Regional Management Earnings 2018-12-31
RM 10K Annual Report
| Balance Sheet | Income Statement | Cash Flow |
|---|---|---|
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| ☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2018
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 001-35477
Regional Management Corp.
(Exact name of registrant as specified in its charter)
| Delaware | 57-0847115 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
| 979 Batesville Road, Suite B Greer, South Carolina | 29651 | |
| (Address of principal executive offices) | (Zip Code) | |
(864) 448-7000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Name of Each Exchange on Which Registered | |
| Common Stock, $0.10 par value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K. ☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☒ | |||
| Non-accelerated filer | ☐ | Smaller reporting company | ☐ | |||
| Emerging growth company | ☐ | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
As of June 29, 2018 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of the common stock held by non-affiliates of the registrant was $345,188,148 based upon the closing sale price as reported on the New York Stock Exchange. See Part II, Item 5 of this Annual Report on Form 10-K for additional information.
As of March 7, 2019, there were 11,828,806 shares of the registrant’s common stock outstanding.
Documents Incorporated by Reference
Certain information required by Part III of this Annual Report on Form 10-K is incorporated herein by reference to the Proxy Statement for the registrant’s 2019 Annual Meeting of Stockholders, which is expected to be filed pursuant to Regulation 14A within 120 days after the end of the registrant’s fiscal year ended December 31, 2018.
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REGIONAL MANAGEMENT CORP.
ANNUAL REPORT ON FORM 10-K
Fiscal Year Ended December 31, 2018
Table of Contents
Each of the terms “Regional,” the “Company,” “we,” “us,” and “our” as used herein refers collectively to Regional Management Corp. and its wholly-owned subsidiaries, unless otherwise stated.
This Annual Report on Form 10-K includes “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including, but not limited to, certain statements and disclosures contained in Part I, Item 1, “Business,” Part I, Item 1A, “Risk Factors,” and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These forward-looking statements include, but are not limited to, statements about our strategies, future operations, future financial position, future revenues, projected costs, expectations regarding demand and acceptance for our financial products, growth opportunities and trends in the market in which we operate, prospects, plans and objectives of management, representations, and contentions, and are not historical facts. Forward-looking statements typically are identified by the use of terms such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” and similar words, although some forward-looking statements are expressed differently. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. The forward-looking statements included herein reflect and contain management’s current judgment, and involve risks and uncertainties that could cause actual results, events, and/or performance to differ materially from the plans, intentions, and expectations disclosed in the forward-looking statements. Such risks and uncertainties include, without limitation, the risks set forth in Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K. We do not intend to update any of these forward-looking statements or publicly announce the results of or any revisions to these forward-looking statements, other than as is required under the federal securities laws.
The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, our audited consolidated financial statements, including the notes thereto.
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PART I
| ITEM 1. | BUSINESS. |
Overview
We are a diversified consumer finance company that provides installment loan products primarily to customers with limited access to consumer credit from banks, thrifts, credit card companies, and other lenders. We operate under the name “Regional Finance” in 359 branch locations across 11 states in the Southeastern, Southwestern, Mid-Atlantic, and Midwestern United States, serving 401,500 active accounts, as of December 31, 2018. Most of our loan products are secured, and each is structured on a fixed rate, fixed term basis with fully amortizing equal monthly installment payments, repayable at any time without penalty. We source our loans through our multiple channel platform, which includes our branches, centrally-managed direct mail campaigns, digital partners, retailers, and our consumer website. We operate an integrated branch model in which nearly all loans, regardless of origination channel, are serviced through our branch network. This provides us with frequent in-person contact with our customers, which we believe improves our credit performance and customer loyalty. Our goal is to consistently grow our finance receivables and to soundly manage our portfolio risk, while providing our customers with attractive and easy-to-understand loan products that serve their varied financial needs.
Our products include small, large, and retail installment loans. Our small loans and large loans are our core loan products and will be the drivers of our future growth.
| • | Small Loans – We offer small installment loans with cash proceeds to the customer ranging from $500 to $2,500, with terms of up to 48 months. Our small loans are typically secured by non-essential household goods and/or, to a lesser extent, a lien on a vehicle, which may be an automobile, motorcycle, boat, or all-terrain vehicle. As of December 31, 2018, we had 276,800 small loans outstanding representing $437.7 million in finance receivables, or an average of approximately $1,600 per loan. In 2018, 2017, and 2016, interest and fee income from small loans contributed $156.6 million, $150.1 million, and $142.1 million, respectively, to our total revenue. |
| • | Large Loans – We offer large installment loans with cash proceeds to the customer generally ranging from $2,501 to $12,000, with terms of between 18 and 60 months. Our large loans are typically secured by non-essential household goods and/or a vehicle. As of December 31, 2018, we had 99,800 large loans outstanding representing $438.0 million in finance receivables, or an average of approximately $4,400 per loan. In 2018, 2017, and 2016, interest and fee income from large loans contributed $111.1 million, $80.3 million, and $55.0 million, respectively, to our total revenue. |
| • | Retail Loans – We offer indirect retail loans of up to $7,500, with terms of between 6 and 48 months, which are secured by the purchased items. These loans are offered at the point of sale through a network of retailers within and, to a limited extent, outside of our branch footprint. As of December 31, 2018, we had 21,200 retail loans outstanding representing $30.4 million in finance receivables, or an average of approximately $1,400 per loan. In 2018, 2017, and 2016, interest and fee income from retail loans contributed $5.9 million, $5.9 million, and $5.8 million, respectively, to our total revenue. |
| • | Optional Payment and Collateral Protection Insurance Products – We offer our customers optional payment and collateral protection insurance relating to many of our loan products. In 2018, 2017, and 2016, insurance income, net contributed $14.8 million, $13.1 million, and $9.5 million, respectively, to our total revenue. |
Through November 2017, we also offered direct and indirect automobile purchase loans of up to $27,500. We ceased originating automobile loans in November 2017, but we continue to own and service the automobile loans that we previously originated. As of December 31, 2018, we had 3,700 automobile loans outstanding representing $26.2 million in finance receivables, or an average of approximately $7,100 per loan. In 2018, 2017, and 2016, interest and fee income from automobile loans contributed $6.4 million, $12.8 million, and $18.1 million, respectively, to our total revenue.
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Our Industry, Customers, and Purpose
We operate in the consumer finance industry, in which consumers are generally described as super-prime (most creditworthy), prime, near-prime, non-prime, subprime, or deep-subprime (least creditworthy). Our customers typically have less-than-perfect credit profiles and, for that reason, are generally considered subprime, non-prime, or near-prime consumers. As a result, our customers often do not qualify for prime financing from banks, thrifts, credit card providers, and other lenders. However, like prime consumers, our customers have a need and a desire to utilize credit.
Notwithstanding that many lenders are unwilling to serve our customers, we believe that responsible, transparent, and fairly-priced credit products should be made available to our customers. We exist to serve that purpose. Accordingly, we offer our customers access to credit through our affordable, easy-to-understand small loan, large loan, and retail loan products, which we price on fair terms in consideration of the associated credit risk and servicing costs.
The average annual percentage rate (“APR”) of our small loans originated in 2018 was 44.4%. Our large loans, which are reserved for higher credit quality customers who meet more stringent underwriting requirements than those applied to small loan applicants, had an average APR of 30.0% for loans originated in 2018. We believe that the rates on our products are significantly more attractive than many other credit options available to our customers, such as payday, pawn, and title loans, which often come with APRs over 300%. Our loans are also safer and more favorably structured than loans offered by alternative financial service providers. We underwrite our loans based on an applicant’s ability to repay, whereas payday, pawn, and title loans are typically underwritten based on an ability to collect, either through access to the borrower’s bank account or by repossession and sale of collateral. We also structure our loans on a fixed rate, fixed term basis with fully amortizing equal monthly installment payments that are designed to be affordable for our customers and made over an average term of 21 months for small loans and 43 months for large loans (based on loans originated in 2018). By comparison, payday, pawn, and title loans typically have balloon payments following short terms of 14 to 60 days.
Importantly, we further differentiate ourselves from alternative financial service providers by reporting our customers’ payment performance to credit bureaus. This practice provides our customers with the opportunity to improve their credit profile by establishing a responsible payment history with us and, ultimately, to gain access to a wider range of credit options, including our own. For example, in 2018, we worked with many of our deserving customers to refinance nearly 12,000 of our customers’ small loans into large loans, representing more than $53 million in finance receivables at origination, and resulting in a decrease in these customers’ average APR from 44.1% to 31.8%. We also believe that over time many of our customers transition away from our company to prime sources of credit.
Our diversity of loan products with competitive, safe, and transparent pricing and terms, combined with the opportunity for our customers to improve their credit history and profile, distinguishes us in the consumer finance market, provides us with a competitive advantage, and allows us to serve an important purpose that is mutually beneficial to our customers, communities, employees, and stockholders.
Our Business Model
Multiple Channel Platform. Our multiple channel platform, which includes our branches, direct mail campaigns, digital partners, retailers, and our consumer website, enables us to offer a range of loan products to new, existing, and former customers throughout our markets. We began building our branch network over 30 years ago and have expanded the network to 359 branches as of December 31, 2018. Our branch personnel market our products in a number of ways, including through a merchant referral program, customer referrals, direct telephone and mail solicitations of current and former customers, and by leveraging our direct mail program. Our direct mail campaigns include pre-screened convenience check mailings and mailings of
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pre-qualified offers and invitations to apply, which enable us to market our products to millions of current and potential customers in a cost-effective manner. We have also developed our consumer website and partnered with digital lead generation sources to promote our products and facilitate loan applications via the internet. Finally, we have relationships with retailers that offer our retail loans in their stores at the point of sale. We believe that our multiple channel platform provides us with a competitive advantage by giving us broad access to our existing and former customers and multiple avenues to attract new customers.
Attractive Products for Customers with Limited Access to Credit. Our flexible loan products, generally ranging from $500 to $12,000 with terms of up to 60 months, are competitively priced, easy to understand, and incorporate features designed to meet the varied financial needs and credit profiles of a broad range of consumers. This product diversity distinguishes us from monoline competitors and provides us with the ability to offer our customers new loan products as their credit profiles evolve, building customer loyalty and increasing the overall value of customer relationships.
Integrated Branch Model. Our branch network serves as the foundation of our multiple channel platform and the primary point of contact with our customers. Nearly 80% of our loan originations in 2018 occurred in one of our branch locations, and nearly all loans, regardless of origination channel, are serviced through our branches, allowing us to maintain frequent, in-person contact with our customers. By integrating loan origination and loan servicing at the branch level, our employees are able to maintain a relationship with our customers throughout the life of a loan. We believe this frequent-contact, relationship-driven lending model provides greater insight into potential payment difficulties, reduces credit risk, and allows us to assess the borrowing needs of our customers, better enabling us to offer them new loan products as their credit profiles and needs evolve.
Consistent Portfolio Performance. Over the past several years, we have sharpened our focus on credit quality by investing in highly-qualified personnel, refining underwriting practices, developing custom credit scorecards, streamlining procedures, automating underwriting decisions, and improving reporting capabilities, all of which allow us to better control the credit quality of our portfolio, maintain compliance with evolving state and federal law, and react quickly whenever market dynamics may change. We have also expanded our centralized collections department and provided our branches with improved collections tools, training, and incentives. As a result of these efforts and practices, between 2015 and 2018, we reported annual net credit loss rates in a relatively narrow band of 8.8% to 9.4% of average finance receivables.
Demonstrated Organic Growth. We have grown our total finance receivables by 70.7%, from $546.2 million at December 31, 2014 to $932.2 million at December 31, 2018, a compound annual growth rate (“CAGR”) of 14.3%. More importantly, we have grown our core small loan and large loan finance receivables by 139.5%, from $365.7 million at December 31, 2014 to $875.7 million at December 31, 2018, a CAGR of 24.4%. This receivables growth has driven a revenue increase of 49.8%, from $204.7 million in 2014 to $306.7 million in 2018, a CAGR of 10.6%. Our portfolio growth has come from expanding our branch network, growing our finance receivable portfolios within existing branches, and developing new products and channels, including through digital lead generation. From 2014 to 2018, we grew our year-end branch count from 300 branches to 359 branches. We opened a net 17 new branches in 2018, and we have also grown our existing branch revenues. Historically, our branches have rapidly increased their outstanding finance receivables during the early years of operations and generally achieved profitability within one year of opening.
Experienced Management Team. Our executive and senior operations management teams consist of individuals experienced in installment lending and other consumer finance services. Both our Chief Executive Officer and our Chief Operating Officer have nearly 30 years of experience in consumer financial services, and our Chief Risk Officer has over 20 years of financial and consumer lending experience, including expertise in credit risk management. As of December 31, 2018, our state operations vice presidents averaged nearly 28 years of industry experience and more than 8 years of service at Regional, while our district supervisors averaged nearly 21 years of industry experience and more than 6 years of service with Regional. Our executive and senior operations management team members intend to leverage their experience and expertise in consumer lending to grow our business, deliver high-quality service to our customers, and carefully manage our credit risk.
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Our Strategies
Grow Our Branch Network. We intend to continue to grow the receivables, revenue, and profitability of our existing branches, to open new branches within our existing geographic footprint, and to expand our operations into new states. Establishing local contact with our customers through our branch network is key to our frequent-contact, relationship-driven lending model. We believe that there remains substantial opportunity to grow the finance receivable portfolios of our existing branches by continuing our focus on large loan originations and by cross-selling new loan products to our existing customers, including those customers with retail loans and automobile loans. In addition, from 2014 to 2018, we opened or acquired a net 59 new branches, and in 2018, we opened our first branches in Missouri and Wisconsin. We expect that as our newer branches mature, their revenue will grow faster than our overall same-store revenue growth rate. We believe there is sufficient demand for consumer finance services to continue new branch openings in certain of the states where we currently operate, allowing us to capitalize on our existing infrastructure and experience in these markets. We also intend to explore opportunities for growth in several states outside of our existing geographic footprint that enjoy favorable operating environments. Our competitors operate in as many as 44 states.
Leverage Our Direct Mail Capabilities. Direct mail campaigns are launched throughout the year, but are weighted to coincide with seasonal consumer demand. In addition, we mail convenience checks in new markets as soon as new branches are open, which develops a customer base and builds finance receivables for these new branches. In 2018, we mailed 6.6 million convenience checks, 1.4 million pre-qualified loan offers, and 2.2 million invitations to apply. Moving forward, we plan to continue to invest in and to improve the targeting criteria, offer strategies, and testing protocols of our direct mail campaigns, which we believe will enable us to efficiently grow our receivables with improved credit performance. We expect that these efforts will allow us to increase volume at our branches by adding new customers, recapturing former customers, and creating opportunities to offer new loan products to our existing customers.
Expand Our Digital Presence. In order to better serve and attract customers who prefer to conduct business digitally, we make an online loan application available on our consumer website, generate customer leads through digital partners, and provide our customers with online account management capabilities. Throughout 2018, we continued to grow our digital acquisition channel, more than tripling our investment from 2017 to 2018. This investment enabled us to increase our digitally-sourced loan originations by nearly 130% year-over-year and to grow the percentage of new customers generated through this channel to more than 15% of all new small and large loan customers in 2018. We also continued to enhance and promote our online account management tools that enable customers to make payments and manage their accounts online. In 2019, we expect to continue to invest in the digital channel, thereby adding capabilities, improving efficiencies, enhancing the customer experience, and testing new mechanisms for lead generation to further diversify and expand our new business acquisition mechanisms.
Maintain Sound Underwriting and Credit Control. Since 2015, we have invested heavily in our credit and collections functions. We plan to continue to do so in the future by maintaining highly-qualified employees dedicated to managing credit risk, refining our underwriting models, and improving our collection efforts, through both our branch operations and our centralized collections department. In early 2018, we completed the implementation of our new loan origination and servicing software platform, which allows us to automate our underwriting decisions, among other benefits. In addition, in the second half of 2018, we began to integrate custom credit models into our automated underwriting processes. We expect to complete the rollout of our custom credit models to all of our states in 2019, with the benefit of such models expected to begin impacting our results in late 2019 and 2020. Through these efforts and others, we plan to continue to carefully manage our credit exposure as we grow our business, offer new products, and enter new markets.
Carefully Manage Our G&A Expenses. We have made significant investments in our business over the past several years, including by increasing our marketing spend to drive new business, expanding our branch network, hiring operations employees to service our growing finance receivable portfolio, and improving our
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credit and information technology capabilities. However, during that time, we also remained keenly focused on driving operating leverage through the prudent management of our expenses. Between 2015 and 2018, our general and administrative expenses as a percentage of average finance receivables decreased from 20.2% to 16.4%. As we grow our business, we will remain vigilant in our management of general and administrative expenses, with the goal of causing such expenses to decrease as a percentage of average finance receivables over time.
Our Loan Products
We offer small, large, and retail installment loans to our customers. Our underwriting standards focus on our customers’ ability to affordably make loan payments out of their discretionary income, with the value of pledged collateral serving as a credit enhancement rather than the primary underwriting criterion. The interest rates, fees and other charges, maximum principal amounts, and maturities for our loans vary from state to state, depending on the competitive environment and relevant laws and regulations.
Small loans and large loans are closed in our branch network or originated through our convenience check direct mail campaigns. Our convenience check direct mail loan offers enable prospective customers to enter into a loan with us by cashing or depositing the check attached to the loan offer, thereby agreeing to the terms of the loan as prominently set forth on the check and accompanying disclosures. When a customer enters into a loan by cashing or depositing the convenience check, our personnel gather additional information on the borrower to assist in servicing the loan. Our retail loans are indirect installment loans structured as retail installment sales contracts. Retail loans are made through a retailer at the point of sale without the need for the customer to visit one of our branches. Our customers use our retail loans to finance the purchase of furniture, appliances, and other retail products. The vast majority of our retail loans are originated inside of our eleven-state brick-and-mortar footprint, but on a limited basis, we offer retail loans in states outside of our footprint. The servicing of nearly all retail loans is performed within our branches, with only out-of-footprint retail loans being serviced centrally from our headquarters in South Carolina.
For loans originated in our branch network, we consider numerous factors in evaluating a potential customer’s creditworthiness, such as unencumbered income, debt-to-income ratios, length of current employment, duration of residence, and a credit report detailing the applicant’s credit history. Our loan origination and servicing software platform guides our branch personnel through the credit application process and automates much of the underwriting, with underwriting exceptions generally subject to review and approval by a senior operations or centralized underwriting team member. For retail loans, our retail partners typically submit credit applications to us online while the customer waits in the retailer’s store. Underwriting for our retail loans is conducted by our centralized underwriting team using standards substantially similar to our branch small loan and large loan underwriting guidelines. Our retail loan credit decisions generally are provided to the retailer within ten minutes of our receipt of the application. For convenience check loans, each prospect that we solicit has been pre-screened through a major credit bureau against our underwriting criteria, which includes an evaluation of the recipient’s credit score, bankruptcy history, and a number of additional credit attributes relevant to the recipient’s likely ability and willingness to repay the offered convenience check loan.
Loan renewals are also an important part of our business. Our customers use renewals to extend and expand their lending relationships with us. We generally offer loan renewals to existing customers who have demonstrated an ability and willingness to repay amounts owed to us. Renewals typically refinance one or more of a customer’s loans into a single new loan, which in some cases will be for a larger principal balance than the customer’s original loan, though we permit renewals of existing loans at or below the original loan amount. In evaluating a loan for renewal, in addition to our standard underwriting requirements, we are able to take into consideration the customer’s prior payment performance with us, which we believe is a very strong indicator of the customer’s future credit performance. In 2018, renewals of loans in an amount greater than the original loan amount represented 47% of our loan originations and renewals of loans at or below the original loan amount represented 19% of our loan originations.
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Small Loans. In 2018, the average originated net loan size and term for our small loans were $1,831 and 21 months, respectively. The average yield we earned on our portfolio of small loans was 40.0% in 2018. The following table sets forth the distribution of our small loan finance receivable portfolio by state as of the dates indicated.
| At December 31, | ||||||||||||||||||||
| 2014 | 2015 | 2016 | 2017 | 2018 | ||||||||||||||||
| Texas | 29 | % | 31 | % | 32 | % | 34 | % | 34 | % | ||||||||||
| South Carolina | 25 | % | 23 | % | 20 | % | 17 | % | 16 | % | ||||||||||
| North Carolina | 15 | % | 15 | % | 15 | % | 14 | % | 15 | % | ||||||||||
| Alabama | 13 | % | 13 | % | 14 | % | 14 | % | 13 | % | ||||||||||
| All Other States | 18 | % | 18 | % | 19 | % | 21 | % | 22 | % | ||||||||||
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The following table sets forth the total number of small loans, total small loan finance receivables, and average size per loan by state as of December 31, 2018.
| Number of Loans | Finance Receivables | Average Size Per Loan | ||||||||||
| (In thousands) | ||||||||||||
| Texas | 100,416 | $ | 154,821 | $ | 1,542 | |||||||
| South Carolina | 40,918 | 68,169 | 1,666 | |||||||||
| North Carolina | 40,212 | 64,013 | 1,592 | |||||||||
| Alabama | 32,738 | 54,987 | 1,680 | |||||||||
| All Other States | 62,475 | 95,672 | 1,531 | |||||||||
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| Total | 276,759 | $ | 437,662 | $ | 1,581 | |||||||
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Large Loans. In 2018, our average originated net loan size and term for large loans were $5,015 and 43 months, respectively. The average yield we earned on our portfolio of large loans was 28.5% for 2018. The following table sets forth the distribution of our large loan finance receivable portfolio by state as of the dates indicated.
| At December 31, | ||||||||||||||||||||
| 2014 | 2015 | 2016 | 2017 | 2018 | ||||||||||||||||
| Texas | 10 | % | 22 | % | 22 | % | 24 | % | 27 | % | ||||||||||
| South Carolina | 25 | % | 22 | % | 20 | % | 19 | % | 21 | % | ||||||||||
| North Carolina | 27 | % | 18 | % | 21 | % | 19 | % | 16 | % | ||||||||||
| Alabama | 26 | % | 17 | % | 14 | % | 12 | % | 11 | % | ||||||||||
| All Other States | 12 | % | 21 | % | 23 | % | 26 | % | 25 | % | ||||||||||
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The following table sets forth the total number of large loans, total large loan finance receivables, and average size per loan by state as of December 31, 2018.
| Number of Loans | Finance Receivables | Average Size Per Loan | ||||||||||
| (In thousands) | ||||||||||||
| Texas | 28,297 | $ | 116,355 | $ | 4,112 | |||||||
| South Carolina | 19,010 | 92,297 | 4,855 | |||||||||
| North Carolina | 17,165 | 70,721 | 4,120 | |||||||||
| Alabama | 10,633 | 47,591 | 4,476 | |||||||||
| All Other States | 24,692 | 111,034 | 4,497 | |||||||||
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| Total | 99,797 | $ | 437,998 | $ | 4,389 | |||||||
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Retail Loans. In 2018, our average originated net loan size and term for retail loans were $1,994 and 28 months, respectively. The average yield we earned on our portfolio of retail loans was 19.0% for 2018. The following table sets forth the distribution of our retail loan finance receivable portfolio by state as of the dates indicated.
| At December 31, | ||||||||||||||||||||
| 2014 | 2015 | 2016 | 2017 | 2018 | ||||||||||||||||
| Texas | 62 | % | 69 | % | 73 | % | 75 | % | 72 | % | ||||||||||
| North Carolina | 14 | % | 10 | % | 8 | % | 7 | % | 9 | % | ||||||||||
| Oklahoma | 7 | % | 8 | % | 6 | % | 5 | % | 6 | % | ||||||||||
| All Other States | 17 | % | 13 | % | 13 | % | 13 | % | 13 | % | ||||||||||
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The following table sets forth the total number of retail loans, total retail loan finance receivables, and average size per loan by state as of December 31, 2018.
| Number of Loans | Finance Receivables | Average Size Per Loan | ||||||||||
| (In thousands) | ||||||||||||
| Texas | 15,482 | 22,149 | 1,431 | |||||||||
| North Carolina | 1,840 | 2,611 | 1,419 | |||||||||
| Oklahoma | 1,303 | 1,850 | 1,420 | |||||||||
| All Other States | 2,609 | 3,819 | 1,464 | |||||||||
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| Total | 21,234 | $ | 30,429 | $ | 1,433 | |||||||
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Our Insurance and Ancillary Products
We also offer our customers various optional payment and collateral protection insurance products as a complement to our lending operations. Our primary insurance products include optional credit life insurance, accident and health insurance, involuntary unemployment insurance, and personal property insurance. These insurance products are optional and not a condition of the loan, and we do not sell insurance to non-borrowers. Our insurance products, including the types of products offered and their terms and conditions, vary from state to state in compliance with applicable laws and regulations. Insurance policy premiums, claims, and expenses are included in the company’s results of operations as insurance income, net in the consolidated statements of income. In 2018, insurance income, net was $14.8 million, or 4.8% of our total revenue.
Credit life insurance provides for the payment in full of the borrower’s credit obligation to the lender in the event of the borrower’s death and, in some states, may provide a payment to a secondary beneficiary listed by the
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borrower. Credit accident and health insurance provides for the repayment of certain loan installments to the lender that come due during an insured’s period of income interruption resulting from disability from illness or injury. Credit involuntary unemployment insurance provides for repayment of certain loan installments in the event that the borrower is no longer employed as the result of a qualifying event, such as a layoff or reduction in workforce. Credit personal property insurance provides for payment following accidental loss of or damage to personal property collateral resulting from certain casualty events. We require that customers maintain property insurance on any personal property securing loans and offer customers the option of providing proof of such insurance purchased from a third party (such as homeowners or renters insurance) in lieu of purchasing property insurance from us. We also require proof of insurance on any vehicles securing loans, and in select markets, we offer vehicle single interest insurance on vehicles used as collateral on small and large loans.
All customers purchasing these types of insurance from us are required to sign multiple statements affirming that they understand that their purchase of insurance is optional and not a condition of the loan. In addition, a customer may cancel purchased insurance at any time during the life of the loan, including in connection with an early payoff or loan refinancing. Customers who cancel within thirty (30) days of the date of purchase receive a full refund of the insurance premium, and customers who cancel thereafter receive a refund of the unearned portion of the insurance premium.
Apart from the various optional payment and collateral protection insurance products that we offer to our customers, on certain loans, we also collect a fee from our customers and, in turn, purchase non-file insurance from an unaffiliated insurance company for our benefit in lieu of recording and perfecting our security interest in personal property collateral. Non-file insurance protects us from credit losses where, following an event of default, we are unable to take possession of personal property collateral because our security interest is not perfected (for example, in certain instances where a customer files for bankruptcy). In such circumstances, non-file insurance generally will pay to us an amount equal to the lesser of the loan balance or the collateral value, with such claims payment lowering our net credit losses.
We market and sell insurance policies as an agent of an unaffiliated insurance company, within the limitations established by our agency contracts with the unaffiliated insurance company. We then remit to the unaffiliated insurance company the premiums we collect, net of refunds on prepaid loans and net of commission on new business. The unaffiliated insurance company then cedes to our wholly-owned insurance subsidiary, RMC Reinsurance, Ltd., the net insurance premium revenue and the associated insurance claims liability for all insurance products, including the non-file insurance that we purchase. Life insurance premiums are ceded as written, and non-life insurance premiums are ceded as earned. In accepting the premium revenue and associated claims liability, RMC Reinsurance, Ltd. acts as reinsurer for all insurance products that we sell to our customers and for the non-file insurance that we purchase. RMC Reinsurance, Ltd. pays the unaffiliated insurance company a ceding fee for the continued administration of all insurance products.
In addition, in select states, we offer an “Auto Plus Plan” auto club product that is administered and serviced through a third-party provider. The product generally provides certain automobile, home, travel, and other services and benefits to customers, including emergency towing and roadside assistance, emergency locksmith service, automobile repair reimbursement, stolen car expense benefit, automobile insurance deductible reimbursement, limited legal services, and various travel and other discounts. As with the optional insurance products that we offer, any customer purchasing an Auto Plus Plan acknowledges that the purchase is optional and not a condition of the loan and that the plan may be cancelled within 30 days for a full refund.
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Our Branches
Our branches are generally located in visible, high-traffic locations, such as shopping centers. We believe that our branches have an open, welcoming, and hospitable layout. In evaluating whether to locate a branch in a particular community, we examine several factors, including the demographic profile of the community, demonstrated demand for consumer finance, the regulatory and political climate, and the availability of suitable employees to staff, manage, and supervise the new branch.
The following table sets forth the number of branches as of the dates indicated:
| At December 31, | ||||||||||||||||||||
| 2014 | 2015 | 2016 | 2017 | 2018 | ||||||||||||||||
| Texas | 83 | 98 | 98 | 98 | 103 | |||||||||||||||
| South Carolina | 70 | 72 | 72 | 68 | 67 | |||||||||||||||
| Alabama | 49 | 50 | 49 | 47 | 46 | |||||||||||||||
| North Carolina | 34 | 36 | 36 | 37 | 36 | |||||||||||||||
| Oklahoma | 27 | 28 | 28 | 28 | 28 | |||||||||||||||
| Tennessee | 21 | 21 | 21 | 21 | 23 | |||||||||||||||
| Virginia | — | 1 | 8 | 17 | 18 | |||||||||||||||
| New Mexico | 13 | 18 | 19 | 18 | 17 | |||||||||||||||
| Missouri | — | — | — | — | 9 | |||||||||||||||
| Georgia | 3 | 7 | 8 | 8 | 8 | |||||||||||||||
| Wisconsin | — | — | — | — | 4 | |||||||||||||||
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| Total | 300 | 331 | 339 | 342 | 359 | |||||||||||||||
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The following table sets forth the average finance receivables per branch based on maturity, excluding acquired branches:
| Age of Branch (As of December 31, 2018) | Average Finance Receivables Per Branch as of December 31, 2018 | Percentage Increase From Prior Age Category | Number of Branches | |||||||||
| (In thousands) | ||||||||||||
| Branches open less than one year | $ | 843 | — | 22 | ||||||||
| Branches open one to three years | $ | 2,158 | 156.0 | % | 28 | |||||||
| Branches open three to five years | $ | 2,623 | 21.5 | % | 56 | |||||||
| Branches open five years or more | $ | 2,792 | 6.4 | % | 253 | |||||||
The average contribution to operating income from our branches has historically increased as our branches mature. The following table sets forth the average operating income contribution per branch for the year ended December 31, 2018, based on maturity of the branch, excluding acquired branches.
| Age of Branch (As of December 31, 2018) | Average Branch Operating Income (Loss) Contribution | Percentage Increase From Prior Age Category | Number of Branches | |||||||||
| (In thousands) | ||||||||||||
| Branches open less than one year | $ | (12 | ) | — | 22 | |||||||
| Branches open one to three years | $ | 137 | 1,241.7 | % | 28 | |||||||
| Branches open three to five years | $ | 309 | 125.5 | % | 56 | |||||||
| Branches open five years or more | $ | 407 | 31.7 | % | 253 | |||||||
We calculate the average branch contribution as total revenues generated by the branch less the expenses directly attributable to the branch, including the provision for losses and operating expenses, such as personnel, lease, and interest expenses. General corporate overhead, including management salaries, is not attributed to any
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individual branch. Accordingly, the sum of branch contributions from all of our branches is greater than our income before taxes.
Employees and Training
As of December 31, 2018, we had 1,535 employees. New employees must complete a comprehensive training curriculum that focuses on the company- and position-specific competencies needed to be successful. The training includes a blended approach utilizing eLearning modules, hands-on exercises, webinars, and assessments. Training content is focused on our operating policies and procedures, as well as several key compliance areas. Incentive compensation for new employees is contingent upon the successful and timely completion of the required new hire training curriculum. All current employees are also required to complete annual compliance training and re-certification. Additional management and developmental training is provided for those employees seeking to advance within our company.
Payment and Loan Servicing
We have implemented company-wide payment and loan servicing policies and procedures, which are designed to maintain consistent portfolio performance and to ensure regulatory compliance. Our district supervisors, state vice presidents, and compliance and internal audit teams regularly review servicing and collection records to ensure compliance with our policies and procedures. Our centralized management information system enables regular monitoring of branch portfolio metrics by management, and the compensation opportunities of our operations employees and senior management have a significant performance component that is closely tied to credit quality, among other defined performance targets.
The responsibility for the servicing and collection of each loan generally rests with the originating branch. Borrowers who have signed up for online account access have on-demand access to their account information through Regional’s website. In addition, borrowers may elect to receive automated, one-way text messages with information regarding their account, including payment reminders. Borrowers have the option of making payments (i) in person at a branch where they may pay by cash, check, money order, debit card, or immediate, one-time future, or recurring ACH, (ii) through our customer portal via debit card or immediate, one-time future, or recurring ACH, or (iii) by immediate or one-time future debit card or ACH over the phone. In the fourth quarter of 2018, more than half of customer payments were made by debit card or ACH.
If a loan becomes severely delinquent, a branch may receive co-collection assistance from our centralized servicing facility. Our philosophy is to work with customers experiencing payment difficulties. If a customer is unable to make the required payments to bring his or her loan current, acceptable solutions to remedy a past due loan may include deferment of a payment, loan renewal, or settlement. All solutions are intended to enable the customer to meet his or her current and future obligations in a manner that we believe will mitigate our risk, while also complying with state and federal laws and regulations, as well as our policies and procedures.
Customers are limited to two deferrals in a rolling twelve-month period unless it is determined that an exception is warranted (e.g. following a natural disaster). We generally limit the refinancing of delinquent loans to those customers who have made recent payments and for whom we have verified current employment, and we do not charge any origination fees on the refinancing of a delinquent loan. We believe that refinancing delinquent loans for certain deserving customers who have made periodic payments allows us to help customers resolve temporary financial setbacks and repair or sustain their credit. During 2018, we refinanced approximately $26.5 million of loans that were 60 or more days contractually past due, representing approximately 2.5% of our total loan originations in 2018. As of December 31, 2018, the outstanding balance of such refinanced loans was $33.8 million, or 3.6% of finance receivables as of such date. We may also agree to settle a past due loan by accepting less than the full principal balance owed. A settlement is only used in certain limited cases and is only offered once we have determined that we are unlikely to collect the entire outstanding balance of the loan.
For seriously delinquent accounts, we may seek legal judgments or pursue repossession of collateral. We typically initiate repossession efforts only when we have exhausted other means of collection and, in the opinion
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of management, the customer is unlikely to make further payments. We sell substantially all repossessed collateral through sales conducted by independent auction organizations, after the required post-repossession waiting period. Generally, we charge off loans during the month that the loan becomes 180 days contractually delinquent. Non-titled accounts in a confirmed Chapter 7 or Chapter 13 bankruptcy are charged off at 60 days contractually delinquent, subject to certain exceptions. Deceased borrower accounts are charged off in the month following the proper notification of passing, with the exception of borrowers with credit life insurance. We sell most of our charged-off accounts to third-party debt buyers.
Information Technology
In 2016, we entered into an agreement with Nortridge Software, LLC (“Nortridge”) to transition to the Nortridge loan origination and servicing platform. From January 2016 to February 2018, we conducted a state-by-state phased implementation of the Nortridge platform in each of our states of operation. As of February 2018, all of our branches operate using the Nortridge platform. Prior to our use of Nortridge, we serviced our loan portfolio using a software package developed and owned by ParaData Financial Systems.
We utilize the Nortridge platform both to originate loans and to service our loan portfolio, and we have invested in customizing the Nortridge platform to meet our needs based upon our specific products, processes, and reporting requirements. The Nortridge custom decision engine utilizes application information and a credit report detailing the applicant’s credit history to generate an initial credit decision and to guide our branch employees through the loan origination process to the final credit decision. Throughout the life of the loan, our employees utilize Nortridge to, among other things, enter payments, generate collection queues, and log collection activity. Nortridge also facilitates electronic and recurring payments, automated text messaging, and customer account access through a customer portal. Nortridge logs and maintains, within our centralized information systems, a permanent record of the loan origination and servicing approvals and processes, and permits all levels of branch and centralized management to review the individual and collective performance of all branches for which they are responsible on a daily basis.
We intend to continue to enhance the Nortridge platform to further leverage its capabilities and to meet our evolving needs. In addition, we rely on Teledata Communications Inc. and other third-party software vendors to provide access to credit applications.
Competition
The consumer finance industry is highly fragmented, with numerous competitors. The competition we face for each of our loan products is distinct.
Small and Large Loans. We compete with several national companies operating greater than 800 branch locations each, as well as a handful of smaller, regionally-focused companies with between 100 and 300 branches in certain of the states in which we operate. We believe that the majority of our competitors are independent operators with generally less than 100 branches. We believe that competition between installment consumer loan companies occurs primarily on the basis of price, breadth of loan product offerings, flexibility of loan terms offered, and the quality of customer service provided. While underbanked customers may also use alternative financial services providers, such as title lenders, payday lenders, and pawn shops, their products offer different terms and typically carry substantially higher interest rates and fees than our installment loans. Accordingly, we believe that alternative financial services providers are not an attractive option for customers who meet our underwriting standards, which are generally stricter than the underwriting standards of alternative financial services providers. Our small and large loans also compete with pure online lenders, peer-to-peer lenders, and issuers of non-prime credit cards.
Retail Loans. In recent years, the retail loan industry has seen an increasing number of lenders enter the market that are dedicated to originating non-prime retail loans. We also face competition from rent-to-own
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financing, leasing, and credit card companies. Our retail loans are typically made at competitive rates, and competition is largely on the basis of interest rates charged, the quality of credit accepted, the flexibility of loan terms offered, the speed of approval, and the quality of customer service provided. Point-of-sale financing decisions must be made rapidly while the customer is on the sales floor. We endeavor to provide responses to customers in less than ten minutes, and we staff our centralized retail loan underwriting team with multiple shifts seven days per week during peak retail shopping hours to ensure rapid response times.
Seasonality
Our loan volume and contractual delinquency follow seasonal trends. Demand for our small and large loans is typically highest during the second, third, and fourth quarters, which we believe is largely due to customers borrowing money for vacation, back-to-school, and holiday spending. With the exception of retail loans, loan demand has generally been the lowest during the first quarter, which we believe is largely due to the timing of income tax refunds. Delinquencies generally reach their lowest point in the first quarter of the year and rise throughout the remainder of the fiscal year. Consequently, we experience seasonal fluctuations in our operating results and cash needs.
Government Regulation
Consumer finance companies are subject to extensive regulation, supervision, and licensing under various federal, state, and local statutes, regulations, and ordinances. Many of these laws impose detailed constraints on the terms of our loans and the retail installment sales contracts that we purchase, the lending forms that we utilize, and our operations. The software that we use to originate loans is designed in part to aid in compliance with all applicable lending laws and regulations.
State Lending Regulation. We are regulated by state agencies that regularly audit our branches and operations. In general, state statutes establish maximum loan amounts and interest rates, as well as the types and maximum amounts of fees and insurance premiums that we may charge for both direct and indirect lending. Specific allowable charges vary by state. In addition, state laws regulate the keeping of books and records and other aspects of the operation of consumer finance companies, and state and federal laws regulate account collection practices. State agency approval is required to open new branches, and each of our branches is separately licensed under the laws of the state in which the branch is located. Licenses granted by the regulatory agencies in these states are subject to renewal every year and may be revoked for failure to comply with applicable state and federal laws and regulations. In the states in which we currently operate, licenses may be revoked only after an administrative hearing. We believe we are in compliance with state laws and regulations applicable to our lending operations in each state.
State Insurance Regulation. Premiums and charges for optional payment and collateral protection insurance products are set at or below authorized statutory rates and are stated separately in our disclosures to customers, as required by the federal Truth in Lending Act and by various applicable state laws. We are also subject to state laws and regulations governing insurance agents in the states in which we sell insurance. State insurance regulations require that insurance agents be licensed and limit the premium amount charged for such insurance. Our captive insurance subsidiary is regulated by the insurance authorities of the Turks and Caicos Islands of the British West Indies, where the subsidiary is organized and domiciled.
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). At the federal level, Congress enacted comprehensive financial regulatory reform legislation in 2010. A significant focus of the law, known as the Dodd-Frank Act, is heightened consumer protection. The Dodd-Frank Act established the Consumer Financial Protection Bureau (the “CFPB”), which has regulatory, supervisory, and enforcement powers over providers of consumer financial products and services, including explicit supervisory authority to examine and require registration of non-depository lenders and to promulgate rules that can affect the practices and activities of lenders.
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The Dodd-Frank Act and the regulations promulgated thereunder may affect our operations through increased oversight of financial services products by the CFPB and the imposition of restrictions on the terms of certain loans. The CFPB has significant authority to implement and enforce federal consumer finance laws, including the protections established in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive, and abusive acts and practices.
The Dodd-Frank Act also gives the CFPB the authority to examine and regulate large non-depository financial companies and gives the CFPB authority over anyone deemed by rule to be a “larger participant of a market for other consumer financial products or services.” The CFPB contemplates regulating the installment lending industry as part of the “consumer credit and related activities” market. However, this so-called “larger participant rule” will not impose substantive consumer protection requirements, but rather will provide to the CFPB the authority to supervise larger participants in certain markets, including by requiring reports and conducting examinations to ensure, among other things, that they are complying with existing federal consumer financial law. While the CFPB has defined a “larger participant” standard for certain markets, such as the debt collection, automobile finance, and consumer reporting markets, it has not yet acted to define “larger participant” in the traditional installment lending market. If, in the future, a traditional installment lending “larger participant rule” is promulgated by the CFPB, the rule would likely cover only the largest installment lenders, and we do not yet know whether the definition of larger participant would cover us.
In addition to the grant of certain regulatory powers to the CFPB, the Dodd-Frank Act gives the CFPB authority to pursue administrative proceedings or litigation for violations of federal consumer financial laws. In these proceedings, the CFPB can 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. Also, where a company has violated Title X of the Dodd-Frank Act or CFPB regulations thereunder, the Dodd-Frank Act empowers state attorneys general and state regulators to bring civil actions to remedy violations of state law.
Other Federal Laws and Regulations. In addition to the Dodd-Frank Act and state and local laws, regulations, and ordinances, numerous other federal laws and regulations affect our lending operations. These laws include the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Servicemembers Civil Relief Act, the Military Lending Act, the Gramm-Leach-Bliley Act, and in each case the regulations thereunder, and the Federal Trade Commission’s Credit Practices Rule. These laws require us to provide complete disclosure of the principal terms of each loan to the borrower prior to the consummation of the loan transaction, prohibit misleading advertising, protect against discriminatory lending practices, govern the manner in which we report customer information to consumer reporting agencies, govern the terms of loans to servicemembers, and proscribe unfair credit practices.
| • | Truth in Lending Act. Under the Truth in Lending Act and Regulation Z promulgated thereunder, we must disclose certain material terms related to a credit transaction, including, but not limited to, the annual percentage rate, finance charge, amount financed, total of payments, the number and amount of payments, and payment due dates to repay the indebtedness. |
| • | Equal Credit Opportunity Act. Under the Equal Credit Opportunity Act and Regulation B promulgated thereunder, we cannot discriminate against any credit applicant on the basis of any protected category, such as race, color, religion, national origin, sex, marital status, or age. We are also required to make certain disclosures regarding consumer rights and advise customers whose credit applications are not approved of the reasons for the rejection. |
| • | Fair Credit Reporting Act. Under the Fair Credit Reporting Act, we must provide certain information to customers whose credit applications are not approved on the basis of a report obtained from a consumer reporting agency, promptly update any credit information reported to a credit reporting agency about a customer, and have a process by which customers may inquire about credit information furnished by us to a consumer reporting agency. |
| • | Servicemembers Civil Relief Act. The Servicemembers Civil Relief Act is designed to ease legal and financial burdens on military personnel and their families during active duty status. We may be |
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| required to reduce interest rates on “pre-service” debts incurred by servicemembers, and we may be prohibited from pursuing certain forms of legal action against servicemembers, such as default judgments, during periods of active duty. |
| • | Military Lending Act. The Military Lending Act applies to active-duty servicemembers and their covered dependents. We are prohibited from charging a borrower covered under the Military Lending Act more than a 36% Military Annual Percentage Rate, which includes certain costs associated with the loan in calculating the interest rate. |
| • | Gramm-Leach-Bliley Act. Under the Gramm-Leach-Bliley Act, we must protect the confidentiality of our customers’ non-public personal information and disclose information on our privacy policy and practices, including with regard to the sharing of customers’ non-public personal information with third parties. This disclosure must be made to customers at the time the customer relationship is established and, in some cases, at least annually thereafter. |
| • | Credit Practices Rule. The Federal Trade Commission’s Credit Practices Rule limits the types of property we may accept as collateral to secure a consumer loan. |
Violations of these statutes and regulations may result in actions for damages, claims for refund of payments made, certain fines and penalties, injunctions against certain practices, and the potential forfeiture of rights to repayment of loans. For a discussion regarding how risks and uncertainties associated with the current regulatory environment may impact our future expenses, net income, and overall financial condition, see Part I, Item 1A, “Risk Factors.”
Additional Information
Regional Management Corp. was incorporated in South Carolina on March 25, 1987, and converted into a Delaware corporation on August 23, 2011. The Company’s principal internet address is www.regionalmanagement.com. The Company provides its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, and all amendments to those reports, free of charge on www.regionalmanagement.com, as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. The Company’s consumer website is www.regionalfinance.com. The information contained on, or that can be accessed through, the Company’s websites is not incorporated by reference into this Annual Report on Form 10-K. The Company has included its website addresses as factual references and does not intend the website addresses to be active links to such websites.
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| ITEM 1A. | RISK FACTORS. |
We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. The following discussion highlights some of the risks that may affect our future operating results. These are the risks and uncertainties that we believe are the most important for you to consider, but the risks described below are not the only risks facing our company. Additional risks and uncertainties not presently known to us, that we currently deem immaterial, or that are similar to those faced by other companies in our industry or in business in general, may also impair our business operations. If any of the following risks or uncertainties occurs, continues, or worsens, our business, financial condition, and operating results would likely suffer. You should carefully consider the risks described below together with the other information set forth in this Annual Report on Form 10-K.
Risks Related to Our Business
We have grown significantly in recent years, and our delinquency, credit loss rates, and overall results of operations may be adversely affected if we do not manage our growth effectively.
We have experienced substantial growth in recent years, opening a net 8 branches in 2016, a net 3 branches in 2017, and a net 17 branches in 2018, and increasing the size of our finance receivable portfolio from $628.4 million at the beginning of 2016 to $932.2 million at the end of 2018, a compound annual growth rate of 14.0%. We intend to continue our growth strategy in the future. As we increase the number of branches we operate, we will be required to find new, or relocate existing, employees to operate our branches and allocate resources to train and supervise those employees. The success of a branch depends significantly on the manager overseeing its operations and on our ability to enforce our underwriting standards and implement controls over branch operations. Recruiting suitable managers for new branches can be challenging, particularly in remote areas and in areas where we face significant competition. Furthermore, the annual turnover rate among our branch managers was approximately 21% in 2017 and 22% in 2018, and turnover rates of managers in our new branches may be similar or higher. Increasing the number of branches that we operate may divide the attention of our senior management or strain our ability to adapt our infrastructure and systems to accommodate our growth. If we are unable to promote, relocate, or recruit suitable managers, oversee their activities effectively, maintain our underwriting and loan servicing standards, and otherwise appropriately and effectively staff our branches, our delinquency and credit loss rates may increase and our overall results of operations may be adversely impacted.
We face significant risks in implementing our growth strategy, some of which are outside of our control.
We intend to continue our growth strategy, which is based on opening and acquiring branches in existing and new markets, introducing new products and channels, and increasing the finance receivable portfolios of our existing branches. Our ability to execute this growth strategy is subject to significant risks, some of which are beyond our control, including:
| • | the inherent uncertainty regarding general economic conditions; |
| • | the prevailing laws and regulatory environment of each state in which we operate or seek to operate and federal laws and regulations, all of which are subject to change at any time; |
| • | the degree of competition in new markets and its effect on our ability to attract new customers; |
| • | our ability to identify attractive locations for new branches; |
| • | our ability to recruit qualified personnel, particularly in remote areas and in areas where we face a great deal of competition; and |
| • | our ability to obtain adequate financing for our expansion plans. |
For example, certain states into which we may expand limit the number of lending licenses granted. For instance, Georgia requires a “convenience and advantage” assessment of a new lending license and location prior
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to the granting of the license. This assessment adds time and expense to opening new locations and creates risk that our state regulator will deny an application for a new lending license due to a perceived oversaturation of existing licensed lenders in the area in which we seek to expand and operate. There can be no assurance that if we apply for a license for a new branch, whether in one of the states where we currently operate or in a state into which we would like to expand, we will be granted a license to operate. We also cannot be certain that any such license, even if granted, would be obtained in a timely manner or without burdensome conditions or limitations. In addition, we may not be able to obtain and maintain the regulatory approvals, government permits, or licenses that may be required to operate.
We are exposed to credit risk in our lending activities.
Our ability to collect on loans depends on the willingness and repayment ability of our borrowers. Any material adverse change in the effectiveness of our underwriting models, our implementation of such models (including through our loan origination software and processes), or the ability or willingness of a significant portion of our borrowers to meet their obligations to us, whether due to changes in general economic, political, or social conditions, the cost of consumer goods, interest rates, natural disasters, acts of war or terrorism, or other causes over which we have no control, or to changes or events affecting our borrowers such as unemployment, major medical expenses, bankruptcy, divorce, or death, would have a material adverse impact on our earnings and financial condition. Further, a substantial majority of our borrowers are non-prime borrowers, who are more likely to be affected, and more severely affected, by adverse macroeconomic conditions. We cannot be certain that our credit administration personnel, policies, and procedures will adequately adapt to changes in economic or any other conditions affecting customers and the quality of the loan portfolio.
Our convenience check strategy exposes us to certain risks.
A significant portion of the growth in our installment loans has been achieved through direct mail campaigns. One aspect of our direct mail campaigns involves mailing “convenience checks” to pre-screened recipients, which customers can sign and cash or deposit, thereby agreeing to the terms of the loan, which are disclosed on the front and back of the check and in the accompanying disclosures. We use convenience checks to seed new branch openings and to attract new customers to existing branches in our geographic footprint. In 2017 and 2018, loans initiated through convenience checks represented 17.2% and 19.2%, respectively, of the value of our originated loans. We expect that convenience checks will continue to represent a meaningful portion of our installment loan originations in the future. There are several risks associated with the use of convenience checks, including the following:
| • | it is more difficult to maintain sound underwriting standards with convenience check customers, and these customers have historically presented a higher risk of default than customers that originate loans in our branches, as we do not meet convenience check customers prior to soliciting them and extending a loan to them, and we may not be able to verify certain elements of their financial condition, including their current employment status, income, or life circumstances; |
| • | we rely on credit information from a third-party credit bureau that is more limited than a full credit report to pre-screen potential convenience check recipients, which may not be as effective as a full credit report or may be inaccurate or outdated; |
| • | we face limitations on the number of potential borrowers who meet our lending criteria within proximity to our branches; |
| • | we may not be able to continue to access the demographic and credit file information that we use to generate our mailing lists due to expanded regulatory or privacy restrictions; |
| • | convenience checks pose a risk of fraud; |
| • | we depend on one bank to issue and clear our convenience checks, and any failure by that bank to properly process the convenience checks could limit the ability of a recipient to cash the check and enter into a loan with us; |
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| • | customers may opt out of direct mail solicitations and solicitations based on their credit file or may otherwise prohibit us from soliciting them; and |
| • | postal rates and production costs may continue to rise. |
In the future, we could experience one or more of these issues associated with our direct mail strategy. Any increase in the use of convenience checks will further increase our exposure to, and the magnitude of, these risks.
Our policies and procedures for underwriting, processing, and servicing loans are subject to potential failure or circumvention, which may adversely affect our results of operations.
A substantial portion of our underwriting activities and our credit extension decisions are made at our local branches. We rely on certain inputs and verifications in the underwriting process to be performed by individual personnel at the branch level. In addition, pursuant to our operations policies and procedures, exceptions to general underwriting criteria can be approved by central underwriting employees and certain other senior employees. We train our employees individually onsite in the branch and through online training modules to make loans that conform to our underwriting standards. Such training includes critical aspects of state and federal regulatory compliance, cash handling, account management, and customer relations. Although we have standardized employee manuals and online training modules, we primarily rely on our district supervisors, with oversight by our state vice presidents, branch auditors, and headquarters personnel, to train and supervise our branch employees, rather than centralized training programs. Therefore, the quality of training and supervision may vary from district to district and branch to branch depending on the amount of time apportioned to training and supervision and individual interpretations of our operations policies and procedures. There can also be no assurance that we will be able to attract, train, and retain qualified personnel to perform the tasks that are part of the underwriting process. If the training and supervision of our personnel fails to be effective, or if we are unable to attract and retain qualified employees, it is possible that our underwriting criteria will be improperly applied to a greater percentage of loan applications. If such improper applications were to increase, delinquency and losses on our loan portfolio could increase.
In addition, we rely on certain third-party service providers in connection with loan underwriting and origination. Any error or failure by a third-party service provider in providing loan underwriting and origination services may cause us to originate loans to borrowers that do not meet our underwriting standards. Likewise, any failure or error by us in utilizing third-party software or services to implement our underwriting and origination criteria may cause us to originate loans to borrowers that do not meet our underwriting standards. We cannot be certain that every loan is made in accordance with our underwriting standards and rules. We have experienced instances of loans extended that varied from our underwriting standards. Variances in underwriting standards and lack of supervision could expose us to greater delinquencies and credit losses than we have historically experienced. Due to the decentralized nature in which the loan application process occurs, employee misconduct or error in the application or closing process could also result in the origination of loans that do not satisfy our underwriting standards, which could in turn have a material adverse effect on our results of operations and financial condition.
In addition, in deciding whether to extend credit or enter into other transactions with customers and counterparties, we rely heavily on information provided by customers, counterparties, and other third parties, including credit bureaus and data aggregators, and we further rely on representations of customers and counterparties as to the accuracy and completeness of that information. If a significant percentage of our customers were to intentionally or negligently misrepresent any of this information, or provide incomplete information, and our internal processes were to fail to detect such misrepresentations in a timely manner, or any or all of the other components of the underwriting process described above were to fail, we could end up approving a loan that, based on our underwriting criteria, we would not have otherwise made. As a result, our earnings and our financial condition could be negatively impacted.
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We may be limited in our ability to collect on our loan portfolio, and the security interests securing a significant portion of our loan portfolio are not perfected, which may increase our credit losses.
Legal and practical limitations may limit our ability to collect on our loan portfolio, resulting in increased credit losses, decreased revenues, and decreased earnings. State and federal laws and regulations restrict our collection efforts. The amounts that we are able to recover from the repossession and sale of collateral typically do not fully cover the outstanding loan balance and costs of recovery. In cases where we repossess a vehicle securing a loan, we generally sell our repossessed automobile inventory through sales conducted by independent automobile auction organizations after the required post-repossession waiting period. In certain instances, we may sell repossessed collateral other than vehicles through our branches after the required post-repossession waiting period and appropriate receipt of valid bids. In either case, such sales are made consistent with applicable state law. The proceeds we receive from such sales depend upon various factors, including the supply of, and demand for, used vehicles and other property at the time of sale. During periods of economic slowdown or recession, there may be less demand for used vehicles and other property that we desire to resell.
Most of our loan portfolio is secured, but a significant portion of such security interests have not been and will not be perfected, which means that we cannot be certain that such security interests will be given first priority over other creditors. The lack of perfected security interests is one of several factors that may make it more difficult for us to collect on our loan portfolio. Additionally, for those of our loans that are unsecured, borrowers may choose to repay obligations under other indebtedness before repaying loans to us because such borrowers may feel that they have no collateral at risk. In addition, given the relatively small size of our loans, the costs of collecting loans may be high relative to the amount of the loan. As a result, many collection practices that are legally available, such as litigation, may be financially impracticable. Lastly, there is an inherent risk that a portion of the retail installment contracts that we hold will be subject to certain claims or defenses that the borrower may assert against the originator of the contract and, by extension, us as the holder of the contract. These factors may increase our credit losses, which would have a material adverse effect on our results of operations and financial condition.
Our insurance operations are subject to a number of risks and uncertainties.
We market and sell optional credit life, accident and health, personal property, involuntary unemployment, and vehicle single interest insurance to our borrowers in selected markets as an agent for an unaffiliated third-party insurance company. In addition, on certain loans, we collect a fee from our customers and in turn purchase non-file insurance from an unaffiliated insurance company for our benefit in lieu of recording and perfecting our security interest in personal property collateral. The unaffiliated insurance company cedes to our wholly-owned insurance subsidiary, RMC Reinsurance, Ltd., the net insurance premium revenue and the associated insurance claims liability for all insurance products, including the non-file insurance that we purchase.
When purchased by a borrower, the optional credit insurance products benefit the borrower by insuring the borrower’s payment obligations on the associated loan in the event of the borrower’s inability to make monthly payments due to death, disability, or involuntary unemployment, or in the event of a casualty event associated with collateral. Payment of the associated premiums can be made by the borrower separately, but except in very rare instances, the borrower finances payment of the premium, with the financed premium included in the balance of the loan. A credit insurance product may be cancelled if, for example, (i) we request cancellation due to the borrower’s default on obligations under the associated loan, (ii) the borrower prepays the principal balance of the associated loan in full, or (iii) the borrower elects to terminate the credit insurance prior to the expiration of the term thereof (which the borrower may do at any time). Generally, upon any cancellation of credit insurance, the borrower will be entitled to a refund of the unearned premium for the cancelled insurance. We typically refund insurance premiums by reducing the principal balance of the associated loan by the required refund amount, following which the unaffiliated insurance company reimburses us for the refunded amount.
Our insurance operations are subject to a number of material risks and uncertainties, including changes in laws and regulations, borrower demand for insurance products, claims experience, and insurance carrier
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relationships. Changes to laws or regulations may, for example, negatively impact our ability to offer one or more of our insurance products or to purchase non-file insurance; the manner in which we are permitted to offer such products; capital and reserve requirements; the frequency and type of regulatory monitoring and reporting to which we are subject; benefits or loss ratio requirements; insurance producer licensing or appointment requirements; and reinsurance operations. In addition, because our borrowers are not required to purchase the credit insurance products that we offer, we cannot be certain that borrower demand for credit insurance products will not decrease in the future. In addition to adversely impacting our insurance income, net, any decrease in the demand for credit insurance products would negatively impact our interest and fee income because we finance substantially all of our borrowers’ insurance premiums. Our insurance operations are also dependent on our lending operations as the sole source of business and product distribution. If our lending operations discontinue offering insurance products, our insurance operations would have no method of distribution. Insurance claims and policyholder liabilities are also difficult to predict and may exceed the related reserves set aside for claims and associated expenses for claims adjudication.
We are also dependent on the continued willingness of unaffiliated third-party insurance companies to participate in the credit insurance market and to offer non-file insurance to us. For example, in 2016, we transitioned our credit insurance business to a new unaffiliated third-party insurance company because the insurance company with which we previously had a relationship made a strategic decision to exit the credit insurance market altogether. While we were able to transition successfully to a new provider in 2016, we cannot be certain that the credit insurance market will remain viable in the future. Further, if our insurance provider is for any reason unable or unwilling to meet its claims and premium reimbursement payment obligations or its premium ceding obligations, we would experience increased net credit losses, regulatory scrutiny, litigation, and other losses and expenses.
Finally, in recent years, as large loans have become a larger percentage of our portfolio, the severity of non-file insurance claims has increased and non-file insurance claims expenses have exceeded non-file insurance premiums by a material amount. The resulting net loss from the non-file insurance product is reflected in our insurance income, net. It is uncertain whether the non-file insurance product will be available to us in the future on the same terms as it is today, or at all. If the unaffiliated insurance company were to enforce limitations on our non-file loss ratios or otherwise change the terms under which it offers non-file insurance to us, our net credit losses, loss rates, and provision for credit losses could increase.
If any of these events, risks, or uncertainties were to occur or materialize, it could have a material adverse effect on our business, financial condition, and results of operations and cash flows.
A reduction in demand for our products and a failure by us to adapt to such reduction could adversely affect our business and results of operations.
The demand for the products we offer may be reduced due to a variety of factors, such as demographic patterns, changes in customer preferences or financial conditions, regulatory restrictions that decrease customer access to particular products, or the availability of competing products, including through alternative or competing marketing channels. For example, we are highly dependent upon selecting and maintaining attractive branch locations. These locations are subject to local market conditions, including the employment available in the area, housing costs, traffic patterns, crime, and other demographic influences, any of which may quickly change, thereby negatively impacting demand for our products in the area. Should we fail to adapt to significant changes in our customers’ demand for, or access to, our products, our revenues could decrease significantly and our operations could be harmed. Even if we do make changes to existing products or introduce new products and channels to fulfill customer demand, customers may resist or may reject such products. Moreover, the effect of any product change on the results of our business may not be fully ascertainable until the change has been in effect for some time, and by that time it may be too late to make further modifications to such product without causing further harm to our business, results of operations, and financial condition.
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We face strong direct and indirect competition.
The consumer finance industry is highly competitive, and the barriers to entry for new competitors are relatively low in the markets in which we operate. We compete for customers, locations, employees, and other important aspects of our business with many other local, regional, national, and international financial institutions, many of which have greater financial resources than we do.
Our installment loan operations compete with other installment lenders, as well as with alternative financial services providers (such as payday and title lenders, check advance companies, and pawnshops), online or peer-to-peer lenders, issuers of non-prime credit cards, and other competitors. We believe that regulatory developments in the consumer finance industry have caused and may in the future cause lenders that focus on alternative financial services to begin to offer installment loans. In addition, if companies in the installment loan business attempt to provide more attractive loan terms than is standard across the industry, we may lose customers to those competitors. With respect to installment loans, we compete primarily on the basis of price, breadth of loan product offerings, flexibility of loan terms offered, and the quality of customer service provided.
Our retail purchase loan operations compete with non-prime retail lenders, store and third-party credit cards, prime lending sources, rent-to-own finance providers, and other competitors. We compete primarily on the basis of interest rates charged, the quality of credit accepted, the flexibility of loan terms offered, the speed of approval, and the quality of customer service provided.
If we fail to compete successfully, we could face lower sales and may decide or be compelled to materially alter our lending terms to our customers, which could result in decreased profitability.
We may attempt to pursue acquisitions or strategic alliances that may be unsuccessful.
We may attempt to achieve our business objectives through acquisitions and strategic alliances. We compete with other companies for these opportunities, including companies with greater financial resources, and we cannot be certain that we will be able to effect acquisitions or strategic alliances on commercially reasonable terms, or at all. Furthermore, most acquisition targets that we have pursued previously have been significantly smaller than us. We do not have extensive experience with integrating larger acquisitions. In pursuing these transactions, we may experience, among other things:
| • | overvaluing potential targets; |
| • | difficulties in integrating any acquired companies, branches, or products into our existing business, including integration of account data into our information systems; |
| • | inability to realize the benefits we anticipate in a timely fashion, or at all; |
| • | attrition of key personnel from acquired businesses; |
| • | unexpected losses due to the acquisition of loan portfolios with loans originated using less stringent underwriting criteria; |
| • | significant costs, charges, or write-downs; or |
| • | unforeseen operating difficulties that require significant financial and managerial resources that would otherwise be available for the ongoing development and expansion of our existing operations. |
Geographic concentration of our loan portfolio may increase the risk of loss.
Any concentration of our loan portfolio in a state or region may present unique risk concentrations. Our branches in South Carolina, Texas, and North Carolina accounted for 18%, 32%, and 16%, respectively, of our finance receivables in 2018. Furthermore, all of our operations are in five Southeastern, three Southwestern, one Mid-Atlantic, and two Midwestern states. As a result, we are highly susceptible to adverse economic conditions
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in those areas. The unemployment and bankruptcy rates in some states in our footprint are among the highest in the country. High unemployment rates may reduce the number of qualified borrowers to whom we will extend loans, which would result in reduced loan originations. In addition, some geographic regions of the United States will, from time to time, experience weaker regional economic conditions and consequently will experience higher rates of loss and delinquency. A regional economy may be adversely affected by the loss of jobs in certain industries, by state and local taxes, or by other factors, including natural disasters, civil disturbances, or international events such as wars. In the event that a significant portion of our loan portfolio is comprised of loans owed by borrowers residing in certain jurisdictions where economic conditions, elevated bankruptcy filings, natural disasters, or other factors specific to these jurisdictions adversely impact the delinquency and default experience of our loan portfolio, we could experience reduced or delayed payments on outstanding loans. For example, in 2017 and 2018, we experienced increases in credit losses as a result of hurricanes impacting customer accounts in our geographic footprint. These losses occurred in states where a substantial majority of our loan portfolio is concentrated—specifically in Texas in 2017 and in South Carolina and North Carolina in 2018. Conversely, an improvement in economic conditions could result in prepayments by our borrowers of their payment obligations on our loans. As a result, we may receive principal payments on the outstanding loans earlier than anticipated, which would reduce our finance receivables and the interest income earned thereon. No prediction can be made and no assurance can be given as to the effect of economic conditions on the rate of delinquencies, prepayments, or losses on our loan portfolio with respect to any part of our geographic footprint.
Furthermore, the concentration of our loan portfolio in one or more states would have a disproportionate effect on our business if governmental authorities in any of those states take action against us. In addition, the occurrence of any of the adverse regulatory or legislative events described in this “Risk Factors” section in states with a high concentration of our loan portfolio could materially and adversely affect our business, results of operations, and financial condition. For example, if interest rates in South Carolina, which currently are not capped, were to be capped, our business, results of operations, and financial condition would be materially and adversely affected.
Failure of third-party service providers upon which we rely could adversely affect our business.
We rely on certain third-party service providers. In particular, we currently rely on one key vendor to print and mail our convenience check and other offers for our direct mail marketing campaigns, and on certain other third-party service providers in connection with loan underwriting, origination, and servicing. Our reliance on these and other third parties can expose us to risks. For example, an error by our current convenience check vendor in 2015 resulted in check offers being misdirected, requiring us in some cases to notify state regulators and to refund certain interest and fee amounts, and exposing us to increased credit risk. If any of our third-party service providers, including our direct mail vendor and those third parties providing services in connection with loan underwriting, origination, and servicing, are unable to provide their services timely, accurately, and effectively, or at all, it could have a material adverse effect on our business, financial condition, and results of operations and cash flows.
We rely on information technology products developed, owned, and supported by third parties. Our ability to manage our business and monitor results is highly dependent upon these information technology products. A failure of these products and systems or of the implementation of new information technology products and systems could disrupt our business.
In the operation of our business, we are highly dependent upon a variety of information technology products, including our loan management system, which allows us to record, document, and manage our loan portfolio. In April 2016, we entered into an agreement with Nortridge pursuant to which Nortridge provides us with loan management software and related services. In February 2018, we completed our transition to the Nortridge loan management software across our operations footprint.
Since we began transitioning to the Nortridge platform, we have tailored it to meet our specific needs. To a certain extent, we depend on the willingness and ability of Nortridge to continue to provide customized solutions
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and to support our evolving products and business model. In the future, Nortridge may not be willing or able to provide the services necessary to meet our loan management system needs. If this occurs, we may be forced to migrate to an alternative software package, which could materially affect our business, results of operations, and financial condition.
Further, the Nortridge platform may in the future fail to perform in a manner consistent with our current expectations and may be inadequate for our needs. As we are dependent upon our ability to gather and promptly transmit accurate information to key decision makers, our business, results of operations, and financial condition may be adversely affected if our loan management system does not allow us to transmit accurate information, even for a short period of time. Failure to properly or adequately address these issues could impact our ability to perform necessary business operations, which could adversely affect our competitive position, business, results of operations, and financial condition.
We also rely on Teledata Communications Inc. and other third-party software vendors to provide access to loan applications and/or screen applications. There can be no assurance that these third party providers will continue to provide us with information in accordance with our lending guidelines or that they will continue to provide us lending leads at all. If this occurs, our credit losses, business, results of operations, and financial condition may be adversely affected.
Further, the Nortridge platform and other third-party software vendor products and applications are subject to damage or interruption from:
| • | power loss, computer systems failures, and internet, telecommunications, or data network failures; |
| • | operator negligence or improper operation by, or supervision of, employees; |
| • | physical and electronic loss of data or security breaches, misappropriation, and similar events; |
| • | computer viruses; |
| • | cyberterrorism; |
| • | intentional acts of vandalism and similar events; and |
| • | hurricanes, fires, floods, and other natural disasters. |
Any failure of the Nortridge platform or any other third-party software vendor product systems, if not addressed by our disaster recovery plan, could cause an interruption in operations. Though we have implemented contingency and disaster recovery processes in the event of one or several technology failures, any unforeseen failure, interruption, or compromise of these systems or security measures could affect the origination, servicing, and collection of loans. The risk of possible failures or interruptions may not be adequately addressed, and such failures or interruptions could occur.
We may not be able to make technological improvements as quickly as some of our competitors, which could harm our competitive ability and adversely affect our business, prospects, results of operations, and financial condition.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products, services, and marketing channels. We rely on our integrated branch network as the foundation of our multiple channel platform and the primary point of contact with our active accounts. However, to serve customers who want to reach us over the internet, we developed a new channel in late 2008 by making an online loan application available on our consumer website, and in 2017, we rolled out an online customer portal, which provides customers with online access to their account information and an electronic payment option. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demand for convenience, as well as
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to create additional efficiencies in our operations. We expect that new technologies and business processes applicable to the consumer finance industry will continue to emerge, and these new technologies and business processes may be more efficient than those that we currently use. We cannot ensure that we will be able to sustain our investment in new technology, and we may not be able to effectively implement new technology-driven products and services as quickly as some of our competitors or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could cause disruptions in our operations, harm our ability to compete with our competitors, and adversely affect our business, prospects, results of operations, and financial condition.
Security breaches, cyber-attacks, failures in our information systems, or fraudulent activity could result in damage to our operations or lead to reputational damage.
We rely heavily on communications and information systems to conduct our business. Each branch is part of an information network that is designed to permit us to maintain adequate cash inventory, reconcile cash balances on a daily basis, and report revenues and expenses to our headquarters. Our computer systems, software, and networks may be vulnerable to breaches (including via computer hackings), unauthorized access, misuse, computer viruses, or other failures or disruptions that could result in disruption to our business or the loss or theft of confidential information, including customer information. Any failure, interruption, or breach in security of these systems, including any failure of our back-up systems, hardware failures, or an inability to access data maintained offsite, could result in failures or disruptions in our customer relationship management, general ledger, loan, and other systems and could result in a loss of data (including loan portfolio data), a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation, possible financial liability, and other adverse consequences, any of which could have a material adverse effect on our financial condition and results of operations. Furthermore, we may not be able to detect immediately any such breach, which may increase the losses that we would suffer. In addition, our existing insurance policies would not reimburse us for all of the damages that we might incur as a result of a breach.
A security breach or cyber-attack on our computer systems could interrupt or damage our operations or harm our reputation. Despite the implementation of security measures, our systems may still be vulnerable to data theft, computer viruses, programming errors, attacks by third parties, or similar disruptive problems. If we were to experience a security breach or cyber-attack, we could be required to incur substantial costs and liabilities, including, among other things, the following:
| • | expenses to rectify the consequences of the security breach or cyber-attack; |
| • | liability for stolen assets or information; |
| • | costs of repairing damage to our systems; |
| • | lost revenue and income resulting from any system downtime caused by such breach or attack; |
| • | increased costs of cyber security protection; |
| • | costs of incentives we may be required to offer to our customers or business partners to retain their business; and |
| • | damage to our reputation causing customers and investors to lose confidence in our company. |
Further, any compromise of security or cyber-attack could deter consumers from entering into transactions that require them to provide confidential information to us. In addition, if confidential customer information or information belonging to our business partners is misappropriated from our computer systems, we could be sued by those who assert that we did not take adequate precautions to safeguard our systems and confidential data belonging to our customers or business partners, which could subject us to liability and result in significant legal fees and expenses in defending these claims. As a result, any compromise of security of our computer systems or cyber-attack could have a material adverse effect on our business, prospects, results of operations, and financial condition.
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As part of our business, and subject to applicable privacy laws, we may share confidential customer information and proprietary information with vendors, service providers, and business partners. The information systems of these third parties may also be vulnerable to security breaches, and we may not be able to ensure that these third parties have appropriate security controls in place to protect the information that we share with them. If our proprietary or confidential customer information is intercepted, stolen, misused, or mishandled while in possession of a third party, it could result in reputational harm to us, loss of customer business, and additional regulatory scrutiny, and it could expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition, and liquidity. Although we maintain insurance that is intended to cover certain losses from such events, there can be no assurance that such insurance will be adequate or available.
Our centralized headquarters’ functions and branch operations are susceptible to disruption by catastrophic events, which could have a material adverse effect on our business, results of operations, and financial condition.
Our headquarters are in an office building located in Greer, South Carolina, a town located outside of Greenville, South Carolina. Our information systems and administrative and management processes are primarily provided to our branches from this centralized location, and our separate data management facility is located in Greenville, South Carolina. These processes could be disrupted if a catastrophic event, such as a tornado, power outage, or act of terror, affected Greenville, Greer, or the nearby areas. Any such catastrophic event(s) or other unexpected disruption of our headquarters or data management facility could have a material adverse effect on our business, results of operations, and financial condition.
Our business could suffer if we are unsuccessful in making, continuing, and growing relationships with retailers, or if the retailers with whom we have relationships experience a decline or disruption in their sales volumes.
Our retail purchase loans are reliant on our relationships with retailers. Our retail purchase loan business model is based on our ability to enter into agreements with individual retailers to provide financing to customers in their stores. If a competitor were to offer better service or more attractive loan products to our retail partners, it is possible that our retail partners would terminate their relationships with us. If we are unable to continue to grow our existing relationships and develop new relationships, our results of operations, financial condition, and ability to continue to expand could be adversely affected.
Even with good relationships with retailers, our ability to originate retail purchase loans is dependent, in large part, on the underlying consumer demand for retail goods. Retail sales are subject to fluctuation as a result of general economic trends and other factors. If sales volumes at the retailers with whom we have relationships decrease in the future as a result of general economic trends or due to any other factors, we may experience a corresponding decrease in the volume of such loans that we originate. In such circumstances, we may experience an adverse effect on our business, results of operations, and financial condition.
Interest rates on retail purchase loans are determined at competitive market interest rates, and we may fail to adequately set interest rates, which may adversely affect our business.
Unlike installment loans, particularly small installment loans, which in certain states are typically made at or near the maximum interest rates permitted by law, retail purchase loans are often made at competitive market interest rates, which are governed by laws for installment sales contracts. If we fail to set interest rates at a level that adequately reflects market rates or the credit risks of our customers, or if we set interest rates at a level too low to sustain our profitability, our business, results of operations, and financial condition could be adversely affected.
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Regular turnover among our managers and other employees at our branches makes it more difficult for us to operate our branches and increases our costs of operations, which could have an adverse effect on our business, results of operations, and financial condition.
Our workforce is comprised primarily of employees who work on an hourly basis. In certain areas where we operate, there is significant competition for employees. In the past, we have lost employees and candidates to competitors who have been willing to pay higher compensation. Our ability to continue to expand our operations depends on our ability to attract, train, and retain a large and growing number of qualified employees. The turnover among all of our branch employees was approximately 42% in 2016, 40% in 2017, and 51% in 2018. This turnover increases our cost of operations and makes it more difficult to operate our branches. Our account executives and assistant manager roles have historically experienced high turnover. We may not be able to retain and cultivate personnel at these ranks for future promotion to branch manager. If our employee turnover rates increase above historical levels or if unanticipated problems arise from our high employee turnover and we are unable to readily replace such employees, our business, results of operations, financial condition, and ability to continue to expand could be adversely affected.
The departure, transition, or replacement of key personnel could significantly impact the results of our operations. If we cannot continue to hire and retain high-quality employees, our business and financial results may be negatively affected.
Our future success significantly depends on the continued service and performance of our key management personnel. Competition for these employees is intense. Our operating results could be adversely affected by higher employee turnover or increased salary and benefit costs. Like most businesses, our employees are important to our success and we are dependent in part on our ability to retain the services of our key management, operational, finance, and administrative personnel. We have built our business on a set of core values, and we attempt to hire employees who are committed to these values. We want to hire and retain employees who will fit our culture of compliance and of providing exceptional service to our customers. In order to compete and to continue to grow, we must attract, retain, and motivate employees, including those in executive, senior management, and operational positions. As our employees gain experience and develop their knowledge and skills, they become highly desired by other businesses. Therefore, to retain our employees, we must provide a satisfying work environment and competitive compensation and benefits. If costs to retain our skilled employees increase, then our business and financial results may be negatively affected.
Our continued growth is also dependent, in part, on the skills, experience, and efforts of our executive officers and senior management. As previously announced on February 12, 2019, our Executive Vice President and Chief Financial Officer, Donald E. Thomas, is retiring from Regional, pending the appointment of a new Chief Financial Officer, and we have engaged an executive search firm to conduct a search for our new Chief Financial Officer. We may not be successful in retaining the other members of our executive or senior management team or our other key employees. The loss of the services of any of our executive officers, senior management, or key team members, including state vice presidents, or the inability to attract additional qualified personnel as needed, could have an adverse effect on our business, financial condition, and results of operations. We also depend on our district supervisors to supervise, train, and motivate our branch employees. These supervisors have significant experience with our company and within our industry, and would be difficult to replace. If we lose a district supervisor to a competitor, we could also be at risk of losing other employees and customers. In addition, the process of identifying management successors creates uncertainty and could become a distraction to our senior management and our Board of Directors, and we may not be successful in attracting qualified candidates to replace key positions when necessary. The identification and recruitment of candidates to fill senior management positions, and the resulting transition process, including in the search for and transition to a new Chief Financial Officer, may be disruptive to our business and operations.
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Employee misconduct or misconduct by third parties acting on our behalf could harm us by subjecting us to significant legal liability, regulatory scrutiny, and reputational harm.
Our reputation is critical to maintaining and developing relationships with our existing and potential customers and third parties with whom we do business. There is a risk that our employees or third-party contractors could engage in misconduct that adversely affects our business. For example, if an employee or third-party contractor were to engage—or be accused of engaging—in illegal or suspicious activities, we could be subject to regulatory sanctions and suffer serious harm to our reputation, financial condition, customer relationships, and ability to attract future customers. Employee or third-party misconduct could prompt regulators to allege or to determine, based upon such misconduct, that we have not established adequate supervisory systems and procedures to inform employees of applicable rules or to detect and deter violations of such rules. It is not always possible to deter employee or third-party misconduct, and the precautions we take to detect and prevent misconduct may not be effective in all cases. Misconduct by our employees or third-party contractors, or even unsubstantiated allegations, could result in a material adverse effect on our reputation and our business.
Security breaches in our branches or acts of theft, fraud, or violence could adversely affect our financial condition and results of operations.
A portion of our account payments occur at our branches, either in person or by mail, and often consist of cash payments, which we deposit at local banks throughout the day. This business practice exposes us daily to the potential for employee theft of funds or, alternatively, to theft and burglary due to the cash we maintain in our branches. Despite controls and procedures to prevent such losses, we have sustained losses due to employee theft and fraud (including collusion), including from the origination of fraudulent loans. We are also susceptible to break-ins at our branches, where money and/or customer records necessary for day-to-day operations (which also contain extensive confidential information about our customers, including financial and personally identifiable information) could be taken. A breach in the security of our branches or in the safety of our employees could result in employee injury, loss of funds or records, and adverse publicity, and could result in a loss of customer business or expose us to additional regulatory scrutiny and penalties, civil litigation, and possible financial liability, any of which could have a material adverse effect on our reputation, financial condition, and results of operations.
Our risk management efforts may not be effective.
We could incur substantial losses and our business operations could be disrupted if we are unable to effectively identify, manage, monitor, and mitigate financial risks, such as credit risk, interest rate risk, prepayment risk, liquidity risk, and other market-related risks, as well as regulatory and operational risks related to our business, assets, and liabilities. Our risk management policies, procedures, and techniques may not be sufficient to identify all of the risks we are exposed to, mitigate the risks we have identified, or identify additional risks to which we may become subject in the future.
We may be unsuccessful in maintaining effective internal controls over financial reporting and disclosure controls and procedures.
Controls and procedures are particularly important for consumer finance companies. Effective internal controls over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure controls and procedures, are designed to prevent fraud or material error. Any system of controls, however well-designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurance that the objectives of the system are met. Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) requires management of public companies to develop and implement internal controls over financial reporting and evaluate the effectiveness thereof. Under standards established by the Public Company Accounting Oversight Board, a material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material
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misstatement of our financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of our financial reporting. Any failure to maintain current internal controls or implement required new or improved controls, or difficulties encountered in their maintenance and/or implementation, could cause us to fail to meet our reporting obligations.
If material weaknesses or significant deficiencies in our internal control over financial reporting are discovered or occur in the future or if our controls and procedures fail or are circumvented, our consolidated financial statements may contain material misstatements, we could be required to restate our financial results, we may be unable to produce accurate and timely financial statements, and we may be unable to maintain compliance with applicable stock exchange listing requirements, any of which could have a material adverse effect on our business, results of operations, financial condition, and stock price. The discovery of a material weakness and the disclosure of that fact, even if quickly remediated, could reduce the market value of shares of our common stock. Additionally, the existence of any material weakness or significant deficiency requires management to devote significant time and incur significant expense to remediate any such material weaknesses or significant deficiency, and management may not be able to remediate any such material weaknesses or significant deficiency in a timely manner. Undetected material weaknesses in our internal controls could lead to financial statement restatements, which could have a material adverse effect on our business, financial condition, and results of operation.
If our estimates of reserves for credit losses are not adequate to absorb actual losses, our provision for credit losses would increase, which would adversely affect our results of operations.
We maintain an allowance for credit losses for all loans we make. To estimate the appropriate level of credit loss reserves, we consider known and relevant internal and external factors that affect loan collectability, including the total amount of loans outstanding; delinquency levels, roll rates, and trends; historical credit losses; our current collection patterns; and economic trends. Our methodology for establishing our reserves for credit losses is based in large part on our delinquency roll rates and our historic loss experience. If customer behavior changes as a result of economic, political, social, or other conditions and if we are unable to predict how the unemployment rate and general economic uncertainty may affect our credit loss reserves, our provision may be inadequate. During fiscal 2018, our provision for credit losses was $87.1 million, and we had net credit losses of $77.7 million related to losses on our loans. As of December 31, 2018, our finance receivables were $932.2 million. Maintaining the adequacy of our allowance for credit losses may require that we make significant and unanticipated increases in our provisions for credit losses, which would materially affect our results of operations. Our credit loss reserves, however, are estimates, and if actual credit losses are materially greater than our credit loss reserves, our financial condition and results of operations could be adversely affected. Neither state regulators nor federal regulators regulate our allowance for credit losses.
In June 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standard Update ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU significantly changes the way that entities will be required to measure credit losses. The new standard requires that the estimated credit loss be based upon an “expected credit loss” approach rather than the “incurred loss” approach currently required. The new approach will require entities to measure all expected credit losses for financial assets based on historical experience, current conditions, and reasonable forecasts of collectability. It is anticipated that the expected credit loss model may require earlier recognition of credit losses than the incurred loss approach. This ASU will become effective for us for fiscal years beginning January 1, 2020. Early adoption is permitted for fiscal years beginning January 1, 2019. We believe the adoption of this ASU will have a material adverse effect on our consolidated financial statements. See Note 2, “Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data” for more information on this new accounting standard.
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If assumptions or estimates we use in preparing our financial statements are incorrect or are required to change, our reported results of operations and financial condition may be adversely affected.
We are required to use certain assumptions and estimates in preparing our financial statements under U.S. Generally Accepted Accounting Principles (“GAAP”), including in determining allowances for credit losses, the fair value of financial instruments, asset impairment, reserves related to litigation and other legal matters, the fair value of share-based compensation, valuation of income, and other taxes and regulatory exposures. In addition, significant assumptions and estimates are involved in determining certain disclosures required under GAAP, including those involving the fair value of our financial instruments. If the assumptions or estimates underlying our financial statements are incorrect, the actual amounts realized on transactions and balances subject to those estimates will be different, and this could have a material adverse effect on our results of operations and financial condition.
In addition, the FASB is currently reviewing or proposing changes to several financial accounting and reporting standards that govern key aspects of our financial statements, including areas where assumptions or estimates are required. As a result of changes to financial accounting or reporting standards, whether promulgated or required by the FASB or other regulators, we could be required to change certain of the assumptions or estimates we previously used in preparing our financial statements, which could negatively impact how we record and report our results of operations and financial condition generally. For additional information on the key areas for which assumptions and estimates are used in preparing our financial statements, see Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” and Note 2, “Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data.”
We depend to a substantial extent on borrowings under our senior revolving credit facility to fund our liquidity needs.
We have a senior revolving credit facility committed through June 2020 that allows us to borrow up to $638.0 million, assuming we are in compliance with a number of covenants and conditions. The credit facility also has an accordion provision that allows for the expansion of the facility up to $700.0 million. The senior revolving credit facility is collateralized by certain of our assets, including substantially all of our finance receivables (other than those held by certain special purpose entities, as described below) and equity interests of the majority of our subsidiaries. As of December 31, 2018, the amount outstanding under our senior revolving credit facility was $328.1 million and we had $68.6 million of eligible borrowing capacity on the credit facility (subject to certain covenants and conditions). During fiscal 2018, the maximum amount of borrowings outstanding under the facility at any one time was $459.5 million. We use our senior revolving credit facility as a source of liquidity, including for working capital and to fund the loans we make to our customers. If our existing sources of liquidity become insufficient to satisfy our financial needs or our access to these sources becomes unexpectedly restricted, we may need to try to raise additional capital in the future. If such an event were to occur, we can give no assurance that such alternate sources of liquidity would be available to us on favorable terms or at all. In addition, we cannot be certain that we will be able to replace the amended and restated senior revolving credit facility when it matures on favorable terms or at all. If any of these events occur, our business, results of operations, and financial condition could be adversely affected.
The credit agreements governing our long-term debt contain restrictions and limitations that could affect our ability to operate our business.
The credit agreements governing our senior revolving credit facility, revolving warehouse credit facility, and amortizing loan contain a number of covenants that could adversely affect our business and our flexibility to respond to changing business and economic conditions or opportunities. Among other things, these covenants limit our ability to:
| • | incur or guarantee additional indebtedness; |
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| • | purchase loan portfolios in bulk; |
| • | pay dividends or make distributions on our capital stock or make certain other restricted payments; |
| • | sell assets, including our loan portfolio or the capital stock of our subsidiaries; |
| • | enter into transactions with our affiliates; |
| • | offer certain loan products; |
| • | create or incur liens; and |
| • | consolidate, merge, sell, or otherwise dispose of all or substantially all of our assets. |
The credit agreements also impose certain obligations on us relating to our underwriting standards, recordkeeping and servicing of our loans, and our loss reserves and charge-off policies, and they require us to maintain certain financial ratios, including an interest coverage ratio and a borrowing base ratio. If we were to breach any covenants or obligations under our credit agreements and such breaches were to result in an event of default, our lenders could cause all amounts outstanding to become due and payable, subject to applicable grace periods. An event of default in any one credit agreement could also trigger cross-defaults under other existing and future credit agreements and other debt instruments, and materially and adversely affect our financial condition and ability to continue operating our business as a going concern.
Our securitizations may expose us to financing and other risks, and there can be no assurance that we will be able to access the securitization market in the future, which may require us to seek more costly financing.
We completed our first securitization in June 2018 and our second securitization in December 2018, and we may in the future securitize certain of our finance receivables to generate cash to originate new finance receivables or to pay our outstanding indebtedness. In such transactions, we typically convey a pool of finance receivables to a special purpose entity, which, in turn, conveys the finance receivables to a trust (the issuing entity). Concurrently, the issuing entity issues non-recourse notes or certificates pursuant to the terms of an indenture and/or amended and restated trust agreement, which then are transferred to the special purpose entity in exchange for the finance receivables. The securities issued by the issuing entity are secured by the pool of finance receivables. In exchange for the transfer of finance receivables to the issuing entity, we typically receive the cash proceeds from the sale of the securities issued by the issuing entity, all residual interests, if any, in the cash flows from the finance receivables after payment of the securities, and a 100% beneficial interest in the issuing entity.
Although we successfully completed our first two securitizations in 2018, we can give no assurances that we will be able to complete additional securitizations, including if, for example, the securitization markets become constrained. In addition, the value of any subordinated securities that we may retain in our securitizations might be reduced or, in some cases, eliminated as a result of an adverse change in economic conditions or other factors.
Regional Management Corp. currently acts as the servicer (in such capacity, the “Servicer”) with respect to each securitization. If the Servicer defaults in its servicing obligations, an early amortization event could occur under each securitization and the Servicer could be replaced as servicer. Servicer defaults include, but are not limited to, the failure of the Servicer to make any payment, transfer, or deposit in accordance with applicable securitization documents; breaches of representations, warranties, or agreements made by the Servicer under applicable securitization documents; and the occurrence of certain insolvency events with respect to the Servicer. Such an early amortization event could have materially adverse consequences on our liquidity and cost of funds.
Rating agencies may also affect our ability to execute a securitization transaction or increase the costs we expect to incur from executing securitization transactions, not only by deciding not to issue ratings for our
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securitization transactions, but also by altering the criteria and process they follow in issuing ratings. Rating agencies could alter their ratings processes or criteria after we have accumulated finance receivables for securitization in a manner that effectively reduces the value of those finance receivables by increasing our financing costs or otherwise requiring that we incur additional costs to comply with those processes and criteria. We have no ability to control or predict what actions the rating agencies may take.
Further, other matters, such as (i) accounting standards applicable to securitization transactions and (ii) capital and leverage requirements applicable to banks and other regulated financial institutions holding asset-backed securities, could result in decreased investor demand for securities issued through our securitization transactions or increased competition from other institutions that undertake securitization transactions. In addition, compliance with certain regulatory requirements, including the Dodd-Frank Act, may affect the type of securitization transactions that we are able to complete.
An inability to consummate further securitization transactions on terms similar to our existing securitization transactions, or at all, could require us to seek more costly financing and/or have a material adverse effect on our business, results of operations, and financial condition.
We may be required to indemnify, or repurchase certain finance receivables from, purchasers of finance receivables that we have sold or securitized, or which we will sell or securitize in the future, if our finance receivables fail to meet certain criteria or characteristics or under other circumstances, which could adversely affect our results of operations, financial condition, and liquidity.
We have entered into certain financing arrangements, including an amortizing loan and a revolving warehouse credit facility, that are secured by certain retail installment contracts and promissory notes (the “Receivables”). In June 2018, we securitized approximately $168.5 million of Receivables, and in December 2018, we securitized approximately $136.9 million of Receivables. Our operating subsidiaries originated the Receivables and subsequently transferred the Receivables to certain of our wholly-owned subsidiaries that were established for the special purpose of entering into the financing arrangements and the respective securitizations. The documents governing our financing arrangements and securitizations contain provisions that require us to repurchase the affected Receivables under certain circumstances. While our financing and securitization documents vary, they generally contain customary provisions that require us and the special purpose entities to make certain representations and warranties about the quality and nature of the Receivables. Together with the special purpose entities, we may be required to repurchase the Receivables if a representation or warranty is later determined to be inaccurate. In such a case, we will be required to pay a repurchase price for the release of the affected Receivables.
We believe that many purchasers of loans and other counterparties to transactions like those provided for in the revolving warehouse credit facility, the amortizing loan, the securitizations, and other similar transactions are particularly aware of the conditions under which originators or sellers of such finance receivables must indemnify for or repurchase finance receivables, and may benefit from enforcing any available repurchase remedies. If we are required to repurchase Receivables that we have sold or pledged, it could adversely affect our results of operations, financial condition, and liquidity.
We are subject to interest rate risk resulting from general economic conditions and policies of various governmental and regulatory agencies.
Interest rate risk arises from the possibility that changes in interest rates will affect our results of operations and financial condition. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. Furthermore, market conditions or regulatory restrictions on interest rates we charge may prevent us from passing any increases in interest rates along to our customers. We originate finance receivables at either prevailing market rates or at statutory limits. Subject to statutory limits, our ability to react to changes in
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prevailing market rates is dependent upon the speed at which our customers pay off or renew loans in our existing loan portfolio, which allows us to originate new loans at prevailing market rates. Our loan portfolio turns over approximately 1.2 times per year from cash payments, renewals, and charged-off loans. Because our large loans have longer maturities than our small loans and typically renew at a slower rate than our small loans, the rate of turnover of the loan portfolio may change as our large loans change as a percentage of our portfolio.
In addition, rising interest rates will increase our cost of capital by influencing the amount of interest we pay on our senior revolving credit facility, our revolving warehouse credit facility, or any other floating interest rate obligations that we may incur, which would increase our operating costs and decrease our operating margins. Interest payable on our senior revolving credit facility and our revolving warehouse credit facility is variable and could increase in the future.
For additional information, see Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”
Any replacement of LIBOR as the basis on which our variable rate debt is calculated may harm our cost of capital, financial results, and cash flows.
Borrowings under our senior revolving credit facility and our revolving warehouse credit facility bear interest at rates that are calculated based on LIBOR, and from time to time, we purchase interest rate cap contracts with strike rates that are also calculated based on LIBOR. In July 2017, the head of the United Kingdom Financial Conduct Authority announced the desire to phase out the use of LIBOR by the end of 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S.-dollar LIBOR with the Secured Overnight Financing Rate, or SOFR, a new index calculated by short-term repurchase agreements, backed by Treasury securities. Although there have been a few issuances utilizing SOFR or the Sterling Over Night Index Average, an alternative reference rate that is based on transactions, it is unknown whether these alternative reference rates will attain market acceptance as replacements of LIBOR.
If LIBOR ceases to exist, the method and rate used to calculate our variable-rate debt in the future may result in interest rates and/or payments that are higher than, lower than, or that do not otherwise correlate over time with the interest rates and/or payments that would have been made on our obligations if LIBOR was available in its current form. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. As such, the potential effect of any such event on our cost of capital, financial results, and cash flows cannot yet be determined.
Our use of derivatives exposes us to credit and market risk.
From time to time, we enter into derivative transactions for economic hedging purposes, such as managing our exposure to interest rate risk. By using derivative instruments, we are exposed to credit and market risk, including the risk of loss associated with variations in the spread between the asset yield and the funding and/or hedge cost, default risk, and the risk of insolvency or other inability of the counterparty to a particular derivative transaction to perform its obligations. For additional information, see Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”
Macroeconomic conditions could have a material adverse effect on our business, financial position, results of operations, and cash flows, and may increase loan defaults and affect the value and liquidity of your investment.
We are not insulated from the pressures and potentially negative consequences of financial crises and similar risks beyond our control that have in the past and may in the future affect the capital and credit markets, the broader economy, the financial services industry, or the segment of that industry in which we operate. Our
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financial performance generally, and in particular the ability of our borrowers to make payments on outstanding loans, is highly dependent upon the business and economic environments in the markets where we operate and in the United States as a whole.
During an economic downturn or recession, credit losses in the financial services industry generally increase and demand for credit products often decreases. Declining asset values, defaults on consumer loans, and the lack of market and investor confidence, as well as other factors, all combine to decrease liquidity during an economic downturn. As a result of these factors, some banks and other lenders have suffered significant losses during economic downturns, and the strength and liquidity of many financial institutions worldwide weakened during the most recent economic crisis. Additionally, during an economic downturn, our loan servicing costs and collection costs may increase as we may have to expend greater time and resources on these activities. Our underwriting criteria, policies and procedures, and product offerings may not sufficiently protect our growth and profitability during a sustained period of economic downturn or recession. Any renewed economic downturn will adversely affect the financial resources of our customers and may result in the inability of our customers to make principal and interest payments on, or refinance, the outstanding debt when due.
In addition, periods of economic slowdown or recession are typically accompanied by decreased consumer demand for retail goods. Our ability to originate retail purchase loans depends, in large part, on the underlying demand for such products. Further, our business is focused on customers who generally do not qualify for conventional retail financing, and customers in this demographic are more likely to be affected, and more severely affected, by an economic downturn. Accordingly, our business, financial position, results of operations, and cash flows may be adversely impacted during any economic downturn or recession.
Should economic conditions worsen, they may adversely affect the credit quality of our loans. In the event of increased default by borrowers under the loans, and/or a decrease in the volume of the loans we originate, our business, results of operations, and financial condition could be adversely affected.
A prolonged shutdown of the federal government may result in higher delinquency and could negatively affect our financial condition and results of operations.
The U.S. federal government experienced a partial shutdown from December 22, 2018 until January 25, 2019, and we do not yet know the full impact of the shutdown on our customers, business, results of operations, and financial condition. Delinquencies in our loan portfolio generally reach their lowest point in the first quarter of the year, which we believe is largely due to the timing of income tax refunds. A federal government shutdown could lead to a delay in our customers receiving their income tax refunds as a result of employees of the Internal Revenue Service not being available to process refunds. If our customers do not timely receive their income tax refunds, we could experience higher delinquency and losses in our loan portfolio. Furthermore, a federal government shutdown could result in reduced income for government employees or employees of companies that engage in business with the federal government, which could result in higher loan delinquencies, increased credit losses, and a decrease in demand for our loan products. Additionally, during and immediately following a prolonged government shutdown, our loan servicing costs and collection costs may increase as we may have to expend greater time and resources on these activities. As a result, our business, results of operations, and financial condition could be adversely affected.
Damage to our reputation could negatively impact our business.
Recently, financial services companies have been experiencing increased reputational risk as consumers and the media take issue with certain of their practices or judgments. Maintaining a strong reputation is critical to our attracting and retaining customers, investors, and employees. Harm to our reputation can arise from many sources, including employee misconduct, misconduct by outsourced service providers or other counterparties, litigation or regulatory actions, failure by us to meet minimum standards of service and quality, inadequate protection of customer information, and compliance failures. Negative publicity regarding our company (or others engaged in a similar business or similar activities), whether or not accurate, may damage our reputation, which could have a material adverse effect on our business, results of operations, and financial condition.
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Risks Related to Regulation and Legal Proceedings
Our business products and activities are strictly and comprehensively regulated at the local, state, and federal levels.
The consumer finance industry is extensively regulated by federal, state, and local laws and regulations, including consumer protection laws and regulations relating to the creation, collection, and enforcement of consumer contracts, such as consumer loans. These laws and regulations impose significant costs and limitations on the way we conduct and expand our business, and these costs and limitations may increase in the future if such laws and regulations are changed. These laws and regulations govern or affect, among other things:
| • | the interest rates and manner of calculating such rates that we may charge customers; |
| • | terms of loans, including fees, maximum amounts, and minimum durations; |
| • | origination practices; |
| • | disclosure requirements, including posting of fees; |
| • | solicitation and advertising practices; |
| • | currency and suspicious activity reporting; |
| • | recording and reporting of certain financial transactions; |
| • | privacy of personal customer information; |
| • | the types of products and services that we may offer; |
| • | servicing and collection practices; |
| • | approval of licenses; and |
| • | locations of our branches. |
Due to the highly regulated nature of the consumer finance industry, we are required to comply with a wide array of federal, state, and local laws and regulations that affect, among other things, the manner in which we conduct our origination and servicing operations. These laws and regulations directly impact our business and require constant compliance, monitoring, and internal and external audits. Although we have an enterprise-wide compliance framework structured to continuously evaluate our activities, compliance with applicable law is costly and may create operational constraints.
At a federal level, these laws and their implementing regulations include, among others, the Truth in Lending Act and Regulation Z, the Consumer Financial Protection Act, the Dodd-Frank Act, the Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Gramm-Leach-Bliley Act, the Electronic Funds Transfer Act, the Federal Trade Commission Act, the Servicemembers Civil Relief Act, the Military Lending Act, the Telephone Consumer Protection Act, and requirements related to unfair, deceptive, or abusive acts or practices. Many states and local jurisdictions have consumer protection laws analogous to, or in addition to, those listed above, such as usury laws and state debt collection practices laws that apply to first-party lenders. These federal, state, and local laws regulate the manner in which consumer finance companies deal with customers when making loans or conducting other types of financial transactions.
Changes to statutes, regulations, or regulatory policies, including the interpretation, implementation, and enforcement of statutes, regulations, or policies, could affect us in substantial and unpredictable ways, including limiting the types of financial services and products that we may offer and increasing the ability of competitors to offer competing financial services and products. Compliance with laws and regulations requires us to invest increasingly significant portions of our resources in compliance planning and training, monitoring tools, and personnel, and requires the time and attention of management. These costs divert capital and focus away from efforts intended to grow our business. Because these laws and regulations are complex and often subject to
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interpretation, or because of a result of unintended errors, we may, from time to time, inadvertently violate these laws, regulations, and policies, as each is interpreted by our regulators. If we do not successfully comply with laws, regulations, or policies, we could be subject to fines, penalties, lawsuits, or judgments, our compliance costs could increase, our operations could be limited, and we may suffer damage to our reputation. If more restrictive laws, rules, and regulations are enacted or more restrictive judicial and administrative interpretations of current laws are issued, compliance with the laws could become more expensive or difficult. Furthermore, changes in these laws and regulations could require changes in the way we conduct our business, and we cannot predict the impact such changes would have on our profitability.
The Dodd-Frank Act also may adversely affect the securitization market because it requires, among other things, that the sponsor of a securitization transaction or a majority-owned affiliate of the sponsor retain not less than 5% of the credit risk of the assets collateralizing the asset-backed securities. The risk retention requirement may limit our ability to securitize loans. The impact of the risk retention rule on the asset-backed securities market remains uncertain. In addition, rules relating to securitizations rated by nationally-recognized statistical rating agencies require that the findings of any third-party due diligence service providers be made publicly available at least five (5) business days prior to the first sale of securities, which has led, and will continue to lead, us to incur additional costs in connection with each securitization.
Our primary regulators are the state regulators for the states in which we operate. We operate each of our branches under licenses granted to us by these state regulators. State regulators may enter our branches and conduct audits of our records and practices at any time, with or without notice. If we fail to observe, or are not able to comply with, applicable legal requirements, we may be forced to discontinue certain product offerings, which could adversely affect our business, results of operations, and financial condition. In addition, violation of these laws and regulations could result in fines and other civil and/or criminal penalties, including the suspension or revocation of our branch licenses, rendering us unable to operate in one or more locations. All of the states in which we operate have laws governing the interest rates and fees that we can charge and required disclosure statements, among other restrictions. Violation of these laws could involve penalties requiring the forfeiture of principal and/or interest and fees that we have charged. Depending on the nature and scope of a violation, fines and other penalties for noncompliance of applicable requirements could be significant and could have a material adverse effect on our business, results of operations, and financial condition.
While we believe that we maintain all material licenses and permits required for our current operations and are in substantial compliance with all applicable federal, state, and local laws and regulations, we may not be able to maintain all requisite licenses and permits, and the failure to satisfy those and other regulatory requirements could have a material adverse effect on our operations. In addition, changes in laws or regulations applicable to us could subject us to additional licensing, registration, and other regulatory requirements in the future or could adversely affect our ability to operate or the manner in which we conduct business. Licenses to open new branches are granted in the discretion of state regulators. Accordingly, licenses may be denied unexpectedly or for reasons outside of our control. This could hinder our ability to implement our business plans in a timely manner or at all.
As we enter new markets and develop new products and services, we may become subject to additional local, state, and federal laws and regulations. For example, although we intend to expand into new states, we may encounter unexpected regulatory or other difficulties in these new states, including as they relate to securing the necessary licenses to operate, which may inhibit our growth. As a result, we may not be able to successfully execute our strategies to grow our revenue and earnings.
We are also subject to potential enforcement, supervision, or other actions that may be brought by state attorneys general or other state enforcement authorities and other governmental agencies. For example, the CFPB, state and federal banking regulators, state attorneys general, the Federal Trade Commission, the U.S. Department of Justice, and federal government agencies have imposed sanctions on consumer loan originators for practices including, but not limited to, charging borrowers excessive fees, steering borrowers to loans with
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higher costs or more onerous terms, imposing higher interest rates than the borrower’s credit risk warrants, failing to disclose material terms of loans to borrowers, and otherwise engaging in discriminatory or unfair lending practices or unfair, deceptive, or abusive acts or practices. While we believe we are in substantial compliance with all applicable federal, state, and local laws and regulations, a contrary determination by a regulator, and any resulting action, could subject us to civil money penalties, customer remediation, and increased compliance costs, as well as damage to our reputation and brand and could limit or prohibit our ability to offer certain products and services or engage in certain business practices.
Additionally, Congress, the states, and regulatory agencies could further regulate the consumer credit industry in ways that make it more difficult for us to conduct business. Further, changes in the regulatory application or judicial interpretation of the laws and regulations applicable to financial institutions also could impact the manner in which we conduct our business. The regulatory environment in which financial institutions operate has become increasingly complex and robust, and following the financial crisis of 2008, supervisory efforts to apply relevant laws, regulations, and policies have become more intense. Any of the events described above could have a material adverse effect on all aspects of our business, results of operations, and financial condition.
We may become involved in investigations, examinations, and proceedings by government and self-regulatory agencies, which may result in material adverse consequences to our business, financial condition, and results of operations.
From time to time, we may become involved in formal and informal reviews, investigations, examinations, proceedings, and information-gathering requests by federal and state government and self-regulatory agencies. Should we become subject to such an investigation, examination, or proceeding, the matter could result in material adverse consequences to us, including, but not limited to, increased compliance costs, adverse judgments, significant settlements, fines, penalties, injunction, or other actions.
Changes in laws and regulations or interpretations of laws and regulations could negatively impact our business, results of operations, and financial condition.
The laws and regulations directly affecting our lending activities are constantly under review and are subject to change. In addition, consumer advocacy groups and various other media sources continue to advocate for governmental and regulatory action to prohibit or severely restrict various financial products, including the loan products we offer. Any changes in such laws and regulations, or the implementation, interpretation, or enforcement of such laws and regulations, could force us to modify, suspend, or cease part or, in the worst case, all of our existing operations. It is also possible that the scope of federal regulations could change or expand in such a way as to preempt what has traditionally been state law regulation of our business activities. The enactment of one or more of such regulatory changes could materially and adversely affect our business, results of operations, and prospects.
State and federal legislatures and regulators may also seek to impose new requirements or interpret or enforce existing requirements in new ways. Changes in current laws or regulations or the implementation of new laws or regulations in the future may restrict our ability to continue our current methods of operation or expand our operations. For example, on December 10, 2018, legislation referred to as the “Unsolicited Loan Act of 2018” was introduced in the Senate. This legislation would prohibit the practice of directly mailing convenience checks to potential borrowers. In order for this legislation to progress, it would have to be reintroduced in Congress, which has not yet occurred. If the Unsolicited Loan Act of 2018 or a similar bill were to be reintroduced and ultimately become law, we would no longer be permitted to mail convenience check offers to potential customers, which could materially and adversely affect our business, results of operations, and prospects.
Additionally, new laws and regulations could subject us to liability for prior operating activities or lower or eliminate the profitability of operations going forward by, among other things, reducing the amount of interest
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and fees we charge in connection with our loans or limiting the types of insurance and other ancillary products that we may offer to our customers. If these or other factors lead us to close our branches in a state, in addition to the loss of net revenues attributable to that closing, we would incur closing costs such as lease cancellation payments and we would have to write off assets that we could no longer use. If we were to suspend rather than permanently cease our operations in a state, we would also have continuing costs associated with maintaining our branches and our employees in that state, with little or no revenues to offset those costs.
In addition to state and federal laws and regulations, our business is subject to various local rules and regulations, such as local zoning regulations. Local zoning boards and other local governing bodies have been increasingly restricting the permitted locations of consumer finance companies. Any future actions taken to require special use permits for or impose other restrictions on our ability to provide products could adversely affect our ability to expand our operations or force us to attempt to relocate existing branches. If we were forced to relocate any of our branches, in addition to the costs associated with the relocation, we may be required to hire new employees in the new areas, which may adversely impact the operations of those branches. Relocation of an existing branch may also hinder our collection abilities, as our business model relies in part on the location of our branches being close to where our customers live in order to successfully collect on outstanding loans.
Changes in laws or regulations may have a material adverse effect on all aspects of our business in a particular state and on our overall business, results of operations, and financial condition.
The Dodd-Frank Act authorizes the CFPB to adopt rules and undertake supervisory and enforcement activity that could potentially have a serious impact on our ability to offer installment loans or otherwise materially and adversely affect our operations and financial performance.
Title X of the Dodd-Frank Act establishes the CFPB, which became operational on July 21, 2011. Under the Dodd-Frank Act, the CFPB has regulatory, supervisory, and enforcement powers over providers of consumer financial products that we offer, including explicit supervisory authority to examine and require registration of installment lenders such as ourselves. Included in the powers afforded to the CFPB is the authority to adopt rules describing specified acts and practices as being “unfair,” “deceptive,” or “abusive,” and hence unlawful. Specifically, the CFPB has the authority to declare an act or practice abusive if it, among other things, materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service or takes unreasonable advantage of a lack of understanding on the part of the consumer of the product or service.
Although the Dodd-Frank Act expressly provides that the CFPB has no authority to establish usury limits, some consumer advocacy groups have suggested that certain forms of alternative consumer finance products, such as traditional installment loans, should be a regulatory priority, and it is possible that the CFPB could propose and adopt rules making the products that we offer materially less profitable or impractical. Further, the CFPB may target specific features of loans or loan practices, such as refinancings, by rulemaking that could cause us to cease offering certain products or cease engaging in certain practices. The CFPB could also adopt rules imposing new and potentially burdensome requirements and limitations with respect to any of our current or future products or lines of business or on our methods of servicing our loans. Any such rules could have a material adverse effect on our business, results of operation, and financial condition.
The Dodd-Frank Act also gives the CFPB the authority to examine and regulate entities it classifies as a “larger participant of a market for other consumer financial products or services.” In the past, the CFPB has indicated that it may in the future issue a proposed rule defining larger participants in the installment lending market. The CFPB has not yet issued a “larger participant” rule applicable to us. However, if in the future we are covered by a final larger participant rule for the installment lending market, we will be subject to related CFPB supervisory examinations.
In addition to the Dodd-Frank Act’s grant of regulatory powers to the CFPB, the Dodd-Frank Act gives the CFPB authority to pursue administrative proceedings or litigation for violations of federal consumer financial
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laws. In these proceedings, the CFPB can 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 a maximum of $5,639 per day for minor violations of federal consumer financial laws (including the CFPB’s own rules) to $28,195 per day for reckless violations and $1,127,799 per day for knowing violations. If we are subject to such administrative proceedings, litigation, orders, or monetary penalties in the future, it 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 find that we have violated the foregoing laws, they could exercise their enforcement powers in ways that would have a material adverse effect on us.
In addition to preexisting enforcement rights for state attorneys general, the Dodd-Frank Act gives attorneys general authority to enforce the Dodd-Frank Act and regulations promulgated under the Dodd-Frank Act’s authority. In conducting an investigation, the CFPB or state attorneys general may issue a civil investigative demand requiring a target company to prepare and submit, among other items, documents, written reports, answers to interrogatories, and deposition testimony. If we are subject to investigation, the required response could result in substantial costs and a diversion of our management’s attention and resources. In addition, the market price of our common stock could decline as a result of the initiation of a CFPB investigation of our company or even the perception that such an investigation could occur, even in the absence of any finding by the CFPB that we have violated any state or federal law.
Although many of the regulations implementing portions of the Dodd-Frank Act have been promulgated, we are still unable to predict how this significant legislation may be interpreted and enforced or the full extent to which implementing regulations and supervisory policies may affect us. Finally, President Donald Trump and the Congressional majority have indicated that the Dodd-Frank Act will be under further scrutiny and some of the provisions of the Dodd-Frank Act and rules promulgated thereunder, including those provisions establishing the CFPB and the rules and regulations proposed and enacted by the CFPB, may be revised, repealed, or amended, but there can be no assurance that future reforms will not significantly and adversely impact our business, financial condition, and results of operations.
We sell certain of our loans, including, in some instances, charged-off loans and loans where the borrower is in default. This practice could subject us to heightened regulatory scrutiny, expose us to legal action, cause us to incur losses, and/or limit or impede our collection activity.
As part of our business model, we have purchased and sold, and may in the future purchase and sell, some of our finance receivables, including loans that have been charged-off and loans where the borrower is in default. The CFPB and other regulators recently have significantly increased their scrutiny of debt sales, especially delinquent and charged-off debt. The CFPB has criticized sellers of debt for insufficient documentation to support and verify the validity or amount of the debt. It has also criticized debt collectors for, among other things, collection tactics, attempting to collect debts that are no longer valid, misrepresenting the amount of the debt, not having sufficient documentation to verify the validity or amount of the debt, and failing to obtain or maintain proper licenses. Accordingly, our sales of loans could expose us to lawsuits or fines by regulators if we do not have sufficient documentation to support and verify the validity and amount of the loans underlying the transactions, or if we or purchasers of our loans use collection methods that are viewed as unfair, deceptive, or abusive. In addition, our collections could suffer and we may incur additional expenses if we are required to change collection practices or stop collecting on certain debts as a result of a lawsuit or action on the part of regulators.
Our use of third-party vendors is subject to increasing regulatory attention.
The CFPB and other regulators have issued regulatory guidance that has focused on the need for financial institutions to oversee their business relationships with service providers in a manner that ensures such service
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providers comply with applicable law. This results in increased due diligence and ongoing monitoring of third-party vendor relationships, thus increasing the scope of management involvement and decreasing the benefit that we receive from using third-party vendors. Moreover, if regulators conclude that we have not met the heightened standards for oversight of our third-party vendors, we could be subject to enforcement actions, civil monetary penalties, supervisory orders to cease and desist, or other remedial actions, which could have an adverse effect on our business, financial condition, and operating results
We are subject to government regulations concerning our hourly and our other employees, including minimum wage, overtime, and health care laws.
We are subject to applicable rules and regulations relating to our relationship with our employees, including minimum wage and break requirements, health benefits, unemployment and sales taxes, overtime, and working conditions and immigration status. Legislated increases in the federal minimum wage and increases in additional labor cost components, such as employee benefit costs, workers’ compensation insurance rates, compliance costs and fines, as well as the cost of litigation in connection with these regulations, would increase our labor costs. Unionizing and collective bargaining efforts have received increased attention nationwide in recent periods. Should our employees become represented by unions, we would be obligated to bargain with those unions with respect to wages, hours, and other terms and conditions of employment, which is likely to increase our labor costs. Moreover, as part of the process of union organizing and collective bargaining, strikes and other work stoppages may occur, which would cause disruption to our business. Similarly, many employers nationally in similar retail environments have been subject to actions brought by governmental agencies and private individuals under wage-hour laws on a variety of claims, such as improper classification of workers as exempt from overtime pay requirements and failure to pay overtime wages properly, with such actions sometimes brought as class actions. These actions can result in material liabilities and expenses. Should we be subject to employment litigation, such as actions involving wage-hour, overtime, break, and working time, it may distract our management from business matters and result in increased labor costs. In addition, we currently sponsor employer-subsidized premiums for major medical programs for eligible personnel who elect health care coverage through our insurance programs. As a result of regulatory changes, we may not be able to continue to offer health care coverage to our employees on affordable terms or at all and subsequently may face increased difficulty in hiring and retaining employees. If we are unable to locate, attract, train, or retain qualified personnel, or if our costs of labor increase significantly, our business, results of operations, and financial condition may be adversely affected.
Our stock price or results of operations could be adversely affected by media and public perception of installment loans and of legislative and regulatory developments affecting activities within the installment lending sector.
Consumer advocacy groups and various media sources continue to criticize alternative financial services providers (such as payday and title lenders, check advance companies, and pawnshops). These critics frequently characterize such alternative financial services providers as predatory or abusive toward consumers. If these persons were to criticize the products that we offer, it could result in further regulation of our business and could negatively impact our relationships with existing borrowers and efforts to attract new borrowers. Furthermore, our industry is highly regulated, and announcements regarding new or expected governmental and regulatory action in the alternative financial services sector may adversely impact our stock price and perceptions of our business even if such actions are not targeted at our operations and do not directly impact us.
Legal proceedings to which we may become subject may have a material adverse impact on our financial position and results of operations.
Like many companies in our industry, we are from time to time involved in various legal proceedings and subject to claims and other actions related to our business activities brought by borrowers and others. All such legal proceedings are inherently unpredictable and, regardless of the merits of the claims, litigation is often
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expensive, time-consuming, disruptive to our operations and resources, and distracting to management. If resolved against us, such legal proceedings could result in excessive verdicts and judgments, injunctive relief, equitable relief, and other adverse consequences that may affect our financial condition and how we operate our business. Similarly, if we settle such legal proceedings, it may affect our financial condition and how we operate our business. Future court decisions, alternative dispute resolution awards, business expansion, or legislative activity may increase our exposure to litigation and regulatory investigations. In some cases, substantial non-economic remedies or punitive damages may be sought. Although we maintain liability insurance coverage, there can be no assurance that such coverage will cover any particular verdict, judgment, or settlement that may be entered against us, that such coverage will prove to be adequate, or that such coverage will continue to remain available on acceptable terms, if at all. If in any legal proceeding we incur liability or defense costs that exceed our insurance coverage or that are not within the scope of our insurance coverage, it could have a material adverse effect on our business, financial condition, and results of operations.
Current and proposed regulation related to consumer privacy, data protection, and information security could increase our costs.
We are subject to a number of federal and state consumer privacy, data protection, and information security laws and regulations. Moreover, various federal and state regulatory agencies require us to notify customers in the event of a security breach. Federal and state legislators and regulators are increasingly pursuing new guidance, laws, and regulations. Compliance with current or future customer privacy, data protection, and information security laws and regulations could result in higher compliance, technology, or other operating costs. Any violations of these laws and regulations may require us to change our business practices or operational structure, and could subject us to legal claims, monetary penalties, sanctions, and the obligation to indemnify and/or notify customers or take other remedial actions.
U.S. federal income tax reform may impact our financial results in unexpected ways or may otherwise have a material adverse impact on our financial position, results of operations, and cash flows.
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (the “Tax Act”) that significantly reformed the Internal Revenue Code of 1986, as amended. The Tax Act contains significant changes to corporate taxation, including a reduction of the corporate tax rate from 35% to 21%, a limitation on the tax deduction for interest expense to 30% of earnings (except for certain small businesses), a limitation on the deduction for net operating losses to 80% of current year taxable income and elimination of net operating loss carrybacks, immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modifying or repealing many business deductions and credits. While our accounting for provisional adjustments in the 2017 financial statements for impacts of the Tax Act was completed in 2018, the Internal Revenue Service did not issue guidance on all elements of the Tax Act in 2018. Accordingly, the overall impact of the Tax Act is uncertain and the ultimate impact may prove to be inconsistent with our current expectations. As a result, the Company’s financial position, results of operations, and cash flows could be adversely affected by the Tax Act, the interpretation and administration of the Tax Act, and/or any future tax reform legislation.
In addition, the Tax Act, its implementing regulations, and associated regulatory guidance significantly changed certain aspects of individual taxation, including tax rates and employer tax withholding requirements. Our customers often utilize income tax refunds in part to make payments on their loans with us, which we believe materially impacts the delinquency levels in our loan portfolio in the first quarter of each year. As a result of the Tax Act, beginning in 2019, our customers may receive an income tax refund that is smaller than the refund that they expect or to which they have become accustomed, or our customers may receive no income tax refund and instead owe additional tax payments. If this were to occur, our customers would have fewer financial resources to make payments on their loans with us. As a result, we could experience higher delinquencies and losses in our loan portfolio, which would adversely affect our financial position, results of operations, and cash flows.
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Risks Related to the Ownership of Our Common Stock
If securities or industry analysts do not publish research or reports about our business, or if they downgrade their recommendations regarding our common stock, our stock price and trading volume could decline.
The trading market for our common stock is influenced by the research and reports that industry or securities analysts publish about us or our business. If any of the analysts who cover us downgrades our common stock or publishes inaccurate or unfavorable research about our business, our common stock price may decline. If analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our common stock price or trading volume to decline and our common stock to be less liquid.
The market price of shares of our common stock may continue to be volatile, which could cause the value of your investment to decline.
The market price of our common stock has been highly volatile and could be subject to wide fluctuations. Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as general economic, market, or political conditions, could reduce the market price of shares of our common stock in spite of our operating performance. In addition, our operating results and the market price of our common stock could be below the expectations of public market analysts and investors due to a number of potential factors, including variations in our quarterly operating results, additions or departures of key management personnel, failure to meet analysts’ earnings estimates, publication of research reports about our industry, litigation and government investigations, changes or proposed changes in laws or regulations or differing interpretations or enforcement thereof affecting our business, adverse market reaction to any indebtedness we may incur or securities we may issue in the future, changes in market valuations of similar companies, speculation in the press or investment community, announcements by our competitors of significant contracts, acquisitions, dispositions, strategic partnerships, joint ventures, or capital commitments, adverse publicity about the industries we participate in, or individual scandals.
We have no current plans to pay cash dividends on our common stock for the foreseeable future.
We do not expect to pay cash dividends for the foreseeable future. Instead, we intend to retain future earnings, if any, for future operation, expansion, and debt repayment. The declaration, amount, and payment of any future cash dividends on shares of common stock will be at the discretion of our Board of Directors. Our Board of Directors may take into account general and economic conditions, our financial condition and results of operations, our available cash and current and anticipated cash needs, capital requirements, contractual, legal, tax, and regulatory restrictions and implications on the payment of cash dividends by us to our stockholders or by our subsidiaries to us, and such other factors as our Board of Directors may deem relevant. In addition, our ability to pay cash dividends may be limited by covenants of any existing and future outstanding indebtedness we or our subsidiaries incur, including our senior revolving credit facility. As a result, investors may need to rely on sales of their common stock after price appreciation, which may not occur, as the only way to realize future gains on their investment.
Your stock ownership may be diluted by the future issuance of additional common stock in connection with our incentive plans, acquisitions, or otherwise.
We have approximately 987 million shares of common stock authorized but unissued, as of March 7, 2019. Our amended and restated certificate of incorporation authorizes us to issue these shares of common stock and options, rights, warrants, and appreciation rights relating to common stock for the consideration and on the terms and conditions established by our Board of Directors in its discretion, whether in connection with acquisitions or otherwise. Our stockholders previously approved the Regional Management Corp. 2015 Long-Term Incentive Plan (as amended and/or restated, the “2015 Plan”). Subject to adjustments as provided in the 2015 Plan, the maximum aggregate number of shares of our common stock that may be issued under the 2015 Plan may not
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exceed the sum of (a) 1,550,000 shares plus (b) any shares (i) remaining available for the grant of awards as of the effective date under the 2007 Management Incentive Plan (the “2007 Plan”) or the 2011 Stock Incentive Plan (the “2011 Plan”), and/or (ii) subject to an award granted under the 2007 Plan or the 2011 Plan, which award is forfeited, cancelled, terminated, expires or lapses. We have 885,742 shares available for issuance under the 2015 Plan, as of March 7, 2019. In addition, our Board may recommend in the future that our stockholders approve new stock plans. Any common stock that we issue, including under our 2015 Plan or other equity incentive plans that we may adopt in the future, would dilute the percentage ownership held by our stockholders. In addition, the market price of our common stock could decline as a result of sales of a large number of shares of common stock in the market or the perception that such sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to issue equity securities in the future at a time and at a price that we deem appropriate.
Anti-takeover provisions in our charter documents and applicable state law might discourage or delay acquisition attempts for us that you might consider favorable.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may make the acquisition of our company more difficult without the approval of our Board of Directors. Among other things, these provisions:
| • | authorize the issuance of undesignated preferred stock, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock; |
| • | prohibit stockholder action by written consent, which will require all stockholder actions to be taken at a meeting of our stockholders; |
| • | provide that the Board of Directors is expressly authorized to make, alter, or repeal our bylaws and that our stockholders may only amend our bylaws with the approval of 80% or more of all of the outstanding shares of our capital stock entitled to vote; and |
| • | establish advance notice requirements for nominations for elections to our Board of Directors or for proposing matters that can be acted upon by stockholders at stockholder meetings. |
In addition, certain states require the approval of a state regulator for the acquisition, directly or indirectly, of more than a certain amount of the voting or common stock of a consumer finance company. The overall effect of these laws is to make it more difficult to acquire a consumer finance company than it might be to acquire control of a nonregulated corporation.
Furthermore, as a Delaware corporation, we are also subject to provisions of Delaware law, which may impair a takeover attempt that our stockholders may find beneficial. These anti-takeover provisions and other provisions under Delaware law could discourage, delay, or prevent a transaction involving a change in control of our company, including actions that our stockholders may deem advantageous, or negatively affect the trading price of our common stock. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire.
Our amended and restated certificate of incorporation contains a provision renouncing our interest and expectancy in certain corporate opportunities identified by our non-employee directors and their affiliates.
Certain of our non-employee directors and their affiliates are in the business of providing buyout capital and growth capital to developing companies and may acquire interests in businesses that directly or indirectly compete with certain portions of our business. Our amended and restated certificate of incorporation provides for the allocation of certain corporate opportunities between us, on the one hand, and certain of our non-employee
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directors and their affiliates, on the other hand. As set forth in our amended and restated certificate of incorporation, such non-employee directors and their affiliates shall not have any duty to refrain from engaging, directly or indirectly, in the same business activities or similar business activities or lines of business in which we operate. Therefore, a non-employee director of our company may pursue certain acquisition opportunities that may be complementary to our business and, as a result, such acquisition opportunities may not be available to us. These potential conflicts of interest could have a material adverse effect on our business, financial condition, results of operations, or prospects if attractive corporate opportunities are allocated by such non-employee directors to themselves or their other affiliates instead of to us.
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| ITEM 1B. | UNRESOLVED STAFF COMMENTS. |
None.
| ITEM 2. | PROPERTIES. |
Our headquarters operations are located in an approximately 51,700 square foot leased facility in Greer, South Carolina, a town located outside of Greenville, South Carolina. As of March 7, 2019, each of our 360 branches is leased under fixed term lease agreements. Our branches are located in 11 states throughout the Southeastern, Southwestern, Mid-Atlantic, and Midwestern United States, and the average branch size is approximately 1,576 square feet.
In the opinion of management, our properties have been well-maintained, are in sound operating condition, and contain all equipment and facilities necessary to operate at present levels. We believe that all of our facilities are suitable and adequate for our present purposes. Our only reportable segment, which is our consumer finance segment, uses the properties described in this Part I, Item 2, “Properties.”
| ITEM 3. | LEGAL PROCEEDINGS. |
The Company is involved in various legal proceedings and related actions that have arisen in the ordinary course of its business that have not been fully adjudicated. The Company’s management does not believe that these matters, when ultimately concluded and determined, will have a material adverse effect on its financial condition, liquidity, or results of operations.
| ITEM 4. | MINE SAFETY DISCLOSURES. |
Not applicable.
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PART II
| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. |
Market Information
Our common stock has been listed on the New York Stock Exchange (the “NYSE”) under the symbol “RM” since March 28, 2012. The last reported sale price of our common stock on the NYSE on March 7, 2019, was $25.96 per share.
Holders
As of March 7, 2019, there were 54 registered holders of our common stock. Because many of the shares of our common stock are held by brokers and other institutions on behalf of stockholders, we are unable to determine the exact number of beneficial stockholders represented by those record holders, but we believe that there were approximately 2,030 beneficial owners of our common stock as of March 1, 2019.
Non-Affiliate Ownership
For purposes of calculating the aggregate market value of shares of our common stock held by non-affiliates, as set forth on the cover page of this Annual Report on Form 10-K, we have assumed that all outstanding shares are held by non-affiliates, except for shares held by each of our executive officers, directors, and 5% or greater stockholders as of June 30, 2018. In the case of 5% or greater stockholders, we have not deemed such stockholders to be affiliates unless there are facts and circumstances which would indicate that such stockholders exercise any control over our company or unless they hold 10% or more of our outstanding common stock. These assumptions should not be deemed to constitute an admission that all executive officers, directors, and 5% or greater stockholders are, in fact, affiliates of our company, or that there are no other persons who may be deemed to be affiliates of our company. Further information concerning shareholdings of our officers, directors, and principal stockholders is incorporated by reference in Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” of this Annual Report on Form 10-K.
Dividends; Stock Repurchases
We have not paid any cash dividends since our initial public offering in 2012, and we have no current plans to pay any cash dividends on our common stock for the foreseeable future. In 2016, we repurchased approximately $25 million of our common stock at a weighted-average price of $16.17 per share. Other than our 2016 stock repurchase program, which was completed in June 2016, we have historically retained earnings for future operations, expansion, and debt repayment.
The declaration, amount, and payment of any future cash dividends on shares of common stock and/or repurchases of common stock will be at the discretion of our Board of Directors. Our Board of Directors may take into account general and economic conditions; our financial condition and results of operations; our available cash and current and anticipated cash needs; capital requirements; contractual, legal, tax, and regulatory restrictions and implications on the payment of cash dividends by us to our stockholders or by our subsidiaries to us; and such other factors as our Board of Directors may deem relevant. Our amended and restated senior revolving credit facility includes a provision restricting our ability to pay dividends on our common stock based upon, among other things, our net income and hypothetical availability under the credit facility. Likewise, certain of our credit facilities restrict certain of our wholly-owned subsidiaries from paying dividends to us, subject to certain exceptions.
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Stock Performance Graph
This performance graph shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of the Company under the Securities Act of 1933.
The following graph shows a comparison of the cumulative total return for our common stock, the NYSE Composite Index, and the NYSE Financial Index for the five years ended December 31, 2018. The graph assumes that $100 was invested at the market close on December 31, 2013, in the common stock of the Company, the NYSE Composite Index, and the NYSE Financial Index, and data for the NYSE Composite Index and the NYSE Financial Index assumes reinvestments of dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance.
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| ITEM 6. | SELECTED FINANCIAL DATA. |
The selected consolidated historical financial data for the periods set forth below are derived from audited consolidated financial statements. We derived the selected historical consolidated statement of income data for each of the years ended December 31, 2018, 2017, and 2016 and the selected historical consolidated balance sheet data as of December 31, 2018 and 2017 from our audited consolidated financial statements, which appear in Part II, Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. We have derived the selected historical consolidated statement of income data for the years ended December 31, 2015 and 2014 and the selected historical consolidated balance sheet data as of December 31, 2016, 2015, and 2014 from our audited financial statements, which do not appear elsewhere in this Annual Report on Form 10-K.
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements, the related notes, and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K. The historical results are not necessarily indicative of the results to be expected for any future period.
| Year Ended December 31, | ||||||||||||||||||||
| In thousands, except per share data | 2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||
| Consolidated Statements of Income Data: | ||||||||||||||||||||
| Revenue | ||||||||||||||||||||
| Interest and fee income | $ | 280,121 | $ | 249,034 | $ | 220,963 | $ | 195,794 | $ | 184,797 | ||||||||||
| Insurance income, net, and other income | 26,585 | 23,425 | 19,555 | 21,512 | 19,922 | |||||||||||||||
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| Total revenue | 306,706 | 272,459 | 240,518 | 217,306 | 204,719 | |||||||||||||||
| Expenses | ||||||||||||||||||||
| Provision for credit losses | 87,056 | 77,339 | 63,014 | 47,348 | 69,057 | |||||||||||||||
| General and administrative expenses | 140,284 | 130,955 | 118,632 | 115,598 | 96,776 | |||||||||||||||
| Interest expense | 33,464 | 23,908 | 19,924 | 16,221 | 14,947 | |||||||||||||||
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| Total expenses | 260,804 | 232,202 | 201,570 | 179,167 | 180,780 | |||||||||||||||
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| Income before income taxes | 45,902 | 40,257 | 38,948 | 38,139 | 23,939 | |||||||||||||||
| Income taxes | 10,557 | 10,294 | 14,917 | 14,774 | 9,137 | |||||||||||||||
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| Net income | $ | 35,345 | $ | 29,963 | $ | 24,031 | $ | 23,365 | $ | 14,802 | ||||||||||
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| Earnings per Share Data: | ||||||||||||||||||||
| Basic earnings per share | $ | 3.03 | $ | 2.59 | $ | 2.03 | $ | 1.82 | $ | 1.17 | ||||||||||
| Diluted earnings per share | $ | 2.93 | $ | 2.54 | $ | 1.99 | $ | 1.79 | $ | 1.14 | ||||||||||
| Basic weighted-average shares | 11,655 | 11,551 | 11,824 | 12,849 | 12,701 | |||||||||||||||
| Diluted weighted-average shares | 12,078 | 11,783 | 12,085 | 13,074 | 12,951 | |||||||||||||||
| Consolidated Balance Sheet Data (at period end): | ||||||||||||||||||||
| Finance receivables(1) | $ | 932,243 | $ | 817,463 | $ | 717,775 | $ | 628,444 | $ | 546,192 | ||||||||||
| Allowance for credit losses | (58,300 | ) | (48,910 | ) | (41,250 | ) | (37,452 | ) | (40,511 | ) | ||||||||||
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| Net finance receivables(2) | $ | 873,943 | $ | 768,553 | $ | 676,525 | $ | 590,992 | $ | 505,681 | ||||||||||
| Total assets | 956,395 | 829,483 | 712,224 | 626,373 | 529,401 | |||||||||||||||
| Long-term debt | 660,507 | 571,496 | 491,678 | 411,177 | 341,419 | |||||||||||||||
| Total liabilities | 677,234 | 590,072 | 504,749 | 421,146 | 351,078 | |||||||||||||||
| Total stockholders’ equity | $ | 279,161 | $ | 239,411 | $ | 207,475 | $ | 205,227 | 178,323 | |||||||||||
| (1) | Finance receivables equal the total amount due from the customer, net of unearned finance charges and insurance premiums. |
| (2) | Net finance receivables equal the total amount due from the customer, net of unearned finance charges, insurance premiums, and allowance for credit losses. |
Regional Management Corp. | 2018 Annual Report on Form 10-K | 47
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| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
The following discussion and analysis should be read in conjunction with, and is qualified in its entirety by reference to, our audited consolidated financial statements and the related notes that appear in Part II, Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. These discussions contain forward-looking statements that reflect our current expectations and that include, but are not limited to, statements concerning our strategies, future operations, future financial position, future revenues, projected costs, expectations regarding demand and acceptance for our financial products, growth opportunities and trends in the market in which we operate, prospects, and plans and objectives of management. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “predicts,” “will,” “would,” “should,” “could,” “potential,” “continue,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Our forward-looking statements involve risks and uncertainties that could cause actual results, events, and/or performance to differ materially from the plans, intentions, and expectations disclosed in the forward-looking statements. Such risks and uncertainties include, without limitation, the risks set forth in Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K. The forward-looking information we have provided in this Annual Report on Form 10-K pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 should be evaluated in the context of these factors. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to update or revise such statements, except as required by the federal securities laws.
Overview
We are a diversified consumer finance company that provides installment loan products primarily to customers with limited access to consumer credit from banks, thrifts, credit card companies, and other lenders. We operate under the name “Regional Finance” in 359 branch locations across 11 states in the Southeastern, Southwestern, Mid-Atlantic, and Midwestern United States, serving 401,500 active accounts, as of December 31, 2018. Most of our loan products are secured, and each is structured on a fixed rate, fixed term basis with fully amortizing equal monthly installment payments, repayable at any time without penalty. Our loans are sourced through our multiple channel platform, which includes our branches, centrally-managed direct mail campaigns, digital partners, retailers, and our consumer website. We operate an integrated branch model in which nearly all loans, regardless of origination channel, are serviced through our branch network. This provides us with frequent in-person contact with our customers, which we believe improves our credit performance and customer loyalty. Our goal is to consistently grow our finance receivables and to soundly manage our loan portfolio risk, while providing our customers with attractive and easy-to-understand loan products that serve their varied financial needs.
Our products include small, large, and retail installment loans:
| • | Small Loans (£$2,500) – As of December 31, 2018, we had 276.8 thousand small installment loans outstanding, representing $437.7 million in finance receivables. This included 99.4 thousand small loan convenience checks, representing $143.5 million in finance receivables. |
| • | Large Loans (>$2,500) – As of December 31, 2018, we had 99.8 thousand large installment loans outstanding, representing $438.0 million in finance receivables. This included 3.4 thousand large loan convenience checks, representing $9.8 million in finance receivables. |
| • | Retail Loans – As of December 31, 2018, we had 21.2 thousand retail purchase loans outstanding, representing $30.4 million in finance receivables. |
| • | Optional Insurance Products – We offer optional payment and collateral protection insurance to our direct loan customers. |
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Small and large installment loans are our core loan products and will be the drivers of our future growth. We ceased originating automobile purchase loans in November 2017 to focus on growing our core loan portfolio, but we continue to own and service the automobile loans that we previously originated. As of December 31, 2018, we had approximately 3.7 thousand automobile loans outstanding, representing $26.2 million in finance receivables. Our primary sources of revenue are interest and fee income from our loan products, of which interest and fees relating to small and large installment loans are the largest component. In addition to interest and fee income from loans, we derive revenue from optional insurance products purchased by customers of our direct loan products.
For additional information regarding our business operations, see Part I, Item 1, “Business.”
Factors Affecting Our Results of Operations
Our business is driven by several factors affecting our revenues, costs, and results of operations, including the following:
Quarterly Information and Seasonality. Our loan volume and contractual delinquency follow seasonal trends. Demand for our small and large loans is typically highest during the second, third, and fourth quarters, which we believe is largely due to customers borrowing money for vacation, back-to-school, and holiday spending. With the exception of retail loans, loan demand has generally been the lowest during the first quarter, which we believe is largely due to the timing of income tax refunds. Delinquencies generally reach their lowest point in the first quarter of the year and rise throughout the remainder of the fiscal year. Consequently, we experience seasonal fluctuations in our operating results and cash needs.
Growth in Loan Portfolio. The revenue that we derive from interest and fees is largely driven by the balance of loans that we originate and purchase. Average finance receivables grew 14.8% from $572.8 million in 2015 to $657.4 million in 2016, grew 13.2% to $744.2 million in 2017, and grew 14.7% to $853.8 million in 2018. We source our loans through our branches, direct mail program, retail partners, digital partners, and our consumer website. Our loans are made almost exclusively in geographic markets served by our network of branches. Increasing the number of loans per branch and the number of branches we operate allows us to increase the number of loans that we are able to service. We opened 17, 3, and 8 net new branches in 2018, 2017, and 2016, respectively. We believe that we have the opportunity to add as many as 700 additional branches in states where it is currently favorable for us to conduct business, and we have plans to continue to grow our branch network.
Product Mix. We are exposed to different credit risks and charge different interest rates and fees with respect to the various types of loans we offer. Our product mix also varies to some extent by state, and we may further diversify our product mix in the future. The interest rates and fees vary from state to state, depending on the competitive environment and relevant laws and regulations.
Asset Quality and Allowance for Credit Losses. Our results of operations are highly dependent upon the credit quality of our loan portfolio. The credit quality of our loan portfolio is the result of our ability to enforce sound underwriting standards, maintain diligent servicing of the portfolio, and respond to changing economic conditions as we grow our loan portfolio. The allowance for credit losses calculation uses the current delinquency profile and historical delinquency roll rates as key data points in estimating the allowance. We believe that the primary underlying factors driving the provision for credit losses for each loan type are our underwriting standards, the general economic conditions in the areas in which we conduct business, loan portfolio growth, and the effectiveness of our collection efforts. In addition, the market for repossessed automobiles at auction is another underlying factor that we believe influences the provision for credit losses for automobile purchase loans and, to a lesser extent, large loans. We monitor these factors, and the amount and past due status of all loans one or more days past due, to identify trends that might require us to modify the allowance for credit losses.
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Interest Rates. Our costs of funds are affected by changes in interest rates, as the interest rates that we pay on certain of our credit facilities are variable. As a component of our strategy to manage the interest rate risk associated with future interest payments on our variable-rate debt, we have purchased interest rate cap contracts. As of December 31, 2018, we held four interest rate cap contracts with an aggregate notional principal amount of $400.0 million. The interest rate caps have maturities of March 2019 ($50.0 million, 2.50% strike rate), April 2020 ($100.0 million, 3.25% strike rate), June 2020 ($50.0 million, 2.50% strike rate), and April 2021 ($200.0 million, 3.50% strike rate). As of December 31, 2018, the one-month LIBOR was 2.50%. When the one-month LIBOR exceeds the strike rate, the counterparty reimburses us for the excess over the strike rate. No payment is required by us or the counterparty when the one-month LIBOR is below the strike rate. In addition, the interest rate on a portion of our long-term debt (the amortizing loan, RMIT 2018-1 securitization, and RMIT 2018-2 securitization (each as described below)) is fixed. As of December 31, 2018, 45.8% of our long-term debt was at a fixed rate.
Operating Costs. Our financial results are impacted by the costs of operations and home office functions. Those costs are included in general and administrative expenses on our consolidated statements of income. Our receivable efficiency ratio (sum of general and administrative expenses divided by average finance receivables) was 16.4% for 2018, compared to 17.6% in 2017 and 18.0% in 2016. We believe that this ratio is generally in line with industry standards for companies of our size, and we expect that it will continue to decline in future years as we continue to grow our loan portfolio and control expense growth.
Components of Results of Operations
Interest and Fee Income. Our interest and fee income consists primarily of interest earned on outstanding loans. Accrual of interest income on finance receivables is suspended when an account becomes 90 days delinquent. If the account is charged off, the accrued interest income is reversed as a reduction of interest and fee income.
Most states allow certain fees in connection with lending activities, such as loan origination fees, acquisition fees, and maintenance fees. Some states allow for higher fees while keeping interest rates lower. Loan fees are additional charges to the customer and generally are included in the annual percentage rate shown in the Truth in Lending disclosure that we make to our customers. The fees may or may not be refundable to the customer in the event of an early payoff, depending on state law. Fees are accrued to income over the life of the loan on the constant yield method.
Insurance Income, Net. Our insurance operations are a material part of our overall business and are integral to our lending activities. Insurance income, net consists primarily of earned premiums, net of certain direct costs, from the sale of various optional payment and collateral protection insurance products offered to customers who obtain loans directly from us. Insurance income, net also includes the earned premiums and direct costs associated with the non-file insurance that we purchase. We do not sell insurance to non-borrowers. Direct costs included in insurance income, net are claims paid, claims reserves, ceding fees, and premium taxes paid. We do not allocate to insurance income, net, any other home office or branch administrative costs associated with managing our insurance operations, managing our captive insurance company, marketing and selling insurance products, legal and compliance review, or internal audits. All of these unallocated administrative costs, which management estimates were approximately $6.7 million in 2018, are included in general and administrative expenses in our consolidated statement of income.
In recent years, as large loans have become a larger percentage of our loan portfolio, the severity of non-file insurance claims has increased and non-file insurance claims expenses have exceeded non-file insurance fees. The resulting net loss from the non-file insurance product has been reflected in our insurance income, net. We have evaluated various ways to lower our non-file insurance claims, and we reduced our utilization of non-file insurance beginning in the fourth quarter of 2018. This policy change will cause substantially offsetting increases to insurance income, net and net credit losses in future years. Therefore, we do not expect this change
Regional Management Corp. | 2018 Annual Report on Form 10-K | 50
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in policy to impact our profitability in future years. For additional information regarding this policy change, including its impact on our allowance for credit losses in 2018, see Note 4, “Finance Receivables, Credit Quality Information, and Allowance for Credit Losses,” of the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data.”
As reinsurer, we maintain cash reserves for life insurance claims in an amount determined by the unaffiliated insurance company. As of December 31, 2018, the restricted cash balance for these cash reserves was $7.1 million. The unaffiliated insurance company maintains the reserves for non-life claims.
Other Income. Our other income consists primarily of late charges assessed on customers who fail to make a payment within a specified number of days following the due date of the payment. In addition, fees for extending the due date of a loan, returned check charges, and commissions earned from the sale of an auto club product are included in other income.
Provision for Credit Losses. Provisions for credit losses are charged to income in amounts that we estimate as sufficient to maintain an allowance for credit losses at an adequate level to provide for estimated losses on the related finance receivable portfolio. Credit loss experience, delinquency of finance receivables, loan portfolio growth, the value of underlying collateral, and management’s judgment are factors used in assessing the overall adequacy of the allowance and the resulting provision for credit losses. Our provision for credit losses fluctuates so that we maintain an adequate credit loss allowance that reflects forecasted future credit losses over the estimated loss emergence period (the interval of time between the event that caused a borrower to default and our recording of the credit loss) for each finance receivable type. Changes in our delinquency and net credit loss rates may result in changes to our provision for credit losses. Substantial adjustments to the allowance may be necessary if there are significant changes in economic conditions or loan portfolio performance.
General and Administrative Expenses. Our general and administrative expenses are comprised of four categories: personnel, occupancy, marketing, and other. We measure our general and administrative expenses as a percentage of average finance receivables, which we refer to as our receivable efficiency ratio.
Our personnel expenses are the largest component of our general and administrative expenses and consist primarily of the salaries and wages, overtime, contract labor, relocation costs, bonuses, benefits, and related payroll taxes associated with all of our operations and home office employees.
Our occupancy expenses consist primarily of the cost of renting our facilities, all of which are leased, as well as the utility, depreciation of leasehold improvements and furniture and fixtures, telecommunication, data processing, and other non-personnel costs associated with operating our business.
Our marketing expenses consist primarily of costs associated with our direct mail campaigns (including postage and costs associated with selecting recipients), digital marketing, and maintaining our consumer website, as well as some local marketing by branches. These costs are expensed as incurred.
Other expenses consist primarily of legal, compliance, audit, and consulting costs, non-employee director compensation, amortization of software licenses and implementation costs, electronic payment processing costs, bank service charges, office supplies, and credit bureau charges. We expect legal and compliance costs to remain elevated due to the regulatory environment in the consumer finance industry. For a discussion regarding how risks and uncertainties associated with the current regulatory environment may impact our future expenses, net income, and overall financial condition, see Part I, Item 1A, “Risk Factors.”
Interest Expense. Our interest expense consists primarily of paid and accrued interest for long-term debt, unused line fees, and amortization of debt issuance costs on long-term debt. Interest expense also includes costs attributable to the interest rate caps that we use to manage our interest rate risk. Changes in the fair value of the interest rate caps are reflected in interest expense.
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Income Taxes. Income taxes consist of state and federal income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The change in deferred tax assets and liabilities is recognized in the period in which the change occurs, and the effects of future tax rate changes are recognized in the period in which the enactment of new rates occurs.
Results of Operations
The following table summarizes our results of operations, both in dollars and as a percentage of average finance receivables:
| Year Ended December 31, | ||||||||||||||||||||||||
| 2018 | 2017 | 2016 | ||||||||||||||||||||||
| In thousands | Amount | % of Average Receivables | Amount | % of Average Receivables | Amount | % of Average Receivables | ||||||||||||||||||
| Revenue | ||||||||||||||||||||||||
| Interest and fee income | $ | 280,121 | 32.8 | % | $ | 249,034 | 33.5 | % | $ | 220,963 | 33.6 | % | ||||||||||||
| Insurance income, net | 14,793 | 1.7 | % | 13,061 | 1.8 | % | 9,456 | 1.4 | % | |||||||||||||||
| Other income | 11,792 | 1.4 | % | 10,364 | 1.3 | % | 10,099 | 1.6 | % | |||||||||||||||
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| Total revenue | 306,706 | 35.9 | % | 272,459 | 36.6 | % | 240,518 | 36.6 | % | |||||||||||||||
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| Provision for credit losses | 87,065 | 10.2 | % | 77,339 | 10.4 | % | 63,014 | 9.6 | % | |||||||||||||||
| Personnel | 84,068 | 9.8 | % | 75,992 | 10.2 | % | 68,979 | 10.5 | % | |||||||||||||||
| Occupancy | 22,519 | 2.6 | % | 21,530 | 2.9 | % | 20,059 | 3.1 | % | |||||||||||||||
| Marketing | 7,745 | 0.9 | % | 7,128 | 1.0 | % | 6,837 | 1.0 | % | |||||||||||||||
| Other | 25,952 | 3.1 | % | 26,305 | 3.5 | % | 22,757 | 3.4 | % | |||||||||||||||
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| Total general and administrative | 140,284 | 16.4 | % | 130,955 | 17.6 | % | 118,632 | 18.0 | % | |||||||||||||||
| Interest expense | 33,464 | 3.9 | % | 23,908 | 3.2 | % | 19,924 | 3.1 | % | |||||||||||||||
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| Income before income taxes | 45,902 | 5.4 | % | 40,257 | 5.4 | % | 38,948 | 5.9 | % | |||||||||||||||
| Income taxes | 10,557 | 1.3 | % | 10,294 | 1.4 | % | 14,917 | 2.2 | % | |||||||||||||||
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| Net income | $ | 35,345 | 4.1 | % | $ | 29,963 | 4.0 | % | $ | 24,031 | 3.7 | % | ||||||||||||
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Information explaining the changes in our results of operations from year-to-year is provided in the following pages.
Comparison of December 31, 2018, Versus December 31, 2017
The following discussion and table describe the changes in finance receivables by product type:
| • | Small Loans (£$2,500) – Small loans outstanding increased by $61.9 million, or 16.5%, to $437.7 million at December 31, 2018, from $375.8 million at December 31, 2017. The increase was primarily due to increased marketing. |
| • | Large Loans (>$2,500) – Large loans outstanding increased by $90.8 million, or 26.1%, to $438.0 million at December 31, 2018, from $347.2 million at December 31, 2017. The increase was primarily due to increased marketing and the transition of small loan customers to large loans. |
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| • | Automobile Loans – Automobile loans outstanding decreased by $35.3 million, or 57.4%, to $26.2 million at December 31, 2018, from $61.4 million at December 31, 2017. We ceased originating automobile loans in November 2017 to focus on growing our core loan portfolio. |
| • | Retail Loans – Retail loans outstanding decreased $2.6 million, or 7.9%, to $30.4 million at December 31, 2018, from $33.1 million at December 31, 2017. |
| Finance Receivables by Product | ||||||||||||||||
| In thousands | December 31, 2018 | December 31, 2017 | YoY $ Inc (Dec) | YoY % Inc (Dec) | ||||||||||||
| Small loans | $ | 437,662 | $ | 375,772 | $ | 61,890 | 16.5 | % | ||||||||
| Large loans | 437,998 | 347,218 | 90,780 | 26.1 | % | |||||||||||
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| Total core loans | 875,660 | 722,990 | 152,670 | 21.1 | % | |||||||||||
| Automobile loans | 26,154 | 61,423 | (35,269 | ) | (57.4 | )% | ||||||||||
| Retail loans | 30,429 | 33,050 | (2,621 | ) | (7.9 | )% | ||||||||||
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| Total finance receivables | $ | 932,243 | $ | 817,463 | $ | 114,780 | 14.0 | % | ||||||||
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| Number of branches at period end | 359 | 342 | 17 | 5.0 | % | |||||||||||
| Average finance receivables per branch | $ | 2,597 | $ | 2,390 | $ | 207 | 8.7 | % | ||||||||
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Comparison of the Year Ended December 31, 2018, Versus the Year Ended December 31, 2017
Net Income. Net income increased $5.4 million, or 18.0%, to $35.3 million during 2018, from $30.0 million in 2017. The increase was primarily due to an increase in revenue of $34.2 million, offset by an increase in provision for credit losses of $9.7 million, an increase in general and administrative expenses of $9.3 million, and an increase in interest expense of $9.6 million.
Revenue. Total revenue increased $34.2 million, or 12.6%, to $306.7 million in 2018, from $272.5 million in 2017. The components of revenue are explained in greater detail below.
Interest and Fee Income. Interest and fee income increased $31.1 million, or 12.5%, to $280.1 million in 2018, from $249.0 million in 2017. The increase was primarily due to a 14.7% increase in average finance receivables, offset by a 0.7% decrease in average yield.
The following table sets forth the average finance receivables balance and average yield for our loan products:
| Average Finance Receivables for the Year Ended | Average Yields for the Year Ended | |||||||||||||||||||||||
| In thousands | December 31, 2018 | December 31, 2017 | YoY % Inc (Dec) | December 31, 2018 | December 31, 2017 | YoY % Inc (Dec) | ||||||||||||||||||
| Small loans | $ | 391,481 | $ | 355,826 | 10.0 | % | 40.0 | % | 42.2 | % | (2.2 | )% | ||||||||||||
| Large loans | 389,919 | 278,397 | 40.1 | % | 28.5 | % | 28.8 | % | (0.3 | )% | ||||||||||||||
| Automobile loans | 41,026 | 78,317 | (47.6 | )% | 15.6 | % | 16.3 | % | (0.7 | )% | ||||||||||||||
| Retail loans | 31,393 | 31,660 | (0.8 | )% | 19.0 | % | 18.8 | % | 0.2 | % | ||||||||||||||
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| Total interest and fee yield | $ | 853,819 | $ | 744,200 | 14.7 | % | 32.8 | % | 33.5 | % | (0.7 | )% | ||||||||||||
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Regional Management Corp. | 2018 Annual Report on Form 10-K | 53
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Small loan yields decreased 2.2% compared to 2017 as more of our small loan customers have originated loans with larger balances and longer maturities, which typically are priced at lower interest rates. Large loan yields decreased 0.3% compared to 2017. As our large loan portfolio matured in 2018, a greater amount of accrued interest income was reversed as a reduction of interest and fee income for charged-off accounts. Automobile loan yields decreased 0.7% compared to 2017. We anticipate that the automobile loan yields will remain at the current level or decline due to higher-yielding loans paying off or renewing into large loans, leaving the lower-yielding loans in the liquidating automobile loan portfolio. When compared to 2017, retail loan yields increased 0.2% as a result of adjusted pricing that reflects current market conditions.
Since we began focusing on large loan growth in early 2015, the large loan portfolio has grown faster than the rest of our loan products, and we expect that this trend will continue in the future. Over time, large loan growth will change our product mix, which will reduce our total interest and fee yield.
The following table represents the amount of loan originations and refinancing, net of unearned finance charges:
| Net Loans Originated for the Year Ended | ||||||||||||||||
| In thousands | December 31, 2018 | December 31, 2017 | YoY $ Inc (Dec) | YoY % Inc (Dec) | ||||||||||||
| Small loans | $ | 624,243 | $ | 573,858 | $ | 50,385 | 8.8 | % | ||||||||
| Large loans | 409,174 | 355,931 | 53,243 | 15.0 | % | |||||||||||
| Automobile loans | — | 20,331 | (20,331 | ) | (100.0 | )% | ||||||||||
| Retail loans | 26,579 | 28,885 | (2,306 | ) | (8.0 | )% | ||||||||||
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| Total net loans originated | $ | 1,059,996 | $ | 979,005 | $ | 80,991 | 8.3 | % | ||||||||
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The hurricanes that impacted our branches in September 2018 and August 2017 had an estimated $2.8 million and $3.0 million negative impact on loan originations in 2018 and 2017, respectively. We believe that the small loan portfolio experienced most of these impacts.
The following table summarizes the components of the increase in interest and fee income:
| Components of Increase in Interest and Fee Income Year Ended December 31, 2018 Compared to Year Ended December 31, 2017 Increase (Decrease) | ||||||||||||||||
| In thousands | Volume | Rate | Volume & Rate | Net | ||||||||||||
| Small loans | $ | 15,036 | $ | (7,680 | ) | $ | (770 | ) | $ | 6,586 | ||||||
| Large loans | 32,159 | (930 | ) | (372 | ) | 30,857 | ||||||||||
| Automobile loans | (6,073 | ) | (542 | ) | 258 | (6,357 | ) | |||||||||
| Retail loans | (50 | ) | 52 | (1 | ) | 1 | ||||||||||
| Product mix | (4,390 | ) | 4,223 | 167 | — | |||||||||||
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| Total increase in interest and fee income | $ | 36,682 | $ | (4,877 | ) | $ | (718 | ) | $ | 31,087 | ||||||
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The $31.1 million increase in interest and fee income in 2018 compared to 2017 was primarily driven by finance receivables growth, offset by a decrease in yield, as illustrated in the table above. We expect future increases in interest and fee income to continue to be driven primarily from growth in our average finance receivables.
Insurance Income, Net. Insurance income, net increased $1.7 million, or 13.3%, to $14.8 million in 2018, from $13.1 million in 2017. Insurance income, net represented 1.7% and 1.8% of average finance receivables in 2018 and 2017, respectively. In both 2018 and 2017, personal property insurance premiums
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represented the largest component of aggregate earned insurance premiums and non-file insurance claims expense represented the largest component of direct insurance expenses.
The following table summarizes the components of insurance income, net:
| Insurance Premiums and Direct Expenses for the Year Ended | ||||||||||||||||
| In thousands | December 31, 2018 | December 31, 2017 | YoY $ B(W) | YoY % B(W) | ||||||||||||
| Earned premiums | $ | 31,095 | $ | 25,860 | $ | 5,235 | 20.2 | % | ||||||||
| Claims, reserves, and certain direct expenses | (16,302 | ) | (12,799 | ) | (3,503 | ) | (27.4 | )% | ||||||||
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| Insurance income, net | $ | 14,793 | $ | 13,061 | $ | 1,732 | 13.3 | % | ||||||||
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In 2018, earned premiums increased by $5.2 million and claims, reserves, and certain direct expenses increased by $3.5 million, in each case compared to 2017. The increase in earned premiums was primarily due to loan growth. The increase in claims, reserves, and certain direct expenses was primarily due to higher non-file insurance claims expense compared to 2017. The increase in non-file insurance claims expense was primarily due to an increase in the severity of non-file insurance claims. As large loans have become a larger percentage of our loan portfolio, the severity of non-file insurance claims has increased.
In addition, non-file insurance claims expense was lower in 2017 due to a transition in insurance carriers during which fewer accounts were covered by non-file insurance. Furthermore, as described above, the non-file insurance product has been operating at a loss that has been reflected in our insurance income, net. Effective in the fourth quarter of 2018, we implemented a policy change that reduces the amount of non-file insurance claims that we file. This policy change causes substantially offsetting increases to insurance income, net and net credit losses. Therefore, we do not expect this change in policy to impact our profitability in future periods. This policy change is described in greater detail in Note 4, “Finance Receivables, Credit Quality Information, and Allowance for Credit Losses,” of the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data.” As a result of these factors, $2.9 million and $4.4 million of non-file insurance claims impacted net credit losses instead of insurance income, net in 2018 and 2017, respectively.
Other Income. Other income increased $1.4 million, or 13.8%, to $11.8 million in 2018, from $10.4 million in 2017, due to a $1.2 million increase in commissions earned from the sale of our auto club product and a $0.4 million increase in loan deferral fee income. These increases were offset by a decrease of $0.2 million in income from late charges. The decrease in late charges was primarily due to large loan customers with higher credit quality comprising a greater percentage of our total loan portfolio in 2018, compared to 2017, and our expanded use of electronic payments to reduce early-stage delinquency. As large loans continue to represent a greater percentage of our total loan portfolio and we continue to leverage electronic payment options, we expect lower late charges per active account. Other income represented 1.4% and 1.3% of average finance receivables in 2018 and 2017, respectively.
Provision for Credit Losses. Our provision for credit losses increased $9.7 million, or 12.6%, to $87.1 million in 2018, from $77.3 million in 2017. The increase was primarily due to an increase in net credit losses of $8.0 million and a $1.7 million increase in the allowance for credit losses compared to 2017. The provision for credit losses as a percentage of average finance receivables in 2018 was 10.2%, compared to 10.4% in 2017. Fiscal 2018 included a 0.4% impact from the net $3.7 million hurricane-related provision and a 0.3% impact from the $2.9 million increase in net credit losses discussed in the insurance income, net paragraph above. Fiscal 2017 included a 0.4% impact from the hurricane-related $2.9 million provision and a 0.6% impact from the $4.4 million increase in net credit losses discussed in the insurance income, net paragraph above, offset by a 0.1% benefit from the bulk sale of previously charged-off customer accounts in bankruptcy (the “2017 Bulk Sale”).
Regional Management Corp. | 2018 Annual Report on Form 10-K | 55
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The increase in the provision for credit losses is explained in greater detail below.
Hurricane Impact. During 2018, our provision for credit losses was impacted by a $3.9 million increase in the allowance for credit losses related to estimated incremental credit losses on customer accounts impacted by a hurricane. In late 2018, we released $0.3 million of the hurricane allowance for credit losses to cover hurricane-related net credit losses. As of December 31, 2018, the allowance for credit losses related to the hurricane was $3.6 million. During 2017, our provision for credit losses was impacted by a $3.0 million increase in the allowance for credit losses related to estimated incremental credit losses on customer accounts impacted by two hurricanes. In late 2017, we released $0.2 million of the hurricane allowance for credit losses to cover hurricane-related net credit losses. As of December 31, 2017, the allowance for credit losses related to the hurricanes was $2.8 million.
Bulk Sale. We recognized a recovery of $1.0 million in 2017 from the 2017 Bulk Sale. These accounts were excluded from prior sales of charged-off loans.
Net Credit Losses. Net credit losses increased $8.0 million, or 11.5%, to $77.7 million in 2018, from $69.7 million in 2017. The increase was primarily due to a $109.6 million increase in average finance receivables in 2018. Net credit losses as a percentage of average finance receivables were 9.1% in 2018, compared to 9.4% in 2017. Fiscal 2018 included a 0.2% impact from the $1.7 million increase in net credit losses resulting from the 2017 hurricanes and a 0.3% impact from the $2.9 million increase in net credit losses discussed in the insurance income, net paragraph above. Fiscal 2017 included a 0.6% impact from the $4.4 million increase in net credit losses discussed in the insurance income, net paragraph above, offset by a 0.1% benefit from the $1.0 million 2017 Bulk Sale.
The following table provides net credit losses and the benefit to net credit losses associated with non-file insurance claims payments as a percentage of average finance receivables for the periods indicated:
| Non-File Insurance Impact on Net Credit Loss Rates for the Year Ended | ||||||||
| December 31, 2018 | December 31, 2017 | |||||||
| Net credit losses | 9.1 | % | 9.4 | % | ||||
| Non-file benefit | 1.0 | % | 0.8 | % | ||||
We have evaluated various ways to lower our non-file insurance claims, and we decided to reduce our utilization of non-file insurance beginning in the fourth quarter of 2018. As a result, we expect that the benefit provided by non-file insurance will decrease by approximately 0.65% as a percentage of average finance receivables over the next four quarters, resulting in a corresponding increase in our net credit loss rate. Our allowance for credit losses contains sufficient reserves for this anticipated increase in net credit losses. See Note 4, “Finance Receivables, Credit Quality Information, and Allowance for Credit Losses,” of the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data.” In addition, due to the decrease in non-file insurance claims, our insurance income, net will increase by an amount comparable to the anticipated increase in net credit losses, resulting in an income statement offset. Therefore, we do not expect this policy change to impact our profitability in future periods.
Delinquency Performance. Our December 31, 2018 contractual delinquency as a percentage of total finance receivables increased to 7.7% from 7.5% as of December 31, 2017, primarily due to credit tightening and the maturation of our large loan portfolio. Total contractual delinquency as of December 31, 2018 and December 31, 2017 were inclusive of increases of 0.4% and 0.3%, respectively, attributable to the impact of the hurricanes. We expect that the 2018 hurricane will negatively impact our delinquencies and net credit losses in the first half of 2018, but we believe that we are fully reserved for such losses.
In mid-2018, we implemented stricter underwriting guidelines, which primarily impacted our large loan customers. A portion of our existing large loan customers attempted to renew their loans but did not qualify due to these tighter underwriting guidelines. As a result, some of these accounts became delinquent. We expect
Regional Management Corp. | 2018 Annual Report on Form 10-K | 56
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this credit tightening to increase delinquency and losses in the short-term and decrease delinquency and losses in the long-term. In addition to delinquencies increasing from tighter underwriting guidelines, we also observed higher delinquencies from the maturing of our large loan portfolio in 2018. Each of these items contributed to incremental increases in delinquency rates as of December 31, 2018, compared to December 31, 2017. We also continue to monitor the impacts of the recent government shutdown and the Tax Act on our customers, including as to any delay in the processing of tax refunds due to the government shutdown and the size of tax refunds due to the Tax Act. At this time, we are uncertain whether the government shutdown or the Tax Act will adversely affect our delinquencies and losses in 2019.
To actively manage the delinquencies and losses of our loan portfolios, we have undertaken a number of initiatives to drive improved delinquency results in 2019. For example, custom credit scorecards have been implemented in nine of eleven states as of January 2019. The scorecards provide a significant improvement over the previous criteria that were used to underwrite small and large loans.
The following tables include delinquency balances by aging category and by product:
| Contractual Delinquency by Aging | ||||||||||||||||
| In thousands | December 31, 2018 | December 31, 2017 | ||||||||||||||
| Allowance for credit losses | $ | 58,300 | 6.3 | % | $ | 48,910 | 6.0 | % | ||||||||
| Current | 754,162 | 80.9 | % | 669,451 | 81.9 | % | ||||||||||
| 1 to 29 days past due | 105,920 | 11.4 | % | 86,533 | 10.6 | % | ||||||||||
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| Delinquent accounts: | ||||||||||||||||
| 30 to 59 days | 22,529 | 2.3 | % | 18,728 | 2.2 | % | ||||||||||
| 60 to 89 days | 17,382 | 1.9 | % | 15,297 | 1.9 | % | ||||||||||
| 90 to 119 days | 12,279 | 1.3 | % | 11,339 | 1.4 | % | ||||||||||
| 120 to 149 days | 10,890 | 1.2 | % | 8,865 | 1.1 | % | ||||||||||
| 150 to 179 days | 9,081 | 1.0 | % | 7,250 | 0.9 | % | ||||||||||
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| Total contractual delinquency | $ | 72,161 | 7.7 | % | $ | 61,479 | 7.5 | % | ||||||||
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| Total finance receivables | $ | 932,243 | 100.0 | % | $ | 817,463 | 100.0 | % | ||||||||
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| Contractual Delinquency by Product | ||||||||||||||||
| In thousands | December 31, 2018 | December 31, 2017 | ||||||||||||||
| Small loans | $ | 40,663 | 9.3 | % | $ | 35,246 | 9.4 | % | ||||||||
| Large loans | 26,814 | 6.1 | % | 18,540 | 5.3 | % | ||||||||||
| Automobile loans | 2,083 | 8.0 | % | 4,896 | 8.0 | % | ||||||||||
| Retail loans | 2,601 | 8.5 | % | 2,797 | 8.5 | % | ||||||||||
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| Total contractual delinquency | $ | 72,161 | 7.7 | % | $ | 61,479 | 7.5 | % | ||||||||
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Allowance for Credit Losses. We evaluate delinquency and losses in each of our loan products in establishing the allowance for credit losses. The following table sets forth our allowance for credit losses compared to the related finance receivables as of the end of the periods indicated:
| December 31, 2018 | December 31, 2017 | |||||||||||||||||||||||
| In thousands | Finance Receivables | Allowance for Credit Losses | Allowance as a Percentage of Finance Receivables | Finance Receivables | Allowance for Credit Losses | Allowance as a Percentage of Finance Receivables | ||||||||||||||||||
| Small loans | $ | 437,662 | $ | 30,759 | 7.0 | % | $ | 375,772 | $ | 24,749 | 6.6 | % | ||||||||||||
| Large loans | 437,998 | 23,702 | 5.4 | % | 347,218 | 17,548 | 5.1 | % | ||||||||||||||||
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| Total core loans | 875,660 | 54,461 | 6.2 | % | 722,990 | 42,297 | 5.9 | % | ||||||||||||||||
| Automobile loans | 26,154 | 1,893 | 7.2 | % | 61,423 | 4,025 | 6.6 | % | ||||||||||||||||
| Retail loans | 30,429 | 1,946 | 6.4 | % | 33,050 | 2,588 | 7.8 | % | ||||||||||||||||
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| Total | $ | 932,243 | $ | 58,300 | 6.3 | % | $ | 817,463 | $ | 48,910 | 6.0 | % | ||||||||||||
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The allowance for credit losses as a percentage of finance receivables increased to 6.3% as of December 31, 2018, from 6.0% as of December 31, 2017. The increase was primarily due to a higher delinquency level as of December 31, 2018, compared to December 31, 2017, and a $0.8 million increase in the remaining allowance for credit losses on customer accounts impacted by the hurricanes. The remaining allowance for credit losses on customer accounts impacted by the hurricanes was $3.6 million as of December 31, 2018.
General and Administrative Expenses. Our general and administrative expenses, comprising expenses for personnel, occupancy, marketing, and other expenses, increased $9.3 million, or 7.1%, to $140.3 million in 2018 from $131.0 million in 2017. Our receivable efficiency ratio (general and administrative expenses as a percentage of average finance receivables) decreased to 16.4% in 2018, from 17.6% in 2017. We believe that our receivable efficiency ratio will continue to decline in future years as we continue to grow our loan portfolio and control expense growth. The absolute dollar increase in general and administrative expenses is explained in greater detail below.
Personnel. The largest component of general and administrative expenses is personnel expense, which increased $8.1 million, or 10.6%, to $84.1 million in 2018, from $76.0 million in 2017. Labor expense increased $4.7 million primarily due to added headcount in our information technology department, centralized late-stage collections department, and branches, most of which was added to effectively service active account growth that has occurred since December 31, 2017. Corporate incentive compensation expense increased $2.7 million compared to 2017 primarily due to the 2018 annual grant of awards (which have three-year performance targets) under our long-term incentive plan. Fiscal 2018 was the first year that three annual outstanding award grants impacted our personnel expense in one year. During 2018, we opened 17 net new branches, including 13 net new branches that opened in the fourth quarter. These new branches resulted in a net $0.7 million increase in personnel costs.
Occupancy. Occupancy expenses increased $1.0 million, or 4.6%, to $22.5 million in 2018, from $21.5 million in 2017. The increase was due to increases in rent and maintenance costs of $0.7 million, computer support service costs of $0.6 million (offset by a decrease in software amortization in other expense), depreciation expense of $0.3 million, and $0.2 million in costs related to 17 net new branches. These increases were offset by a $0.9 million decrease in telecommunication costs due to reduced rates from our service provider.
Marketing. Marketing expenses increased $0.6 million, or 8.7%, to $7.7 million in 2018, from $7.1 million in 2017. The increase was primarily due to increased investment in our digital marketing channels and the impact of our 17 net new branches that opened during 2018.
Other Expenses. Other expenses decreased $0.4 million, or 1.3%, to $26.0 million in 2018, from $26.3 million in 2017. The decrease was primarily due to a $1.0 million decrease in costs related to the implementation of our loan management system, a $0.7 million decrease in software amortization (offset by an increase in computer support service costs in occupancy expense), and a $0.9 million decrease in legal and settlement expenses. These decreases were offset by a $1.0 million increase in electronic payment processing fees, a $0.7 million increase in loan management system software amortization, and a $0.7 million increase in collection expense.
Interest Expense. Interest expense on long-term debt increased $9.6 million, or 40.0%, to $33.5 million in 2018, from $23.9 million in 2017. The increase was primarily due to an increase in interest rates and increases in the average balance of our long-term debt facilities from finance receivable growth, which combined to result in a $7.5 million increase in interest expense. Additionally, amortization of debt issuance costs increased $1.3 million, while unused line fees and interest expense related to our rate cap agreements increased $0.5 million and $0.3 million, respectively. The average cost of our total long-term debt increased 0.93% to 5.66% in 2018, from 4.73% in 2017. The average cost of our long-term debt has increased as we have diversified our long-term funding sources.
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Income Taxes. Income taxes increased $0.3 million, or 2.6%, to $10.6 million in 2018, from $10.3 million in 2017. During 2018, tax benefits from the exercise and vesting of share-based awards and research and development tax credits decreased $1.2 million and $0.3 million, respectively, compared to 2017. A $5.6 million increase in income before income taxes in 2018 resulted in a $1.2 million increase in federal income taxes compared to 2017. The Tax Act reduced the corporate federal tax rate from 35% to 21% and made other changes to U.S. tax law. This decrease in the corporate federal tax rate resulted in a $5.6 million decrease in income taxes in 2018, compared to 2017. During 2017, the revaluation of net deferred tax liabilities to the newly enacted federal corporate tax rate resulted in a $3.1 million income tax benefit.
Our effective tax rates were 23.0% and 25.6% in 2018 and 2017, respectively. The tax benefits related to the exercise and vesting of share-based awards and other items (2017 tax return to provisional estimates) reduced the 2018 effective tax rate by 0.8% and 0.5%, respectively. The revaluation of the net deferred tax liability decreased the 2017 effective tax rate by 7.8%. The tax benefits related to the exercise and vesting of share-based awards and research and development tax credits reduced the 2017 effective tax rate by 4.0% and 1.0%, respectively. In future years, we expect our effective tax rates to be negatively impacted by changes in the Tax Act related to the deductibility of executive compensation.
Comparison of December 31, 2017, Versus December 31, 2016
The following discussion and table describe the changes in finance receivables by product type:
| • | Small Loans (£$2,500) – Small loans outstanding increased by $17.3 million, or 4.8%, to $375.8 million at December 31, 2017, from $358.5 million at December 31, 2016, despite the transition of many small loan customers to large loans. The growth in receivables in branches opened in 2016 and 2017 contributed to the growth in small loans outstanding. |
| • | Large Loans (>$2,500) – Large loans outstanding increased by $111.9 million, or 47.5%, to $347.2 million at December 31, 2017, from $235.3 million at December 31, 2016. The increase was primarily due to increased marketing and the transition of small loan customers to large loans. |
| • | Automobile Loans – Automobile loans outstanding decreased by $29.0 million, or 32.1%, to $61.4 million at December 31, 2017, from $90.4 million at December 31, 2016, as we continued to restructure our automobile loan business to a centralized model during the first 10 months of 2017 and then determined to cease originating automobile loans in November 2017 to focus on growing our core loan portfolio. |
| • | Retail Loans – Retail loans outstanding decreased $0.5 million, or 1.4%, to $33.1 million at December 31, 2017, from $33.5 million at December 31, 2016. |
| Finance Receivables by Product | ||||||||||||||||
| In thousands | December 31, 2017 | December 31, 2016 | YoY $ Inc (Dec) | YoY % Inc (Dec) | ||||||||||||
| Small loans | $ | 375,772 | $ | 358,471 | $ | 17,301 | 4.8 | % | ||||||||
| Large loans | 347,218 | 235,349 | 111,869 | 47.5 | % | |||||||||||
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| Total core loans | 722,990 | 593,820 | 129,170 | 21.8 | % | |||||||||||
| Automobile loans | 61,423 | 90,432 | (29,009 | ) | (32.1 | )% | ||||||||||
| Retail loans | 33,050 | 33,523 | (473 | ) | (1.4 | )% | ||||||||||
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| Total finance receivables | $ | 817,463 | $ | 717,775 | $ | 99,688 | 13.9 | % | ||||||||
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| Number of branches at period end | 342 | 339 | 3 | 0.9 | % | |||||||||||
| Average finance receivables per branch | $ | 2,390 | $ | 2,117 | $ | 273 | 12.9 | % | ||||||||
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Comparison of the Year Ended December 31, 2017, Versus the Year Ended December 31, 2016
Net Income. Net income increased $5.9 million, or 24.7%, to $30.0 million in 2017, from $24.0 million in 2016. The increase was primarily due to an increase in revenue of $31.9 million and a decrease in income taxes
Regional Management Corp. | 2018 Annual Report on Form 10-K | 59
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of $4.6 million, offset by an increase in provision for credit losses of $14.3 million, an increase in general and administrative expenses of $12.3 million, and an increase in interest expense of $4.0 million.
Revenue. Total revenue increased $31.9 million, or 13.3%, to $272.5 million in 2017, from $240.5 million in 2016. The components of revenue are explained in greater detail below.
Interest and Fee Income. Interest and fee income increased $28.1 million, or 12.7%, to $249.0 million in 2017, from $221.0 million in 2016. The increase was primarily due to a 13.2% increase in average finance receivables, offset by a 0.1% yield decrease.
The following table sets forth the average finance receivables balance and average yield for each of our loan products:
| Average Finance Receivables for the Year Ended | Average Yields for the Year Ended | |||||||||||||||||||||||
| In thousands | December 31, 2017 | December 31, 2016 | YoY % Inc (Dec) | December 31, 2017 | December 31, 2016 | YoY % Inc (Dec) | ||||||||||||||||||
| Small loans | $ | 355,826 | $ | 334,152 | 6.5 | % | 42.2 | % | 42.5 | % | (0.3 | )% | ||||||||||||
| Large loans | 278,397 | 190,855 | 45.9 | % | 28.8 | % | 28.8 | % | 0.0 | % | ||||||||||||||
| Automobile loans | 78,317 | 102,023 | (23.2 | )% | 16.3 | % | 17.7 | % | (1.4 | )% | ||||||||||||||
| Retail loans | 31,660 | 30,321 | 4.4 | % | 18.8 | % | 19.2 | % | (0.4 | )% | ||||||||||||||
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| Total interest and fee yield | $ | 744,200 | $ | 657,351 | 13.2 | % | 33.5 | % | 33.6 | % | (0.1 | )% | ||||||||||||
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Small loan yields decreased 0.3% compared to 2016 as more of our small loan customers originated loans with larger balances and longer maturities, which typically are priced at lower interest rates. Automobile loan yields decreased 1.4% compared to 2016 due to our revised pricing model for our automobile loan program. Retail loan yields decreased 0.4% compared to 2016 as a result of adjusted pricing that reflected market conditions.
The following table represents the amount of loan originations and refinancing, net of unearned finance charges:
| Net Loans Originated for the Year Ended | ||||||||||||||||
| In thousands | December 31, 2017 | December 31, 2016 | YoY $ Inc (Dec) | YoY % Inc (Dec) | ||||||||||||
| Small loans | $ | 573,858 | $ | 580,936 | $ | (7,078 | ) | (1.2 | )% | |||||||
| Large loans | 355,931 | 250,862 | 105,069 | 41.9 | % | |||||||||||
| Automobile loans | 20,331 | 37,038 | (16,707 | ) | (45.1 | )% | ||||||||||
| Retail loans | 28,885 | 34,629 | (5,744 | ) | (16.6 | )% | ||||||||||
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| Total net loans originated | $ | 979,005 | $ | 903,465 | $ | 75,540 | 8.4 | % | ||||||||
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The hurricanes that impacted our branches in August 2017 had an estimated $3.0 million negative impact on loan originations during 2017. We believe that the small loan portfolio experienced most of this impact.
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The following table summarizes the components of the increase in interest and fee income:
| Components of Increase in Interest and Fee Income Year Ended December 31, 2017 Compared to Year Ended December 31, 2016 Increase (Decrease) | ||||||||||||||||
| In thousands | Volume | Rate | Volume & Rate | Net | ||||||||||||
| Small loans | $ | 9,215 | $ | (1,165 | ) | $ | (75 | ) | $ | 7,975 | ||||||
| Large loans | 25,220 | 54 | 24 | 25,298 | ||||||||||||
| Automobile loans | (4,205 | ) | (1,480 | ) | 344 | (5,341 | ) | |||||||||
| Retail loans | 257 | (113 | ) | (5 | ) | 139 | ||||||||||
| Product mix | (1,293 | ) | 1,712 | (419 | ) | — | ||||||||||
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| Total increase in interest and fee income | $ | 29,194 | $ | (992 | ) | $ | (131 | ) | $ | 28,071 | ||||||
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The $28.1 million increase in interest and fee income in 2017 compared to 2016 was primarily driven by finance receivables growth, offset by a decrease in yield, as illustrated in the table above.
Insurance Income, Net. Insurance income, net increased $3.6 million, or 38.1%, to $13.1 million in 2017, from $9.5 million in 2016. Insurance income, net represented 1.8% and 1.4% of average finance receivables in 2017 and 2016, respectively. During 2017 and 2016, personal property insurance premiums represented the largest component of aggregate earned insurance premiums and non-file insurance claims expenses represented the largest component of direct insurance expenses.
The following table summarizes the components of insurance income, net:
| Insurance Premiums and Direct Expenses for the Year Ended | ||||||||||||||||
| In thousands | December 31, 2017 | December 31, 2016 | YoY $ B(W) | YoY % B(W) | ||||||||||||
| Earned premiums | $ | 25,860 | $ | 23,191 | $ | 2,669 | 11.5 | % | ||||||||
| Claims, reserves, and certain direct expenses | (12,799 | ) | (13,735 | ) | 936 | 6.8 | % | |||||||||
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| Insurance income, net | $ | 13,061 | $ | 9,456 | $ | 3,605 | 38.1 | % | ||||||||
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In 2017, earned premiums increased by $2.7 million and claims, reserves, and certain direct expenses decreased by $0.9 million, in each case compared to 2016. The increase in earned premiums was primarily due to loan growth. The decrease in claims, reserves, and certain direct expenses was primarily due to a transition in insurance carriers that caused $4.4 million of insurance claims to impact net credit losses instead of insurance income, offset by an increase in claims expense.
Other Income. Other income, which consisted primarily of late charges, increased $0.3 million, or 2.6%, to $10.4 million in 2017, from $10.1 million in 2016. Other income represented 1.3% of average finance receivables in 2017, compared to 1.6% of average finance receivables in 2016, with the decrease primarily due to large loans (with higher credit quality and fewer late fee charges) becoming a greater percentage of our total loan portfolio in 2017. Our most significant driver for other income is average active accounts. Average active accounts increased 3.0% in 2017, while average finance receivables increased 13.2%.
Provision for Credit Losses. Our provision for credit losses increased $14.3 million, or 22.7%, to $77.3 million in 2017, from $63.0 million in 2016. The increase was due to an increase in net credit losses of $10.5 million and a $3.9 million increase in the allowance for credit losses compared to 2016. The provision for credit losses represented 10.4% of average finance receivables in 2017 compared to 9.6% of average finance receivables in 2016. Fiscal 2017 included a 0.4% impact from the net $2.9 million hurricane-related provision and a 0.6% impact from the shift of $4.4 million in insurance claims into net credit losses during a transition in our insurance provider, offset by a 0.1% benefit from the $1.0 million 2017 Bulk Sale.
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The increase in the provision for credit losses is explained in greater detail below.
Hurricane Impact. During 2017, our provision for credit losses was impacted by a $3.0 million increase in the allowance for credit losses related to estimated incremental credit losses on customer accounts impacted by hurricanes. In late 2017, we released $0.2 million of the hurricane allowance for credit losses to cover hurricane-related net credit losses. As of December 31, 2017, the allowance for credit losses related to the hurricanes was $2.8 million.
Bulk Sale. We recognized a recovery of $1.0 million from the 2017 Bulk Sale. These accounts were excluded from prior sales of charged-off loans.
Net Credit Losses. Net credit losses increased $10.5 million, or 17.7%, to $69.7 million in 2017, from $59.2 million in 2016. The increase was primarily due to an $86.8 million increase in average finance receivables in 2017 and a shift of $4.4 million in insurance claims into net credit losses during a transition in our insurance provider, offset by the recovery of $1.0 million from the 2017 Bulk Sale. Net credit losses as a percentage of average finance receivables were 9.4% in 2017 compared to 9.0% in 2016. Fiscal 2017 included 0.6% from the shift of $4.4 million in insurance claims into net credit losses and a 0.1% benefit from the $1.0 million 2017 Bulk Sale. To improve future net credit losses, we reduced lending to specific underperforming segments of our customer base in 2017.
The following table provides net credit losses and the benefit to net credit losses associated with non-file insurance claims payments as a percentage of average finance receivables for the periods indicated:
| Non-File Insurance Impact on Net Credit Loss Rates for the Year Ended | ||||||||
| December 31, 2017 | December 31, 2016 | |||||||
| Net credit losses | 9.4 | % | 9.0 | % | ||||
| Non-file benefit | 0.8 | % | 1.4 | % | ||||
Delinquency Performance. Contractual delinquency as a percentage of total finance receivables increased to 7.5% (inclusive of an increase of 0.3% attributable to the impact of the hurricanes) on December 31, 2017, from 7.4% as of December 31, 2016. Along with the impact from the hurricanes, our delinquency results were also elevated due to our loan management system conversion in Texas, which was completed in October 2017. The delinquency increases from the loan management system conversions were temporary and only impacted the two to three months immediately following the loan management system conversion.
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The following tables include delinquency balances by aging category and by product:
| Contractual Delinquency by Aging | ||||||||||||||||
| In thousands | December 31, 2017 | December 31, 2016 | ||||||||||||||
| Allowance for credit losses | $ | 48,910 | 6.0 | % | $ | 41,250 | 5.7 | % | ||||||||
| Current | 669,451 | 81.9 | % | 587,202 | 81.9 | % | ||||||||||
| 1 to 29 days past due | 86,533 | 10.6 | % | 77,106 | 10.7 | % | ||||||||||
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| Delinquent accounts: | ||||||||||||||||
| 30 to 59 days | 18,728 | 2.2 | % | 16,727 | 2.3 | % | ||||||||||
| 60 to 89 days | 15,297 | 1.9 | % | 11,641 | 1.6 | % | ||||||||||
| 90 to 119 days | 11,339 | 1.4 | % | 10,021 | 1.4 | % | ||||||||||
| 120 to 149 days | 8,865 | 1.1 | % | 8,205 | 1.1 | % | ||||||||||
| 150 to 179 days | 7,250 | 0.9 | % | 6,873 | 1.0 | % | ||||||||||
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| Total contractual delinquency | $ | 61,479 | 7.5 | % | $ | 53,467 | 7.4 | % | ||||||||
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| Total finance receivables | $ | 817,463 | 100.0 | % | $ | 717,775 | 100.0 | % | ||||||||
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| Contractual Delinquency by Product | ||||||||||||||||
| In thousands | December 31, 2017 | December 31, 2016 | ||||||||||||||
| Small loans | $ | 35,246 | 9.4 | % | $ | 32,955 | 9.2 | % | ||||||||
| Large loans | 18,540 | 5.3 | % | 12,114 | 5.1 | % | ||||||||||
| Automobile loans | 4,896 | 8.0 | % | 6,300 | 7.0 | % | ||||||||||
| Retail loans | 2,797 | 8.5 | % | 2,098 | 6.3 | % | ||||||||||
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| Total contractual delinquency | $ | 61,479 | 7.5 | % | $ | 53,467 | 7.4 | % | ||||||||
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Allowance for Credit Losses. We evaluate delinquency and losses in each of our loan categories in establishing the allowance for credit losses. The following table sets forth our allowance for credit losses compared to the related finance receivables as of the end of the periods indicated:
| December 31, 2017 | December 31, 2016 | |||||||||||||||||||||||
| In thousands | Finance Receivables | Allowance for Credit Losses | Allowance as a Percentage of Finance Receivables | Finance Receivables | Allowance for Credit Losses | Allowance as a Percentage of Finance Receivables | ||||||||||||||||||
| Small loans | $ | 375,772 | $ | 24,749 | 6.6 | % | $ | 358,471 | $ | 21,770 | 6.1 | % | ||||||||||||
| Large loans | 347,218 | 17,548 | 5.1 | % | 235,349 | 11,460 | 4.9 | % | ||||||||||||||||
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| Total core loans | 722,990 | 42,297 | 5.9 | % | 593,820 | 33,230 | 5.6 | % | ||||||||||||||||
| Automobile loans | 61,423 | 4,025 | 6.6 | % | 90,432 | 5,910 | 6.5 | % | ||||||||||||||||
| Retail loans | 33,050 | 2,588 | 7.8 | % | 33,523 | 2,110 | 6.3 | % | ||||||||||||||||
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| Total | $ | 817,463 | $ | 48,910 | 6.0 | % | $ | 717,775 | $ | 41,250 | 5.7 | % | ||||||||||||
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The allowance as a percentage of finance receivables increased to 6.0% as of December 31, 2017, from 5.7% as of December 31, 2016. The increase was primarily due to the $2.8 million remaining allowance for credit losses on customer accounts impacted by the hurricanes.
General and Administrative Expenses. Our general and administrative expenses, comprising expenses for personnel, occupancy, marketing, and other expenses, increased $12.3 million, or 10.4%, to $131.0 million in 2017 from $118.6 million in 2016. Our receivable efficiency ratio (general and administrative expenses as a percentage of average finance receivables) decreased to 17.6% during 2017 from 18.0% in 2016. The absolute dollar increase in general and administrative expenses is explained in greater detail below.
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Personnel. The largest component of general and administrative expenses is personnel expense, which increased $7.0 million, or 10.2%, to $76.0 million in 2017 from $69.0 million in 2016. The increase was primarily due to a $1.7 million increase from added headcount in our information technology department, $1.2 million in costs related to building the centralized late-stage collections department, a $2.1 million increase in branch costs to effectively service active account growth since December 31, 2016, and a $1.7 million increase in incentive compensation expense primarily due to the 2017 annual grant of awards under our long-term incentive plan, which have three-year performance targets.
Occupancy. Occupancy expenses increased $1.5 million, or 7.3%, to $21.5 million in 2017 from $20.1 million in 2016. The increase was due to costs related to the opening of 3 net new branches since December 31, 2016, branch relocations, and expenses associated with a larger home office building. Additionally, we frequently experience increases in rent, leasehold improvements, and computer equipment as we renew existing branch leases.
Marketing. Marketing expenses increased $0.3 million, or 4.3%, to $7.1 million in 2017 from $6.8 million in 2016. The increase was due to more convenience check mailings, increased direct mail to existing customers, and expanded digital marketing, partially offset by increased efficiencies in the direct mail campaigns.
Other Expenses. Other expenses increased $3.5 million, or 15.6%, to $26.3 million in 2017 from $22.8 million in 2016. The increase was primarily due to a $0.9 million increase in collection expenses, a $0.9 million increase due to training costs and amortization related to our loan management system, a $0.9 million increase in electronic payment processing costs, and a $0.8 million increase in various costs related to finance receivable growth (office supplies, travel costs, training expense, and credit bureau costs) since December 31, 2016.
Interest Expense. Interest expense on long-term debt increased $4.0 million, or 20.0%, to $23.9 million in 2017 from $19.9 million in 2016. The increase was primarily due to increases in the average balance of our long-term debt facilities from finance receivable growth, an increase in interest rates, an increase in unused line fees, and additional debt issuance cost amortization related to both the amended senior revolving credit facility and our warehouse credit facility. The average cost of our combined revolving credit facilities increased 0.21% to 4.73% in 2017 from 4.52% in 2016.
Income Taxes. Income taxes decreased $4.6 million, or 31.0%, to $10.3 million in 2017 from $14.9 million in 2016. The decrease was primarily due to a $3.1 million reduction of a net deferred tax liability as a result of the Tax Act, $1.6 million in tax benefits related to the exercise and vesting of share-based awards, and $0.4 million in tax benefits related to research and development tax credits, offset by an increase in income before income taxes of $1.3 million. In December 2017, the Tax Act was signed into law. This legislation makes changes to U.S. tax law, including a reduction in the corporate tax rate from 35% to 21%. As a result of the enacted law, we were required to revalue deferred tax assets and liabilities at the enacted rate. This revaluation resulted in a benefit of $3.1 million to income tax expense and a corresponding reduction in the deferred tax liability.
Our effective tax rates were 25.6% and 38.3% in 2017 and 2016, respectively. The reduction of the net deferred tax liability decreased the 2017 effective tax rate by 7.8%. The tax benefits related to the exercise and vesting of share-based awards and research and development tax credits reduced the 2017 effective tax rate by 4.0% and 1.0%, respectively.
Liquidity and Capital Resources
Our primary cash needs relate to the funding of our lending activities and, to a lesser extent, expenditures relating to improving our technology infrastructure and expanding and maintaining our branch locations. In
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connection with our plans to improve our technology infrastructure and to expand our branch network in future years, we expect to incur approximately $9.0 million to $12.0 million of expenditures annually. We have historically financed, and plan to continue to finance, our short-term and long-term operating liquidity and capital needs through a combination of cash flows from operations and borrowings under our senior revolving credit facility, revolving warehouse credit facility, amortizing loan, and, more recently, asset-backed securitization transactions, all of which are described below. We had a debt-to-equity ratio of 2.4 to 1.0 and a shareholder equity ratio of 29.2% as of December 31, 2018.
We believe that cash flow from our operations and borrowings under our long-term debt facilities will be adequate to fund our business for the next twelve months, including initial operating losses of new branches and finance receivable growth of new and existing branches. From time to time, we have extended the maturity date of and increased the borrowing limits under our senior revolving credit facility. While we have successfully obtained such extensions and increases in the past, there can be no assurance that we will be able to do so if and when needed in the future. In addition, the revolving periods of our warehouse credit facility, RMIT 2018-1 securitization, and RMIT 2018-2 securitization (each as described below) end in February 2020, June 2020, and December 2020, respectively. There can be no assurance that we will be able to secure an extension of the warehouse credit facility or close additional securitization transactions if and when needed in the future.
We are continuing to seek ways to diversify our long-term funding sources, though new funding sources may be more expensive than our existing funding sources.
Cash Flow.
Operating Activities. Net cash provided by operating activities increased by $30.9 million, or 26.7%, to $146.3 million in 2018, from $115.4 million in 2017. The increase was primarily due to the growth in our business described above, which produced an increase in net income, before provision for credit losses.
Investing Activities. Investing activities consist of originations and purchases of finance receivables, purchases of intangible assets, and purchases of property and equipment for new and existing branches. Net cash used in investing activities in 2018 was $199.2 million, compared to $179.9 million in 2017, a net increase of $19.3 million. The increase in cash used was primarily due to increased net originations of finance receivables.
Financing Activities. Financing activities consist of borrowings and payments on our outstanding indebtedness and issuances of common stock. In 2018, net cash provided by financing activities was $81.1 million, an increase of $7.3 million compared to $73.8 million in 2017. The increase was primarily a result of advances on the RMIT 2018-1 and RMIT 2018-2 securitizations of $150.2 million and $130.4 million, respectively. The increase was partially offset by an increase in net payments on debt and debt issuance costs of $274.2 million.
Financing Arrangements.
Senior Revolving Credit Facility. In June 2017, we amended and restated our senior revolving credit facility to, among other things, increase the availability under the facility from $585 million to $638 million and extend the maturity of the facility from August 2019 to June 2020. The facility has an accordion provision that allows for the expansion of the facility to $700 million. Excluding the receivables held by our variable interest entities (each, a “VIE”), the senior revolving credit facility is secured by substantially all of our finance receivables and equity interests of the majority of our subsidiaries. Advances on the senior revolving credit facility are capped at 85% of eligible secured finance receivables and 70% of eligible unsecured finance receivables. These advance rates are subject to adjustment at certain credit quality levels (81% of eligible secured finance receivables and 66% of eligible unsecured finance receivables as of December 31, 2018). As of December 31, 2018, we had $68.6 million of eligible borrowing capacity under the facility. Borrowings under the facility bear interest, payable monthly, at rates equal to LIBOR of a maturity we elect between one and six
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months (one-month LIBOR was 2.50% as of December 31, 2018), with a LIBOR floor of 1.00%, plus a 3.00% margin, increasing to 3.25% when the availability percentage is below 10%. Alternatively, we may pay interest at the prime rate (5.50% as of December 31, 2018) plus a 2.00% margin, increasing to 2.25% when the availability percentage is below 10%. We also pay an unused line fee of 0.50% per annum, payable monthly. This fee decreases to 0.375% when the average outstanding balance exceeds $413.0 million.
Our long-term debt under the senior revolving credit facility was $328.1 million as of December 31, 2018. A year or more in advance of its June 2020 maturity date, we intend to extend the maturity date of the amended and restated senior revolving credit facility or take other appropriate action to address repayment upon maturity. See Part I, Item 1A, “Risk Factors” for a discussion of risks related to our amended and restated senior revolving credit facility, including refinancing risk.
Variable Interest Entity Debt. As part of our overall funding strategy, we have transferred certain finance receivables to affiliated VIEs for asset-backed financing transactions, including securitizations. The following debt arrangements are issued by our wholly-owned, bankruptcy-remote, special purpose entities (each, an “SPE”), which are considered VIEs under GAAP and are consolidated into the financial statements of their primary beneficiary. We are considered to be the primary beneficiary because we have (i) power over the significant activities through our role as servicer of the finance receivables under each debt arrangement and (ii) the obligation to absorb losses or the right to receive returns that could be significant through our interest in the monthly residual cash flows of the SPEs after each debt is paid.
These long-term debts are supported by the expected cash flows from the underlying collateralized finance receivables. Collections on these finance receivables are remitted to restricted cash collection accounts, which totaled $33.5 million and $8.6 million as of December 31, 2018 and 2017, respectively. Cash inflows from the finance receivables are distributed to the lenders/investors, the service providers, and/or the residual interest that we own in accordance with a monthly contractual priority of payments. The SPEs pay a servicing fee to us, which is eliminated in consolidation. Distributions from the SPEs to us are permitted under the debt arrangements.
At each sale of receivables from our affiliates to the SPEs, we make certain representations and warranties about the quality and nature of the collateralized receivables. The debt arrangements require us to repurchase the receivables in certain circumstances, including circumstances in which the representations and warranties made by us concerning the quality and characteristics of the receivables are inaccurate. Assets transferred to SPEs are legally isolated from us and our affiliates, as well as the claims of our and our affiliates’ creditors. Further, the assets of each SPE are owned by such SPE and are not available to satisfy the debts or other obligations of us or any of our affiliates. See Part I, Item 1A, “Risk Factors” for a discussion of risks related to our variable interest entity debt.
Amortizing Loan. In November 2017, we and our wholly-owned SPE, Regional Management Receivables, LLC (“RMR I”), amended and restated the December 2015 credit agreement that provided for a $75.7 million asset-backed, amortizing loan. The amended and restated credit agreement provided for an additional advance in the amount of $37.8 million and extended the maturity date to December 2024. The debt is secured by finance receivables and other related assets that we purchased from our affiliates, which we then sold and transferred to RMR I. Advances on the loan were capped at 88% of eligible finance receivables. RMR I held $1.3 million in restricted cash reserves as of December 31, 2018 to satisfy provisions of the credit agreement. Borrowings previously bore interest, payable monthly, at a rate of 3.00%. In February 2018, the advance rate lowered to 85% and the interest rate increased to 3.25%. The credit agreement allows us to prepay the loan when the outstanding balance falls below 20% of the original loan amount. As of December 31, 2018, our long-term debt under the credit agreement was $21.6 million.
Revolving Warehouse Credit Facility. In August 2018, we and our wholly-owned SPE, Regional Management Receivables II, LLC (“RMR II”), amended the June 2017 credit agreement that provides for a
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$125 million revolving warehouse credit facility to RMR II. The amendment extended the date at which the facility converts to an amortizing loan and the termination date to February 2020 and February 2021, respectively. The facility has an accordion provision that allows for the expansion of the facility to $150 million. We elected to expand the facility to $150 million from May 2018 to August 2018. The debt is secured by finance receivables and other related assets that we purchased from our affiliates, which we then sold and transferred to RMR II. Advances on the facility are capped at 80% of eligible finance receivables. Borrowings under the facility previously bore interest, payable monthly, at a blended rate equal to three-month LIBOR, plus a margin of 3.50%. In October 2017 and February 2018, the margin decreased to 3.25% and 3.00%, respectively, following the satisfaction of milestones associated with our conversion to a new loan origination and servicing system. The August 2018 amendment to the credit agreement decreased the margin to 2.20%. The three-month LIBOR was 2.81% and 1.69% at December 31, 2018 and 2017, respectively. RMR II pays an unused commitment fee of between 0.35% and 0.85% based upon the average daily utilization of the facility. We intend to seek an extension of the maturity date of the facility before February 2020. As of December 31, 2018, our long-term debt under the credit facility was $30.1 million.
RMIT 2018-1 Securitization. In June 2018, we, our wholly-owned SPE, Regional Management Receivables III, LLC (“RMR III”), and our indirect wholly-owned SPE, Regional Management Issuance Trust 2018-1 (“RMIT 2018-1”), completed a private offering and sale of $150 million of asset-backed notes. The transaction consisted of the issuance of three classes of fixed-rate asset-backed notes by RMIT 2018-1. The asset-backed notes are secured by finance receivables and other related assets that RMR III purchased from us, which RMR III then sold and transferred to RMIT 2018-1. The notes have a revolving period ending in June 2020, with a final maturity date in July 2027. Borrowings under the RMIT 2018-1 securitization bear interest, payable monthly, at a weighted-average rate of 3.93%. Prior to maturity in July 2027, we may redeem the notes in full, but not in part, at our option on any note payment date on or after the payment date occurring in July 2020. No payments of principal of the notes will be made during the revolving period. As of December 31, 2018, our long-term debt under the securitization was $150.2 million.
RMIT 2018-2 Securitization. In December 2018, we, our wholly-owned SPE, RMR III, and our indirect wholly-owned SPE, Regional Management Issuance Trust 2018-2 (“RMIT 2018-2”), completed a private offering and sale of $130 million of asset-backed notes. The transaction consisted of the issuance of four classes of fixed-rate asset-backed notes by RMIT 2018-2. The asset-backed notes are secured by finance receivables and other related assets that RMR III purchased from us, which RMR III then sold and transferred to RMIT 2018-2. The notes have a revolving period ending in December 2020, with a final maturity date in January 2028. Borrowings under the RMIT 2018-2 securitization bear interest, payable monthly, at a weighted-average rate of 4.87%. Prior to maturity in January 2028, we may redeem the notes in full, but not in part, at our option on any note payment date on or after the payment date occurring in January 2021. No payments of principal of the notes will be made during the revolving period. As of December 31, 2018, our long-term debt under the securitization was $130.4 million.
Our debt arrangements are subject to certain covenants, including monthly and annual reporting, maintenance of specified interest coverage and debt ratios, restrictions on distributions, limitations on other indebtedness, maintenance of a minimum allowance for credit losses, and certain other restrictions. At December 31, 2018, we were in compliance with all debt covenants.
We expect that the LIBOR reference rate will be phased out by the end of 2021. Both our senior revolving credit facility and revolving warehouse credit facility use LIBOR as a benchmark in determining the cost of funds borrowed. We plan to work with our banking partners to modify our credit agreements to contemplate the cessation of the LIBOR reference rate. We will also work to identify a replacement rate to LIBOR and look to adjust the pricing structure of our facilities as needed.
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Restricted Cash Reserve Accounts.
Amortizing Loan. As required under the credit agreement governing the amortizing loan, we deposited $3.7 million of cash proceeds into a restricted cash reserve account at closing. The reserve requirement decreased to $1.7 million in June 2016 following our satisfaction of certain provisions of the credit agreement. The credit agreement was amended and restated in November 2017 with a cash reserve requirement of $1.3 million, which will remain until the termination of the facility. The amortizing loan is supported by the expected cash flows from the underlying collateralized finance receivables. Collections are remitted to a restricted cash collection account, which totaled $1.1 million as of December 31, 2018.
Revolving Warehouse Credit Facility. The credit agreement governing the revolving warehouse credit facility requires that we maintain a 1% cash reserve based upon the ending finance receivables balance of the facility. As of December 31, 2018, the warehouse facility cash reserve requirement totaled $1.6 million. The warehouse facility is supported by the expected cash flows from the underlying collateralized finance receivables. Collections are remitted to a restricted cash collection account, which totaled $1.8 million as of December 31, 2018.
RMIT 2018-1 Securitization. As required under the transaction documents governing the RMIT 2018-1 securitization, we deposited $1.7 million of cash proceeds into a restricted cash reserve account at closing. The securitization is supported by the expected cash flows from the underlying collateralized finance receivables. Collections are remitted to a restricted cash collection account, which totaled $14.5 million as of December 31, 2018.
RMIT 2018-2 Securitization. As required under the transaction documents governing the RMIT 2018-2 securitization, we deposited $1.4 million of cash proceeds into a restricted cash reserve account at closing. The securitization is supported by the expected cash flows from the underlying collateralized finance receivables. Collections are remitted to a restricted cash collection account, which totaled $16.2 million as of December 31, 2018.
RMC Reinsurance. Our wholly-owned subsidiary, RMC Reinsurance, Ltd., is required to maintain cash reserves ($7.1 million as of December 31, 2018) against life insurance policies ceded to it, as determined by the ceding company, and has also purchased a $0.1 million cash-collateralized letter of credit in favor of the ceding company.
Interest Rate Caps.
As a component of our strategy to manage the interest rate risk associated with future interest payments on our variable-rate debt, we have purchased interest rate cap contracts. As of December 31, 2018, we held four interest rate cap contracts with an aggregate notional principal amount of $400.0 million. The interest rate caps have maturities of March 2019 ($50.0 million, 2.50% strike rate), April 2020 ($100.0 million, 3.25% strike rate), June 2020 ($50.0 million, 2.50% strike rate), and April 2021 ($200.0 million, 3.50% strike rate). As of December 31, 2018, the one-month LIBOR was 2.50%. When the one-month LIBOR exceeds the strike rate, the counterparty reimburses us for the excess over the strike rate. No payment is required by us or the counterparty when the one-month LIBOR is below the strike rate.
Off-Balance Sheet Arrangements
Our wholly-owned subsidiary, RMC Reinsurance, Ltd., is required to maintain cash reserves against life insurance policies ceded to it, as determined by the ceding company. As of December 31, 2018, the cash reserves were $7.1 million. We have also purchased a cash collateralized letter of credit in favor of the ceding company. As of December 31, 2018, the letter of credit was $0.1 million.
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Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2018, and the effect such obligations are expected to have on our liquidity and cash flows in future periods.
| Payments Due by Period | ||||||||||||||||||||
| In thousands | Total | Less than 1 Year | 1 – 3 Years | 3 – 5 Years | More than 5 Years | |||||||||||||||
| Principal payments on long-term debt obligations | $ | 660,507 | $ | 13,954 | $ | 578,786 | $ | 67,767 | $ | — | ||||||||||
| Interest payments on long-term debt obligations | 64,184 | 35,006 | 27,547 | 1,631 | — | |||||||||||||||
| Operating lease obligations | 29,699 | 6,814 | 10,862 | 6,701 | 5,322 | |||||||||||||||
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| Total | $ | 754,390 | $ | 55,774 | $ | 617,195 | $ | 76,099 | $ | 5,322 | ||||||||||
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Impact of Inflation
Our results of operations and financial condition are presented based on historical cost, except for interest rate caps, which are carried at fair value. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our results of operations and financial condition have been immaterial.
Critical Accounting Policies
Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP and conform to general practices within the consumer finance industry. The preparation of these financial statements requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and disclosure of contingent assets and liabilities for the periods indicated in the financial statements. Management bases estimates on historical experience and other assumptions it believes to be reasonable under the circumstances and evaluates these estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.
We set forth below those material accounting policies that we believe are the most critical to an understanding of our financial results and condition and that involve a higher degree of complexity and management judgment.
Credit Losses.
Provisions for credit losses are charged to income as losses are estimated to have occurred and in amounts sufficient to maintain an allowance for credit losses at an adequate level to provide for future losses on our finance receivables. We charge credit losses against the allowance when the account becomes 180 days delinquent, subject to certain exceptions. Our policy for non-titled accounts in a confirmed bankruptcy is to charge them off at 60 days delinquent, subject to certain exceptions. Deceased borrower accounts are charged off in the month following the proper notification of passing, with the exception of borrowers with credit life insurance. Subsequent recoveries, if any, are credited to the allowance. Loss experience, the loss emergence period, contractual delinquency of finance receivables by loan type, the value of underlying collateral, and management’s judgment are factors used in assessing the overall adequacy of the allowance and the resulting provision for credit losses. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or loan portfolio performance. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revisions as more information becomes available.
We initiate repossession proceedings when, in the opinion of management, the customer is unlikely to make further payments. We sell substantially all repossessed vehicle inventory through sales conducted by
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independent automobile auction organizations after the required post-repossession waiting period. Losses on the sale of repossessed collateral are charged to the allowance for credit losses.
The allowance for credit losses consists of general and specific components. The general component of the allowance estimates credit losses for groups of finance receivables on a collective basis and relates to probable incurred losses of unimpaired finance receivables. Prior to September 30, 2016, the general component of the allowance was primarily based on historical loss rates. Effective September 30, 2016, it is based on delinquency roll rates. Our finance receivable types are stratified by delinquency stages, and the future monthly delinquency profiles and credit losses are projected forward using historical delinquency roll rates. We record a general allowance for credit losses that includes forecasted future credit losses over the estimated loss emergence period (the interval of time between the event which caused a borrower to default and our recording of the credit loss) for each finance receivable type.
We adjust the computed roll rate forecast as described above for qualitative factors based on an assessment of internal and external influences on credit quality that are not fully reflected in the roll rate forecast. Those qualitative factors include trends in growth in the loan portfolio, delinquency, unemployment, bankruptcy, operational risks, and other economic trends.
The specific component of the allowance for credit losses relates to impaired finance receivables, which include accounts for which a customer has initiated a bankruptcy filing and finance receivables that have been modified under our loss mitigation policies. Finance receivables that have been modified are accounted for as troubled debt restructurings. At the time of the bankruptcy filing or restructuring pursuant to a loss mitigation policy, a specific valuation allowance is established for such finance receivables within the allowance for credit losses. We compute the estimated loss on our impaired loans by discounting the projected cash flows at the original contract rates on the loan using the terms imposed by the bankruptcy court or restructured by us. This method is applied in the aggregate to each of our four classes of loans. In making the computations of the present value of cash payments to be received on impaired accounts in each product category, we use the weighted-average interest rates and weighted-average remaining term based on data as of each balance sheet date.
For customers in a confirmed Chapter 13 bankruptcy plan, we reduce the interest rate to that specified in the bankruptcy order and we receive payments with respect to the remaining amount of the loan from the bankruptcy trustee. For customers who recently filed for Chapter 13 bankruptcy, we generally do not receive any payments until their bankruptcy plan is confirmed by the court. If the customers have made payments to the trustee in advance of plan confirmation, we may receive a lump sum payment from the trustee once the plan is confirmed. This lump sum payment represents our pro-rata share of the amount paid by the customer. If a customer fails to comply with the terms of the bankruptcy order, we will petition the trustee to have the customer dismissed from bankruptcy. Upon dismissal, we restore the account to the original terms and pursue collection through our normal loan servicing activities.
If a customer files for bankruptcy under Chapter 7 of the bankruptcy code, the bankruptcy court has the authority to cancel the customer’s debt. If a vehicle secures a Chapter 7 bankruptcy account, the customer has the option of surrendering the vehicle, buying the vehicle at fair value, or reaffirming the loan and continuing to pay the loan.
The FASB issued an accounting update in June 2016 to change the impairment model for estimating credit losses on financial assets. The current incurred loss impairment model requires the recognition of credit losses when it is probable that a loss has been incurred. The incurred loss model will be replaced by an expected loss model, which requires entities to estimate the lifetime expected credit loss on such instruments and to record an allowance to offset the amortized cost basis of the financial asset. This update is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted. We believe the implementation of the accounting update will have a material adverse effect on our consolidated financial statements, and we are in the process of quantifying the potential impacts.
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Income Recognition.
Interest income is recognized using the interest method (constant yield method). Therefore, we recognize revenue from interest at an equal rate over the term of the loan. Unearned finance charges on pre-compute contracts are rebated to customers utilizing statutory methods, which in many cases is the sum-of-the-years’ digits method. The difference between income recognized under the constant yield method and the statutory method is recognized as an adjustment to interest income at the time of rebate. Accrual of interest income on finance receivables is suspended when an account becomes 90 days delinquent. If the account is charged off, the accrued interest income is reversed as a reduction of interest and fee income.
We recognize income on credit life insurance, credit property insurance, and automobile insurance using the sum-of-the-years’ digits or straight-line methods over the terms of the policies. We recognize income on credit accident and health insurance using the average of the sum-of-the-years’ digits and the straight-line methods over the terms of the policies. We recognize income on credit involuntary unemployment insurance using the straight-line method over the terms of the policies. Rebates are computed using statutory methods, which in many cases match the GAAP method, and where it does not match, the difference between the GAAP method and the statutory method is recognized in income at the time of rebate. Fee income for non-file insurance is recognized using the sum-of-the-years’ digits method over the loan term.
We deferred fees charged to automobile dealers and recognize income using the constant yield method for indirect loans and the straight-line method for direct loans over the lives of the respective loans.
Charges for late fees are recognized as income when collected.
Share-Based Compensation.
We measure compensation cost for share-based awards at estimated fair value and recognize compensation expense over the service period for awards expected to vest. We use the closing stock price on the date of grant as the fair value of restricted stock awards. The fair value of stock options is determined using the Black-Scholes valuation model. The Black-Scholes model requires the input of highly subjective assumptions, including expected volatility, risk-free interest rate, and expected life, changes to which can materially affect the fair value estimate. We estimate volatility using our historical stock prices. The risk-free rate is based on the zero coupon U.S. Treasury bond rate for the expected term of the award on the grant date. The expected term is calculated by using the simplified method (average of the vesting and original contractual terms) due to insufficient historical data to estimate the expected term. In addition, the estimation of share-based awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised.
Income Taxes.
We record a tax provision for the anticipated tax consequences of our reported operating results. The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effects of future tax rate changes are recognized in the period when the enactment of new rates occurs.
We recognize the financial statement effects of a tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination. The tax benefits of the position recognized in the consolidated financial statements are then measured based on the largest amount of benefit that is greater than 50% likely to be realized upon settlement with a taxing authority. As of December 31, 2018, we had not taken any tax position that exceeds the amount described above.
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Pursuant to the adoption of an accounting standard update issued in March 2016 and effective beginning in fiscal year 2017, we recognize the tax benefits or deficiencies from the exercise or vesting of share-based awards in the income tax line of our consolidated statements of income. These tax benefits and deficiencies were previously recognized within additional paid-in-capital on our consolidated balance sheet.
Recently Issued Accounting Standards
See Note 2, “Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data” for a discussion of recently issued accounting pronouncements, including information on new accounting standards and the future adoption of such standards.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk
Interest rate risk arises from the possibility that changes in interest rates will affect our results of operations and financial condition. We originate finance receivables at either prevailing market rates or at statutory limits. Our finance receivables are structured on a fixed rate, fixed term basis. Accordingly, subject to statutory limits, our ability to react to changes in prevailing market rates is dependent upon the speed at which our customers pay off or renew loans in our existing loan portfolio, which allows us to originate new loans at prevailing market rates. Our loan portfolio turns over approximately 1.2 times per year from payments, renewals, and net credit losses. Because our large loans have longer maturities than our small loans and typically renew at a slower rate than our small loans, the rate of turnover of the loan portfolio may change as our large loans change as a percentage of our portfolio.
We also are exposed to changes in interest rates as a result of certain borrowing activities. As of December 31, 2018, the interest rates on 45.8% of our long-term debt (the amortizing loan, RMIT 2018-1 securitization, and RMIT 2018-2 securitization) were fixed. We maintain liquidity and fund our business operations in part through variable-rate borrowings under a senior revolving credit facility and a revolving warehouse credit facility. At December 31, 2018, the outstanding balances under the senior revolving credit facility and the revolving warehouse credit facility were $328.1 million and $30.1 million, respectively.
Borrowings under the senior revolving credit facility bear interest, payable monthly, at a rate equal to LIBOR of a maturity we elect between one and six months, with a LIBOR floor of 1.00%, plus a margin of 3.00%, increasing to 3.25% when the availability percentage is below 10%. Alternatively, we may pay interest under the senior revolving credit facility at a rate based on the prime rate, plus a margin of 2.00%, increasing to 2.25% when the availability percentage is below 10%. Borrowings under the revolving warehouse credit facility previously bore interest, payable monthly, at a blended rate equal to three-month LIBOR, plus a margin of 3.50%. Effective October 2017 and February 2018, the revolving warehouse credit facility margin decreased to 3.25% and 3.00%, respectively, following the satisfaction of milestones associated with our conversion to a new loan origination and servicing system. In August 2018, in connection with an amendment and extension of the revolving warehouse credit facility, the margin further decreased to 2.20%. As of December 31, 2018, the LIBOR rates under the senior revolving credit facility and the revolving warehouse credit facility were 2.50% and 2.81%, respectively.
We have purchased interest rate caps to manage the risk associated with an aggregate notional $400.0 million of our LIBOR-based borrowings. These interest rate caps are based on the one-month LIBOR and reimburse us for the difference when the one-month LIBOR exceeds the strike rate. The interest rate caps have maturities of March 2019 ($50.0 million, 2.50% strike rate), April 2020 ($100.0 million, 3.25% strike rate), June 2020 ($50.0 million, 2.50% strike rate), and April 2021 ($200.0 million, 3.50% strike rate).
Interest rates on borrowings under the senior revolving credit facility and the revolving warehouse credit facility were approximately 5.48% and 5.32%, respectively, for the year ended December 31, 2018, including, in each case, an unused line fee. Based on the LIBOR rates and the outstanding balances at December 31, 2018, an increase of 100 basis points in LIBOR rates would result in approximately $3.6 million of increased interest expense on an annual basis, in the aggregate, under these LIBOR-based borrowings. Our interest rate cap coverage at December 31, 2018 would reduce this increased expense by approximately $1.3 million on an annual basis.
The nature and amount of our debt may vary as a result of future business requirements, market conditions, and other factors.
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| ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. |
REGIONAL MANAGEMENT CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Fiscal Year Ended December 31, 2018
| Page | ||||
| 75 | ||||
| Consolidated Balance Sheets at December 31, 2018 and December 31, 2017 | 78 | |||
| 79 | ||||
| 80 | ||||
| 81 | ||||
| 82 | ||||
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Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of
Regional Management Corp. and Subsidiaries
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Regional Management Corp. and its subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ending December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 8, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ RSM US LLP
We have served as the Company’s auditor since 2007.
Raleigh, North Carolina
March 8, 2019
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Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of
Regional Management Corp. and Subsidiaries
Opinion on the Internal Control Over Financial Reporting
We have audited Regional Management Corp. and its subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets as of December 31, 2018 and 2017 and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2018 of the Company and our report dated March 8, 2019 expressed an unqualified opinion.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying SOX 404 Management Assessment Report—Effectiveness of Internal Controls over Financial Reporting (“ICFR”) for the Twelve Months Ending December 31, 2018. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ RSM US LLP
Raleigh, North Carolina
March 8, 2019
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Regional Management Corp. and Subsidiaries
Consolidated Balance Sheets
December 31, 2018 and 2017
(in thousands, except par value amounts)
| 2018 | 2017 | |||||||
| Assets | ||||||||
| Cash | $ | 3,657 | $ | 5,230 | ||||
| Gross finance receivables | 1,237,526 | 1,066,650 | ||||||
| Unearned finance charges and insurance premiums | (305,283 | ) | (249,187 | ) | ||||
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| Finance receivables | 932,243 | 817,463 | ||||||
| Allowance for credit losses | (58,300 | ) | (48,910 | ) | ||||
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| Net finance receivables | 873,943 | 768,553 | ||||||
| Restricted cash | 46,484 | 16,787 | ||||||
| Property and equipment | 13,926 | 12,294 | ||||||
| Intangible assets | 10,010 | 10,607 | ||||||
| Other assets | 8,375 | 16,012 | ||||||
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| Total assets | $ | 956,395 | $ | 829,483 | ||||
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| Liabilities and Stockholders’ Equity | ||||||||
| Liabilities: | ||||||||
| Long-term debt | $ | 660,507 | $ | 571,496 | ||||
| Unamortized debt issuance costs | (9,158 | ) | (4,950 | ) | ||||
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| Net long-term debt | 651,349 | 566,546 | ||||||
| Accounts payable and accrued expenses | 25,138 | 18,565 | ||||||
| Deferred tax liability | 747 | |||||||