |
Finance receivables |
|
$ |
180,053 |
|
|
$ |
180,823 |
|
Allowance percentage (6) |
|
|
2.05 |
% |
|
|
2.90 |
% |
Total reserves percentage (7) |
|
|
5.95 |
% |
|
|
7.01 |
% |
Note: All three-month of income performance indicators expressed as percentages have been annualized.
(1)Average finance receivables represent the average of the month-end finance receivables throughout the period.
(2)Average indebtedness represents the average outstanding borrowings at day-end under the Line of Credit throughout the period. Average indebtedness does not include the PPP loan.
(3)Gross portfolio yield represents interest and fee income on finance receivables as a percentage of average finance receivables. Net portfolio yield represents (a) interest and fee income on finance receivables minus (b) interest expense minus (c) the provision for credit losses, as a percentage of average finance receivables.
(4)Pre-tax yield represents net portfolio yield minus operating expenses (marketing, salaries, employee benefits, depreciation, and administrative), as a percentage of average finance receivables.
(5)Net charge-off percentage represents net charge-offs (charge-offs less recoveries) divided by average finance receivables outstanding during the period.
(6)Allowance percentage represents the allowance for credit losses divided by finance receivables outstanding as of ending balance sheet date.
(7)Total reserves percentage represents the allowance for credit losses, purchase price discount, and unearned dealer discounts divided by finance receivables outstanding as of ending balance sheet date.
Operating Strategy
The Company remains committed to its branch-based model and its core product of financing primary transportation to and from work for the subprime borrower through the local independent automobile dealership. The Company strategically employs the use of centralized servicing departments to supplement the branch operations and improve operational efficiencies, but its focus is on its core business model of decentralized operations. The Company’s strategy also includes risk-based pricing (rate, yield, advance, term, collateral value) and a commitment to the underwriting discipline required for optimal portfolio performance as opposed to chasing
20
competition for the sake of simply generating volume. The Company’s principal goals are to increase its profitability and its long-term shareholder value. During fiscal 2023, the Company is focusing on the following items:
•maintaining our commitment to the local branch model;
•identifying additional ancillary products to enhance profitability and asset performance;
•continuing to focus on strategic acquisitions or bulk portfolio purchases to accelerate total revenue;
•reducing operating expenses;
•executing a branch consolidation plan along with right-sizing the remaining branch network;
•growing our receivable base;
•identify strategic investments in technology to enhance growth;
•leadership/management training to develop skills at all levels;
•increasing shareholder equity;
•recruiting and retaining top talent.
The Company continues to focus on selecting the right markets to have branch locations. As of June 30, 2022, the Company operated brick and mortar branch locations in 18 states — Alabama, Florida, Georgia, Idaho, Illinois, Indiana, Kentucky, Michigan, Missouri, North Carolina, Nevada, Ohio, Pennsylvania, South Carolina, Tennessee, Texas, Utah and Wisconsin. The Company also originated business in its expansion states of Kansas without a physical branch in such markets.
The Company is currently licensed to provide Direct Loans in 14 states— Alabama, Florida, Georgia (over $3,000), Illinois, Indiana, Kansas, Kentucky, Michigan, Missouri, North Carolina, Ohio, Pennsylvania, South Carolina, and Tennessee. The Company solicits current and former customers in these states for the purpose of providing Direct Loans to such customers, and intends to continue the expansion of its Direct Loan capabilities to the other states in which it acquires Contracts. Even with this targeted expansion, the Company expects its total Direct Loans portfolio to remain between 8% and 16% of its total portfolio for the foreseeable future.
Analysis of Credit Losses
The Company takes into consideration the composition of the portfolio, current economic conditions, the estimated net realizable value of the underlying collateral, historical loan loss experience, delinquency, non-performing assets, and bankrupt accounts when determining management’s estimate of probable credit losses and the adequacy of the allowance for credit losses. Management utilizes significant judgment in determining probable incurred losses and in identifying and evaluating qualitative factors. This approach aligns with the Company’s lending policies and underwriting standards. If the allowance for credit losses is determined to be inadequate, then an additional charge to the provision is recorded to maintain adequate reserves based on management’s evaluation of the risk inherent in the loan portfolio. During the fourth quarter of the fiscal year ended March 31, 2022, the Company made a change in the accounting estimate and began using a trailing twelve-month net charge-offs as a percentage of average finance receivables, and applying this percentage to ending finance receivables to estimate future probable credit losses. This approach better reflects the current trends of incurred losses within the portfolio and more closely aligns the allowance for credit losses with the portfolio’s performance indicators. Prior to the fourth quarter of the fiscal year ended March 31, 2022, the Company used a trailing six-month net charge-offs as a percentage of average finance receivables, annualized, and applied this percentage to ending finance receivables to estimate future probable losses for purposes of determining the allowance for credit losses. Using the prior methodology for estimating the allowance for credit losses would have resulted in higher provision expense of approximately $1.7 million. Management believes that estimating the allowance for credit losses using the trailing twelve-month charge-off analysis more accurately reflects portfolio performance adjusted for seasonality and encompasses historical collection practices. Under the current methodology the management continues to evaluate qualitative factors to support its allowance for credit losses. The Company examines the impact of macro-economic factors, such as inflation, and changes in the value of underlying collateral and as a result incorporated an additional $0.2 million as a qualitative component amount to its current estimate of adequate reserves.
The Company defines non-performing assets as accounts that are contractually delinquent for 60 or more days past due or Chapter 13 bankruptcy accounts. For these accounts, the accrual of interest income is suspended, and any previously accrued interest is reversed. Upon notification of a bankruptcy, an account is monitored for collection with other Chapter 13 accounts. In the event the debtors’ balance is reduced by the bankruptcy court, the Company will record a loss equal to the amount of principal balance reduction. The remaining balance will be reduced as payments are received by the bankruptcy court. In the event an account is dismissed from bankruptcy, the Company will decide based on several factors, whether to begin repossession proceedings or allow the customer to begin making regularly scheduled payments.
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The Company defines a Chapter 13 bankruptcy account as a Troubled Debt Restructuring (“TDR”). The Company records a specific reserve for Chapter 13 bankruptcy accounts which is considered a qualitative reserve to the allowance for credit losses. The Company records the reserve based on the expected collectability of the principal balance of the Chapter 13 Bankruptcy and the specific reserve recorded as of June 30, 2022 and June 30, 2021 was $127,000 and $90,000, respectively.
The provision for credit losses increased to $3.6 million for the three months ended June 30, 2022 from $0.7 million for the three months ended June 30, 2021, due to increase in net charge-off percentage experienced. The Company’s allowance for credit losses also incorporates recent trends such as delinquency, non-performing assets, and bankruptcy. The Company believes that this approach reflects the current trends of incurred losses within the portfolio and better aligns the allowance for credit losses with the portfolio’s performance indicators.
The delinquency percentage for Contracts more than thirty days past due, excluding Chapter 13 bankruptcy accounts, as of June 30, 2022 was 9.5%, an increase from 6.3% as of June 30, 2021. The delinquency percentage for Direct Loans more than thirty days past due, excluding Chapter 13 bankruptcy accounts, as of June 30, 2022 was 5.1%, an increase from 2.6% as of June 30, 2021. The delinquency percentage for both Contracts and Direct Loans increased as general economic factors such began to worsen.
In accordance with Company policies and procedures, certain borrowers qualify for, and the Company offers, one-month principal payment deferrals on Contracts and Direct Loans. For the three months ended June 30, 2022 and June 30, 2021 the Company granted deferrals to approximately 5.1% and 1.7%, respectively, of total Contracts and Direct Loans. The increase in the total number of deferrals in the first quarter of fiscal 2023 compared to the first quarter of fiscal 2022 was primarily the result of declining general economic factors. The number of deferrals is also influenced by portfolio performance, including but not limited to, inflation, credit quality of loans purchased, competition at the time of Contract acquisition, and general economic conditions. For further information on deferrals, please see the disclosure under “COVID-19” above.
Three months ended June 30, 2022 compared to three months ended June 30, 2021
Interest and Fee Income on Finance Receivables
Interest and fee income on finance receivables, which consist predominantly of finance charge income, decreased 4.2% to $12.1 million for the three months ended June 30, 2022, from $12.6 million for the three months ended June 30, 2021. The decrease was primarily due to a 1.4% decrease in average finance receivables to $179.5 million for the three months ended June 30, 2022, when compared to $182.0 million for the corresponding period ended June 30, 2021.
The gross portfolio yield decreased to 26.89% for the three months ended June 30, 2022, compared to 27.68% for the three months ended June 30, 2021. The net portfolio yield decreased to 17.50% for the three months ended June 30, 2022, compared to 23.47% for the three months ended June 30, 2021. The net portfolio yield decreased primarily due to the increase in the provision for credit losses, as described under “Analysis of Credit Losses”.
Operating Expenses
Operating expenses increased to $9.5 million for the three months ended June 30, 2022 compared to $8.3 million for the three months ended June 30, 2021. The increase in operating expenses was primarily attributed to administrative, salaries and employee benefits expenses. Operating expenses as a percentage of average finance receivables, increased to 21.10% for the three months ended June 30, 2022 from 18.35% for the three months ended June 30, 2021 due to a proportionally greater decline in finance receivables.
Provision Expense
The provision for credit losses increased to $3.6 million for the three months ended June 30, 2022 from $0.7 million for the three months ended June 30, 2021. An increase in provision for credit losses taken during the three months ended June 30, 2022 was attributable to increase in net charge-off percentage experienced.
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Interest Expense
Interest expense was $0.6 million for the three months ended June 30, 2022, and $1.2 million for the three months ended June 30, 2021. The following table summarizes the Company’s average cost of borrowed funds, exclusive of debt origination costs:
|
|
|
|
|
|
|
|
|
|
|
Three months ended
June 30, |
|
|
|
2022 |
|
|
2021 |
|
Variable interest under the Line of Credit |
|
|
0.68 |
% |
|
|
1.00 |
% |
Credit spread under the Line of Credit |
|
|
2.25 |
% |
|
|
3.75 |
% |
Average cost of borrowed funds |
|
|
2.93 |
% |
|
|
4.75 |
% |
SOFR rates have increased to 1.50%, which represents the one-month SOFR rate as required under our Wells Fargo Line of Credit, as of June 30, 2022 compared to 0.1%, which represents the one-month LIBOR rate as required under our Line of Credit, as of June 30, 2021. For further discussions regarding interest rates see “Note 6—Line of Credit”.
Income Taxes
The Company recorded an income tax benefit of approximately $627,000 for the three months ended June 30, 2022 compared to income tax expense of approximately $599,000 for the three months ended June 30, 2021. The Company’s effective tax rate increased to 26.1% for the three months ended June 30, 2022 from 25.7% for the three months ended June 30, 2021.
Contract Procurement
As of June 30, 2022, the Company purchases Contracts in the states listed in the table below. The Contracts purchased by the Company are predominantly for used vehicles; for the three-month periods ended June 30, 2022 and 2021, less than 1% were for new vehicles.
The following tables present selected information on Contracts purchased by the Company.
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|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, |
|
|
Three months ended
June 30, |
|
|
|
2022 |
|
|
2022 |
|
|
2021 |
|
State |
|
Number of
branches |
|
|
Net Purchases
(In thousands) |
|
FL |
|
|
11 |
|
|
$ |
4,749 |
|
|
$ |
3,434 |
|
OH |
|
|
6 |
|
|
|
2,982 |
|
|
|
3,253 |
|
GA |
|
|
5 |
|
|
|
2,758 |
|
|
|
3,014 |
|
KY |
|
|
3 |
|
|
|
1,501 |
|
|
|
1,663 |
|
MO |
|
|
2 |
|
|
|
1,391 |
|
|
|
1,453 |
|
NC |
|
|
3 |
|
|
|
1,840 |
|
|
|
1,130 |
|
IN |
|
|
2 |
|
|
|
1,112 |
|
|
|
1,008 |
|
SC |
|
|
3 |
|
|
|
1,341 |
|
|
|
970 |
|
AL |
|
|
2 |
|
|
|
1,066 |
|
|
|
819 |
|
MI |
|
|
2 |
|
|
|
450 |
|
|
|
791 |
|
NV |
|
|
1 |
|
|
|
568 |
|
|
|
538 |
|
TN |
|
|
1 |
|
|
|
296 |
|
|
|
478 |
|
IL |
|
|
1 |
|
|
|
489 |
|
|
|
439 |
|
PA |
|
|
1 |
|
|
|
614 |
|
|
|
360 |
|
TX |
|
|
1 |
|
|
|
526 |
|
|
|
335 |
|
WI |
|
|
1 |
|
|
|
264 |
|
|
|
286 |
|
ID |
|
|
1 |
|
|
|
294 |
|
|
|
171 |
|
UT |
|
|
1 |
|
|
|
71 |
|
|
|
145 |
|
AZ |
|
|
- |
|
|
|
24 |
|
|
|
18 |
|
KS |
|
- |
|
|
|
18 |
|
|
|
- |
|
Total |
|
|
47 |
|
|
$ |
22,354 |
|
|
$ |
20,305 |
|
23
|
|
|
|
|
|
|
|
|
|
|
Three months ended
June 30,
(Purchases in thousands) |
|
Contracts |
|
2022 |
|
|
2021 |
|
Purchases |
|
$ |
22,354 |
|
|
$ |
20,305 |
|
Average APR |
|
|
22.9 |
% |
|
|
23.2 |
% |
Average discount |
|
|
6.6 |
% |
|
|
7.0 |
% |
Average term (months) |
|
|
48 |
|
|
|
46 |
|
Average amount financed |
|
$ |
11,552 |
|
|
$ |
10,429 |
|
Number of Contracts |
|
|
1,935 |
|
|
|
1,947 |
|
Direct Loan Origination
The following table presents selected information on Direct Loans originated by the Company.
|
|
|
|
|
|
|
|
|
Direct Loans |
|
Three months ended
June 30,
(Originations in thousands) |
|
Originated |
|
2022 |
|
|
2021 |
|
Purchases/Originations |
|
$ |
8,215 |
|
|
$ |
5,737 |
|
Average APR |
|
|
31.2 |
% |
|
|
30.1 |
% |
Average term (months) |
|
|
25 |
|
|
|
25 |
|
Average amount financed |
|
$ |
4,128 |
|
|
$ |
4,359 |
|
Number of loans |
|
|
1,990 |
|
|
|
1,316 |
|
Liquidity and Capital Resources
The Company’s cash flows are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
Three months ended
June 30,
(In thousands) |
|
|
|
2022 |
|
|
2021 |
|
Cash provided by (used in): |
|
|
|
|
|
|
Operating activities |
|
$ |
(1,361 |
) |
|
$ |
1,055 |
|
Investing activities |
|
|
(9,307 |
) |
|
|
3,496 |
|
Financing activities |
|
|
9,444 |
|
|
|
(14,055 |
) |
Net (decrease) in cash |
|
$ |
(1,224 |
) |
|
$ |
(9,504 |
) |
The Company’s primary use of working capital for the quarter ended June 30, 2022 was, and for the foreseeable future will continue to be, funding the purchase of Contracts, which are financed substantially through cash from principal and interest payments received, and the Company’s line of credit.
On November 5, 2021, NFI and its direct parent, Nicholas Data Services, Inc. (“NDS” and collectively with NFI, the “Borrowers”), entered into a senior secured line of credit (the “Line of Credit”) pursuant to a loan and security agreement by and among the Borrowers, Wells Fargo Bank, N.A., as agent, and the lenders that are party thereto (the “Credit Agreement”). The Ares Line of Credit was paid off in connection with entering into the Line of Credit.
Pursuant to the Credit Agreement, the lenders have agreed to extend to the Borrowers a line of credit of up to $175,000,000. The availability of funds under the Line of Credit is generally limited to an advance rate of between 80% and 85% of the value of eligible receivables, and outstanding advances under the Line of Credit will accrue interest at a rate equal to the Secured Overnight Financing Rate (SOFR) plus 2.25%. The commitment period for advances under the Line of Credit is three years (the expiration of that time period, the “Maturity Date”).
Pursuant to the Credit Agreement, the Borrowers granted a security interest in substantially all of their assets as collateral for their obligations under the Line of Credit. Furthermore, pursuant to a separate collateral pledge agreement, NDS pledged its equity interest in NFI as additional collateral.
24
The Credit Agreement and the other loan documents contain customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, investments, and sales of assets. If an event of default occurs, the lenders could increase borrowing costs, restrict the Borrowers’ ability to obtain additional advances under the Line of Credit, accelerate all amounts outstanding under the Line of Credit, enforce their interest against collateral pledged under the Line of Credit or enforce such other rights and remedies as they have under the loan documents or applicable law as secured lenders.
If the lenders terminate the Line of Credit following the occurrence of an event of default under the loan documents, or the Borrowers prepay the loan and terminate the Line of Credit prior to the Maturity Date, then the Borrowers are obligated to pay a termination or prepayment fee in an amount equal to a percentage of $175,000,000, calculated as 2% if the termination or prepayment occurs during year one, 1% if the termination or repayment occurs during year two, and 0.5% if the termination or prepayment occurs thereafter.
The Company will continue to depend on the availability the Line of Credit, together with cash from operations, to finance future operations. The availability of funds under the Line of Credit generally depends on availability calculations as defined in the Credit Agreement. See also the disclosure in Note 6. Line of Credit in this Form 10-Q, which is incorporated herein by reference.
On May 27, 2020, the Company obtained a loan in the amount of $3,243,900 from a bank in connection with the U.S. Small Business Administration’s (“SBA”) Paycheck Protection Program (the “PPP Loan”). Pursuant to the Paycheck Protection Program, all or a portion of the PPP Loan may be forgiven if the Company uses the proceeds of the PPP Loan for its payroll costs and other expenses in accordance with the requirements of the Paycheck Protection Program. The Company used the proceeds of the PPP Loan for payroll costs and other covered expenses and sought full forgiveness of the PPP Loan. The Company submitted a forgiveness application to Fifth Third Bank, the lender, on December 7, 2020 and submitted supplemental documentation on January 16, 2021. On December 27, 2021 SBA informed the Company that no forgiveness was granted. The Company filed an appeal with SBA on January 5, 2022. On May 6, 2022 the Office of Hearing and Appeals SBA (OHA) rendered a decision to deny the appeal. The Company subsequently repaid the outstanding principal of $3,243,900 plus accrued and unpaid interest of $64,518 on May 23, 2022.
Off-Balance Sheet Arrangements
The Company does not engage in any off-balance sheet financing arrangements.
25