NICHOLAS FINANCIAL, INC. Forward-Looking Information
This Quarterly Report on Form 10-Q contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are based on management's current beliefs and assumptions, as well as information currently available to management. When used in this document, the words "anticipate", "estimate", "expect", "forecast", "will", "would", "may", "plan," "believe", "intend" and similar expressions are intended to identify forward-looking statements. AlthoughNicholas Financial, Inc. , including its subsidiaries (collectively, the "Company," "we", "us", or "our") believes that the expectations reflected or implied in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. As a result, actual results could differ materially from those indicated in these forward-looking statements. Forward-looking statements in this Quarterly Report may include, without limitation statements about (1) the expected benefits, costs and timing of the Company's restructuring and change in operating strategy, including its servicing arrangement withWestlake Portfolio Management, LLC (collectively with its affiliateWestlake Capital Finance, LLC , "Westlake") (including without limitation the servicing fees, classified as administrative costs), its loan agreement with Westlake (including without limitation anticipated interest payments thereunder), and its exit and disposal activities; (2) the availability and use of excess capital (including by acquiring loan portfolios or businesses or by investing outside of the Company's traditional business); (3) the continuing impact of COVID-19 on our customers and our business, (4) projections of revenue, income, and other items relating to our financial position and results of operations, (5) statements of our plans, objectives, strategies, goals and intentions, (6) statements regarding the capabilities, capacities, market position and expected development of our business operations, and (7) statements of expected industry and general economic trends. These statements are subject to certain risks, uncertainties and assumptions that may cause results to differ materially from those expressed or implied in forward-looking statements, including without limitation:
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the risk that the anticipated benefits of the restructuring and change in operating strategy, including the servicing and financing arrangements with Westlake (including without limitation the expected reduction in overhead, streamlining of operations or reduction in compliance risk), do not materialize to the extent expected or at all, or do not materialize within the timeframe targeted by management;
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the risk that the actual servicing fees paid by the Company under the Westlake servicing agreement, which the Company is classifying as administrative costs on its financial statements, exceed the range estimated;
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the risk that the actual interest payments made by the Company under the Westlake loan agreement exceed the range estimated;
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risks arising from the loss of control over servicing, collection or recovery processes that we have controlled in the past and potentially, termination of these services by Westlake (a failure of Westlake to perform their services under the servicing agreement in a satisfactory manner may have a significant adverse effect on our business);
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the risk that the actual costs of the exit and disposal activities in connection with the consolidation of workforce and closure of offices exceed the Company's estimates or that such activities are not completed on a timely basis;
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the risk that the Company underestimates the staffing and other resources needed to operate effectively after consolidating its workforce and closing offices;
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uncertainties surrounding the Company's success in developing and executing on a new business plan;
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uncertainties surrounding the Company's ability to use any excess capital to increase shareholder returns, including without limitation, by acquiring loan portfolios or businesses or investing outside of the Company's traditional business;
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the ongoing impact on us, our employees, our customers and the overall economy of the COVID-19 pandemic and measures taken in response thereto;
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the ongoing impact on us, our customers and the overall economy of the supply constraints, especially with respect to energy, caused by the COVID-19 pandemic and the Russian invasion ofUkraine and related economic sanctions;
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availability of capital (including the ability to access bank financing);
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recently enacted, proposed or future legislation and the manner in which it is implemented, including tax legislation initiatives or challenges to our tax positions and/or interpretations, and state sales tax rules and regulations;
• fluctuations in the economy;
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the degree and nature of competition and its effects on the Company's financial results;
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fluctuations in interest rates;
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effectiveness of our risk management processes and procedures, including the effectiveness of the Company's internal control over financial reporting and disclosure controls and procedures;
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demand for consumer financing in the markets served by the Company;
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our ability to successfully develop and commercialize new or enhanced products and services;
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the sufficiency of our allowance for credit losses and the accuracy of the assumptions or estimates used in preparing our financial statements;
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increases in the default rates experienced on our automobile finance installment contracts ("Contracts") or direct loans ("Direct Loans");
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higher borrowing costs and adverse financial market conditions impacting our funding and liquidity;
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regulation, supervision, examination and enforcement of our business by governmental authorities, and adverse regulatory changes in the Company's existing and future markets, including the impact of theDodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and other legislative and regulatory developments, including regulations relating to privacy, information security and data protection and the impact of theConsumer Financial Protection Bureau's (the "CFPB") regulation of our business;
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fraudulent activity, employee misconduct or misconduct by third parties, including representatives or agents of Westlake;
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media and public characterization of consumer installment loans;
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failure of third parties to provide various services that are important to our operations;
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alleged infringement of intellectual property rights of others and our ability to protect our intellectual property;
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litigation and regulatory actions;
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our ability to attract, retain and motivate key officers and employees;
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use of third-party vendors and ongoing third-party business relationships, particularly our relationship with Westlake;
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cyber-attacks or other security breaches suffered by us or Westlake;
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disruptions in the operations of our or Westlake's computer systems and data centers;
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the impact of changes in accounting rules and regulations, or their interpretation or application, which could materially and adversely affect the Company's reported consolidated financial statements or necessitate material delays or changes in the issuance of the Company's audited consolidated financial statements;
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uncertainties associated with management turnover and the effective succession of senior management;
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our ability to realize our intentions regarding strategic alternatives, including the failure to achieve anticipated synergies; the risk factors discussed under "Item 1A - Risk Factors" in our Annual Report on Form 10-K, and our other filings made with theU.S. Securities and Exchange Commission ("SEC"). Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or expected. All forward-looking statements included in this Quarterly Report are based on information available to the Company as the date of filing of this Quarterly Report, and the Company assumes no obligation to update any such forward-looking statement. Prospective investors should also consult the risk factors described from time to time in the Company's other filings made with theSEC , including its reports on Forms 10-K, 10-Q, 8-K and annual reports to shareholders.
Restructuring and Change in Operating Strategy
On
Change in Operating Strategy
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The Company announced on Form 8-K filed on November 3, 2022 a change in its
operating strategy and restructuring plan with the goal of reducing operating
expenses and freeing up capital. As part of this plan, the Company has shifted
from a decentralized to a regionalized business model and entered into a loan
servicing agreement with Westlake Portfolio Management, LLC ("WPM", and,
collectively with its affiliate, Westlake Capital Finance, LLC , "Westlake"). An
affiliate of Westlake, Westlake Services, LLC , is the beneficial owner of
approximately 6.8% of the Company's common stock.
While the Company intends to continue Contract purchase and origination activities, albeit on a much smaller scale, its servicing, collections and recovery operations have been outsourced to Westlake. The Company has ceased originations of Direct Loans.
The Company anticipates that execution of its evolving restructuring plan will free up capital and permit the Company to allocate excess capital to increase shareholder returns, whether by acquiring loan portfolios or businesses or by investing outside of the Company's traditional business. The overall timeframe and structure of the Company's restructuring remains uncertain.
Westlake Servicing Agreement
As part of the restructuring plan, the Company entered into a loan servicing
agreement (the "Servicing Agreement") with
Pursuant to the Servicing Agreement, onDecember 1, 2022 , Westlake began servicing all receivables held by the Company under its Contracts and Direct Loans, except for charged-off and certain other receivables. Those receivables covered by the Servicing Agreement as of the Closing Date are referred to as the "initial receivables." The Company expects to add additional Contract receivables to the receivables pool covered under the Servicing Agreement from time to time in the future, but will no longer originate Direct Loans. All receivables remain vested in the Company. More specifically, Westlake has agreed to manage, service, administer and make collections on the receivables, as well as perform certain other duties specified in the agreement, in accordance with servicing practices and standards used by prudent sale finance companies or lending institutions that service motor vehicle secured retail installment contracts of the same type. Westlake will maintain custody of the receivable files and lien certificates, acting as custodian for the Company. Under the Servicing Agreement, the Company has agreed to pay Westlake a boarding fee with respect to the initial receivables, and boarding fees based on a percentage of any additional receivables to be added to the pool in the future. In addition, the Company is obligated to pay Westlake monthly servicing fees depending on the aggregate principal balance of receivables, the types of services provided by Westlake and the payment status of the various loans. The Company classifies such servicing fees as administrative costs on its financial statements. Estimates of such administrative costs applied to the initial receivables are provided below under "Exit and Disposal Activities." Estimated servicing fees for the quarter endingMarch 31, 2023 are between$2.7 million and$3.9 million . Collections of amounts made after accounts have been charged off are split between the Company and Westlake. The Company must also reimburse Westlake for certain expenses specified in the Servicing Agreement. The Servicing Agreement contains representations and warranties by both parties. It allows Westlake to delegate its duties under the agreement to an affiliate or subservicer with the Company's prior written consent. If certain events specified in the Servicing Agreement occur ("Servicer Termination Events"), the Company is entitled to terminate Westlake rights and obligations and appoint a successor servicer under the agreement. The Servicing Agreement expires upon the earliest to occur of (i) the date on which the Company sells, transfers or assigns all outstanding receivables to a third party (including to Westlake), (ii) the date on which the last receivable is repaid or otherwise terminated and (iii) 3 years from the Closing Date. If the Company terminates the Agreement other than for a Servicer Termination Event, it is obligated to pay Westlake a termination fee if the termination occurs prior to the third anniversary of the Closing Date, which fee, if payable, is expected to exceed$1 million .
Exit and Disposal Activities
As part of this restructuring plan, the Company announced the closure of its branches. Consistent with this significant reduction in footprint, the Company reduced its workforce to approximately 18 employees as ofJanuary 2023 .
The expected total remaining charges to be incurred by the Company are approximately 0.8 million, all of which are expected to be cash expenditures.
Of these expected total charges, the Company estimates incurring approximately$0.5 million for lease terminations,$0.3 million for cease-use of contractual services and other restructuring costs. 19 -------------------------------------------------------------------------------- The closing of branches and consolidation of the workforce is expected to be completed byMarch 31, 2023 . The Company recorded the majority of lease terminations and employee-related charges in the third quarter of Fiscal Year 2023. The above estimates of charges and timelines could change as the Company's plans evolve and become finalized. The Company expects significant annual operating cost savings to substantially exceed the upfront costs associated with the restructuring. Westlake Loan Agreement OnJanuary 18 , 2023, the Company, through its subsidiaries, entered into a Loan and Security Agreement (the "Loan Agreement") with Westlake, pursuant to which Westlake is providing the Company a senior secured revolving credit facility in the principal amount of up to$50 million (the "Credit Facility"). The availability of funds under the Credit Facility is generally limited to an advance rate of between 70% and 85% of the value of the Company's eligible receivables. Outstanding advances under the Credit Facility will accrue interest at a rate equal to the secured overnight financing rate (SOFR) plus a specified margin, subject to a specified floor interest rate. For the quarter endingMarch 31, 2023 , the Company expects to incur interest payments between$0.7 million and$0.9 million . Unused availability under the Credit Agreement will accrue interest at a low interest rate. The commitment period for advances under the Credit Facility is two years. We refer to the expiration of that time period as the "Maturity Date." The Loan Agreement contains customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, and sales of assets. The Loan Agreement also requires the Company to maintain (i) a minimum tangible net worth equal to the lower of$40 million and an amount equal to 60% of the outstanding balance of the Credit Facility and (ii) an excess spread ratio of no less than 8.0%. Pursuant to the Loan Agreement, the Company granted a security interest in substantially all of their assets as collateral for their obligations under the Credit Facility. If an event of default occurs, Westlake could increase borrowing costs, restrict the Company's ability to obtain additional advances under the Credit Facility, accelerate all amounts outstanding under the Credit Facility, enforce their interest against collateral pledged under the Loan Agreement or enforce such other rights and remedies as they have under the loan documents or applicable law as secured lenders. If the Company prepays the loan and terminate the Credit Facility prior to the Maturity Date, then the Company would be obligated to pay Westlake a termination fee in an amount equal to a percentage of the average outstanding principal balance of the Credit Facility during the immediately preceding 90 days. If the Company were to sell its accounts receivable to a third party prior to the Maturity Date, then the Company would be obligated to pay Westlake a fee in an amount equal to a specified percentage of the proceeds of such sale. OnJanuary 18, 2023 , in connection with entering into the Loan Agreement, the Company terminated its credit agreement with Wells Fargo (the "WF Credit Agreement"), and the indebtedness under that agreement (consisting of a revolving line of credit in a maximum principal amount of$60 million (with an outstanding balance of approximately$43 million)) was repaid in full. The Company did not incur any termination penalties in connection with the termination of the WF Credit Agreement.
Litigation and Legal Matters
See "Item 1. Legal Proceedings" in Part II of this Quarterly Report below.
Critical Accounting Estimates
The Company's critical accounting estimate (i.e., that involves a significant
level of estimation uncertainty and has or is reasonably likely to have a
material impact on the Company's financial condition or results of operations)
relates to the allowance for credit losses. It is based on management's opinion
of an amount that is adequate to absorb losses incurred in the existing
portfolio. Because of the nature of the customers under the Company's Contracts
and Direct Loan program, the Company considers the establishment of adequate
reserves for credit losses to be imperative.
The Company uses trailing twelve-month net charge-offs as a percentage of
average finance receivables, and applies this calculated percentage to ending
finance receivables to calculate estimated future probable credit losses for
purposes of determining the allowance for credit losses. The Company then takes
into consideration the composition of its portfolio, current economic
conditions, estimated net realizable value of the underlying collateral,
historical loan loss experience, delinquency, non-performing assets, and
bankrupt accounts and adjusts the above, if necessary, to determine management's
total estimate of probable credit losses and its assessment of the overall
adequacy of the allowance for credit losses. Management utilizes significant
judgment in determining probable incurred losses and in identifying and
evaluating qualitative factors. This approach aligns with the Company's lending
policies and underwriting standards.
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If the allowance for credit losses is determined to be inadequate, then an
additional charge to the provision is recorded to maintain adequate reserves
based on management's evaluation of the risk inherent in the loan portfolio.
Conversely, the Company could identify abnormalities in the composition of the
portfolio, which would indicate the calculation is overstated and management
judgment may be required to determine the allowance of credit losses for both
Contracts and Direct Loans.
Contracts are purchased from many different dealers and are all purchased on an
individual Contract-by-Contract basis. Individual Contract pricing is determined
by the automobile dealerships and is generally the lesser of the applicable
state maximum interest rate, if any, or the maximum interest rate which the
customer will accept. In most markets, competitive forces will drive down
Contract rates from the maximum rate to a level where an individual competitor
is willing to buy an individual Contract. The Company generally purchases
Contracts on an individual basis.
The Company has detailed underwriting guidelines it utilizes to determine which
Contracts to purchase. These guidelines are specific and are designed to provide
reasonable assurance that the Contracts purchased have common risk
characteristics.
Introduction
The Company finances primary transportation to and from work for the subprime borrower. We do not finance luxury cars, second units or recreational vehicles, which are the first payments customers tend to skip in time of economic insecurity. We finance the main and often only vehicle in the household that is needed to get our customers to and from work. The amounts we finance are much lower than most of our competitors, and therefore the payments are significantly lower, too. The combination of financing a "need" over a "want" and making that loan on comparatively affordable terms incentivizes our customers to prioritize their account with us. For the three months endedDecember 31, 2022 , the dilutive loss per share was$1.85 as compared to dilutive loss per share of$0.09 for the three months endedDecember 31, 2021 . Net loss was$13.4 million for the three months endedDecember 31, 2022 as compared to net loss of$0.7 million for the three months endedDecember 31, 2021 . Interest and fee income on finance receivables decreased 7.9% to$11.3 million for the three months endedDecember 31, 2022 as compared to$12.2 million for the three months endedDecember 31, 2021 . Provision for credit losses increased 541.6% to$10.7 million for the three months endedDecember 31, 2022 as compared to$1.7 million for the three months endedDecember 31, 2021 . For the nine months endedDecember 31, 2022 , the dilutive loss per share was$2.49 as compared to dilutive earnings per share of$0.34 for the nine months endedDecember 31, 2021 . Net loss was$18.3 million for the nine months endedDecember 31, 2022 as compared to net income of$2.6 million for the nine months endedDecember 31, 2021 . Interest and fee income on finance receivables decreased 4.7% to$35.6 million for the nine months endedDecember 31, 2022 as compared to$37.4 million for the nine months endedDecember 31, 2021 . Provision for credit losses increased 513.1% to$23.3 million for the nine months endedDecember 31, 2022 as compared to$3.8 million for the nine months endedDecember 31, 2021 . Non-GAAP financial measures From time-to-time the Company uses certain financial measures derived on a basis other than generally accepted accounting principles ("GAAP"), primarily by excluding from a comparable GAAP measure certain items the Company does not consider to be representative of its actual operating performance. Such financial measures qualify as "non-GAAP financial measures" as defined inSEC rules. The Company uses these non-GAAP financial measures in operating its business because management believes they are less susceptible to variances in actual operating performance that can result from the excluded items and other infrequent charges. The Company may present these financial measures to investors because management believes they are useful to investors in evaluating the primary factors that drive the Company's core operating performance and provide greater transparency into the Company's results of operations. However, items that are excluded and other adjustments and assumptions that are made in calculating these non-GAAP financial measures are significant components to understanding and assessing the Company's financial performance. Such non-GAAP financial measures should be evaluated in conjunction with, and are not a substitute for, the Company's GAAP financial measures. Further, because these non-GAAP financial measures are not determined in accordance with GAAP and are, thus, susceptible to varying calculations, any non-GAAP financial measures, as presented, may not be comparable to other similarly titled measures of other companies. 21 -------------------------------------------------------------------------------- Three months endedDecember 31 ,
Nine months ended
(In thousands) (In thousands)
2022 2021 2022 2021
Portfolio Summary
Average finance receivables (1) $ 165,783 $ 176,949 $ 174,004 $ 179,333
Average indebtedness (2) $ 52,577 $ 64,824 $ 59,739 $ 72,002
Interest and fee income on finance
receivables $ 11,268 $ 12,240 $ 35,580 $ 37,406
Interest expense 1,239 2,613 2,782 4,923
Net interest and fee income on finance
receivables $ 10,029 $ 9,627 $ 32,798 $ 32,483
Portfolio yield (3) 27.19 % 27.67 % 27.26 % 27.81 %
Interest expense as a percentage of
average finance receivables 2.99 % 5.91 % 2.13 % 3.66 %
Provision for credit losses as a
percentage of average finance
receivables 25.89 % 3.79 % 17.84 % 2.83 %
Net portfolio yield (3) (1.69 )% 17.98 % 7.29 % 21.32 %
Operating expenses as a percentage of
average finance receivables (4) 23.34 % 20.04 % 20.30 % 18.68 %
Pre-tax yield as a percentage of
average finance receivables (5) (25.03 )% (2.06 )% (13.01 )% 2.64 %
Net charge-off percentage (6) 16.57 % 5.67 % 8.79 % 4.70 %
Finance receivables $ 155,213 $ 176,173
Allowance percentage (7) 7.06 % 2.06 %
Total reserves percentage (8) 10.78 % 6.00 %
Note: All three-month and nine-month of income performance indicators expressed as percentages have been annualized.
(1)
Average finance receivables represent the average of finance receivables throughout the period. (This is considered a non-GAAP financial measure). (2) Average indebtedness represents the average outstanding borrowings under the Credit Facility. (This is considered a non-GAAP financial measure). (3) Portfolio yield represents interest and fee income on finance receivables as a percentage of average finance receivables. Net portfolio yield represents (a) interest and fee income on finance receivables minus (b) interest expense minus (c) the provision for credit losses, as a percentage of average finance receivables. (This is considered a non-GAAP financial measure). (4) Operating expenses as presented include restructuring cost of approximately$3.2 million . Operating expenses net of restructuring cost (a non-GAAP financial measure), as a percentage of average finance receivable would have been 15.52% and 17.82% for the three and nine months endedDecember 31, 2022 , respectively. (5) Pre-tax yield represents net portfolio yield minus operating expenses (marketing, salaries, employee benefits, depreciation, and administrative), as a percentage of average finance receivables. (This is considered a non-GAAP financial measure). (6) Net charge-off percentage represents net charge-offs (charge-offs less recoveries) divided by average finance receivables outstanding during the period. (This is considered a non-GAAP financial measure). (7) Allowance percentage represents the allowance for credit losses divided by finance receivables outstanding as of ending balance sheet date. (8) Total reserves percentage represents the allowance for credit losses, purchase price discount, and unearned dealer discounts divided by finance receivables outstanding as of ending balance sheet date.
Analysis of Credit Losses
The Company uses a trailing twelve-month charge-off analysis to calculate the allowance for credit losses and takes into consideration the composition of the portfolio, current economic conditions, estimated net realizable value of the underlying collateral, historical loan loss experience, delinquency, non-performing assets, and bankrupt accounts when determining management's estimate of probable credit losses and adequacy of the allowance for credit losses. By including recent trends such as delinquency, non-performing assets, and bankruptcy in its determination, management believes that the allowance for credit losses reflects the current trends of incurred losses within the portfolio and is better aligned with the portfolio's performance indicators. If the allowance for credit losses is determined to be inadequate, then an additional charge to the provision is recorded to maintain adequate reserves based on management's evaluation of the risk inherent in the loan portfolio. Conversely, the Company could identify abnormalities in the composition of the portfolio, which would indicate the calculation is overstated and management judgment may be required to determine the allowance of credit losses for both Contracts and Direct Loans.
Non-performing assets are defined as accounts that are contractually delinquent for 61 or more days past due or Chapter 13 bankruptcy accounts. For these accounts, the accrual of interest income is suspended, and any previously accrued interest is reversed.
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Upon notification of a bankruptcy, an account is monitored for collection with
other Chapter 13 accounts. In the event the debtors' balance is reduced by the
bankruptcy court, the Company will record a loss equal to the amount of
principal balance reduction. The remaining balance will be reduced as payments
are received by the bankruptcy court. In the event an account is dismissed from
bankruptcy, the Company will decide based on several factors, whether to begin
repossession proceedings or allow the customer to begin making regularly
scheduled payments.
Beginning
The provision for credit losses increased to$10.7 million for the three months ended onDecember 31, 2022 , from$8.9 million for the three months ended onSeptember 30, 2022 , and$1.7 million for the three months ended onDecember 31, 2021 , due to a substantial increase in the net charge-off percentage. The net charge-off percentage increased to 16.57% for the three months ended onDecember 31, 2022 , from 12.4% for the three months ended onSeptember 30, 2022 , and 5.67% for the three months ended onDecember 31, 2021 , primarily driven by increased delinquencies and loan defaults. (See note 6 in the Portfolio Summary table in the "Introduction" above for the definition of net charge-off percentage). Management attributes these increased delinquencies and loan defaults primarily to the fact that the beneficial impact of the government's prior COVID-19-related assistance to the Company's customers had subsided at a time when those customers began facing increased inflationary pressures affecting their cost of living, and expects that the net charge-off percentage will remain, for the foreseeable future, at levels higher than those experienced in prior years for the same reasons. The delinquency percentage for Contracts more than twenty-nine days past due, excluding Chapter 13 bankruptcy accounts, as ofDecember 31, 2022 was 21.1%, an increase from 10.3% as ofDecember 31, 2021 . The delinquency percentage for Direct Loans more than twenty-nine days past due, excluding Chapter 13 bankruptcy accounts, as ofDecember 31, 2022 was 19.5%, an increase from 4.3% as ofDecember 31, 2021 . The changes in delinquency percentage for both Contracts and Direct Loans was driven primarily by market and economic pressure and its adverse impact on consumers. In accordance with our policies and procedures, certain borrowers qualify for, and the Company offers, one-month principal payment deferrals on Contracts and Direct Loans.
Three months ended
Interest and Fee Income on Finance Receivables
Interest and fee income on finance receivables, which consist predominantly of finance charge income, decreased 7.9% to$11.3 million for the three months endedDecember 31, 2022 , from$12.2 million for the three months endedDecember 31, 2021 . The decrease was primarily due to an increased level of charged off accounts as discussed above. The Company also reduced its originations of Contracts and discontinued originating Direct Loans pursuant to its restructuring plan. The portfolio yield decreased to 27.2% for the three months endedDecember 31, 2022 , compared to 27.7% for the three months endedDecember 31, 2021 . The net portfolio yield decreased to (1.7)% for the three months endedDecember 31, 2022 , compared to 18.0% for the three months endedDecember 31, 2021 . The substantial erosion in net portfolio yield was primarily caused by the significant increase in the provision for credit losses, as described under "Analysis of Credit Losses" and the change in the Company's operating strategy. As part of the Company's restructuring and change in operating strategy disclosed above, management expects that operating expenses will decline as the Company transitions its servicing and collections activities to Westlake under the Servicing Agreement, although the effects of this decline will likely not begin materializing until the fourth quarter of fiscal year 2023. The Company estimates that administrative costs with respect to the initial pool of receivables serviced by Westlake will be as disclosed above under "Restructuring and Change in Operating Strategy-Exit and Disposal Activities."
Operating Expenses
Operating expenses increased to$9.7 million for the three months endedDecember 31, 2022 compared to$8.9 million for the three months endedDecember 31, 2021 . The increase in operating expenses was primarily attributed to restructuring cost associated with branch closures, severance expenses, impairment charges for leased assets and cease-use of contractual services, for the total of$3.2 million , and to boarding and servicing fees paid to Westlake under our servicing agreement with them and reported under administrative expense of$0.6 million . These factors more than offset the beneficial effects of the decrease in salary and wages as a result of the Company's headcount reduction. Similarly, operating expenses as a percentage of average finance receivables, also increased to 23.3% for the three months endedDecember 31, 2022 from 20.0% for the three months endedDecember 31, 2021 as a result of the factors above and a decrease in the average receivables balance. 23 --------------------------------------------------------------------------------
Provision Expense
The provision for credit losses increased to$10.7 million for the three months endedDecember 31, 2022 from$1.7 million for the three months endedDecember 31, 2021 , largely due to an increase in the net charge-off percentage to 16.6% for the three months endedDecember 31, 2022 from 5.7% for the three months endedDecember 31, 2021 .
Interest Expense
Interest expense was$1.2 million for the three months endedDecember 31, 2022 and$2.6 million for the three months endedDecember 31, 2021 . The following table summarizes the Company's average cost of borrowed funds: Three months ended Nine months ended December 31, December 31, 2022 2021 2022 2021 Variable interest under the line of credit facility 3.63 % 1.00 % 2.15 % 1.00 % Credit spread under the line of credit facility 4.40 % 3.75 % 2.97 % 3.75 % Average cost of borrowed funds 8.03 % 4.75 % 5.12 % 4.75 % SOFR rates have increased to 4.12%, which represented the daily SOFR rate as required under the WF Credit Agreement, as ofDecember 31, 2022 compared to 0.14% as ofDecember 31, 2021 . For further discussions regarding interest rates see "Note 5. Credit Facility". OnOctober 20, 2022 , the Company received a letter from the agent of its lenders notifying the Company that it was instituting the default rate of interest of 2.5% imposed effective as ofAugust 31, 2022 in connection with an event of default that occurred by virtue of the Company's failure to comply with Section 6.3(a) of the Loan Agreement (EBITDA Ratio) for the calendar month endingAugust 31, 2022 .
The Company subsequently announced on Form 8-K filed on
The amendment furthermore reduced the maximum amount available under the WF Credit Facility from$175 million to$60 million , reduced the availability of funds from an advance rate of between 80% and 85% of the value of eligible receivables to an advance rate of 50% of the value of eligible receivables, and changed the maturity date of the WF Credit Facility fromNovember 5, 2024 toMay 31, 2023 . The Company incurred non-refundable overall costs associated with the restructuring in the amount of$0.3 million . As described under "Westlake Loan Agreement" above and "Liquidity and Capital Resources" below, onJanuary 18 , 2023, the Company entered into a Loan and Security Agreement (the "Loan Agreement") with Westlake, pursuant to which Westlake is providing the Company a senior secured revolving credit facility in the principal amount of up to$50 million (the "Credit Facility"). This Credit Facility bears interest at higher rates than did the WF Credit Agreement. For the quarter endingMarch 31, 2023 , the Company expects to incur interest payments between$0.7 million and$0.9 million .
Income Taxes
The Company established a valuation allowance for deferred tax asset in the amount of$5.7 million during the three months endedDecember 31, 2022 , which resulted in the income tax expense of approximately$3.0 million for the three months endedDecember 31, 2022 compared to income tax benefit of approximately$209 thousand for the three months endedDecember 31, 2021 . The Company's effective tax rate decreased to -29.1% for the three months endedDecember 31, 2022 from 22.9% for the three months endedDecember 31, 2021 .
Nine months ended
Interest Income and Loan Portfolio
Interest and fee income on finance receivables, decreased 4.7% to$35.6 million for the nine months endedDecember 31, 2022 from$37.4 million for the nine months endedDecember 31, 2021 . The decrease was partly due to a lower average discount and a 3.0% decrease in average finance receivables to$174.0 million for the nine months endedDecember 31, 2022 when compared to$179.3 million for the corresponding period endedDecember 31, 2021 . The decrease in average finance receivables was primarily due to the Company's commitment to maintaining its conservative underwriting practices, which typically allows more aggressive competitors to purchase a contract from a dealer. 24 -------------------------------------------------------------------------------- The portfolio yield decreased to 27.3% for the nine months endedDecember 31, 2022 compared to 27.8% for the nine months endedDecember 31, 2021 . The net portfolio yield decreased to 7.3% for the nine months endedDecember 31, 2022 compared to 21.3% for the nine months endedDecember 31, 2021 , respectively. The substantial erosion in net portfolio yield was primarily caused by the significant increase in the provision for credit losses, as described under "Analysis of Credit Losses" and the change in the Company's operating strategy.
Operating Expenses
Operating expenses increased to approximately$26.5 million for the nine months endedDecember 31, 2022 from approximately$25.1 million for the nine months endedDecember 31, 2021 . Operating expenses as a percentage of average finance receivables increased to 20.3% for the nine months endedDecember 31, 2022 from 18.7% for the nine months endedDecember 31, 2021 . The increase in operating expenses was primarily attributed to restructuring cost associated with branch closures, severance expenses, impairment charges for leased assets and cease-use of contractual services, for the total of approximately$4.0 million , and to boarding and servicing fees paid to Westlake under our servicing agreement with them and reported under administrative expense of$0.6 million . These factors more than offset the beneficial effects of the decrease in salary and wages as a result of the Company's headcount reduction.
Provision Expense
The provision for credit losses increased to$23.3 million for the nine months endedDecember 31, 2022 from$3.8 million for the nine months endedDecember 31, 2021 , largely due to an increase in the net charge-off percentage to 8.8% for the nine months endedDecember 31, 2022 from 4.7% for the nine months endedDecember 31, 2021 .
Interest Expense
Interest expense was$2.8 million for the nine months endedDecember 31, 2022 and$4.9 million for the nine months endedDecember 31, 2021 . The decrease in interest expense was primarily driven by a reduced amount of average indebtedness to$59.7 million from$72.0 million for the nine month endedDecember 31, 2022 and 2021, respectively. 25 --------------------------------------------------------------------------------
Income Taxes
The Company established a valuation allowance for deferred tax asset in the amount of$5.7 million during the three months endedDecember 31, 2022 , which resulted in income tax expense of approximately$1.4 million for the nine months endedDecember 31, 2022 compared to income tax expense of approximately$0.9 million for the nine months endedDecember 31, 2021 . The Company's effective tax rate decreased to -8.42% for the nine months endedDecember 31, 2022 from 26.0% for the nine months endedDecember 31, 2021 .
Contract Procurement
As ofDecember 31, 2022 , the Company purchased Contracts in the states listed in the table below. The Contracts purchased by the Company are predominantly for used vehicles for the three-month periods endedDecember 31, 2022 and 2021, less than 1% were for new vehicles. The following tables present selected information on Contracts purchased by the Company. As of Three months ended Nine months ended December 31, December 31, December 31, 2022 2022 2021 2022 2021 Number of Net Purchases Net Purchases State branches (In thousands) (In thousands) FL -$ 955 $ 3,388 $ 9,582 $ 9,621 OH - 571 2,539 6,773 8,677 GA - 416 2,247 5,103 7,664 KY - 175 1,003 2,796 3,802 MO - 292 1,135 2,841 3,920 NC - 227 1,752 3,977 4,710 IN - 208 1,071 2,326 3,150 SC - 575 1,376 2,893 3,587 AL - 393 911 2,919 2,695 MI - 35 800 549 2,103 NV - 47 557 1,150 1,751 TN - 288 486 1,203 1,449 IL - 157 356 1,109 1,102 PA - 59 622 1,139 1,354 TX - - 516 594 1,178 WI - - 312 344 832 ID - 8 186 343 560 UT - 8 69 102 300 AZ - 39 154 128 210 KS - 57 - 75 - Total -$ 4,511 $ 19,480 $ 45,947 $ 58,665 Three months ended Nine months ended December 31, December 31, (Purchases in thousands) (Purchases in thousands) Contracts 2022 2021 2022 2021 Purchases$ 4,511 $ 19,480 $ 45,947 $ 58,665 Average APR 22.4 % 23.1 % 22.7 % 23.1 % Average discount 6.8 % 6.8 % 6.6 % 6.8 % Average term (months) 48 47 48 47 Average amount financed$ 11,778 $ 11,228 $ 11,765 $ 10,906 Number of Contracts 383 1,735 3,913 5,389 26
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Direct Loan Origination
The following table presents selected information on Direct Loans originated by the Company.
Three months ended Nine months ended
December 31, December 31,
Direct Loans (Originations in thousands) (Originations in thousands)
Originated 2022 2021 2022 2021
Purchases/Originations $ 1,080 $ 8,505 $ 15,822 $ 21,282
Average APR 29.6 % 31.8 % 30.4 % 30.6 %
Average term (months) 27 24 26 25
Average amount financed $ 4,128 $ 3,727 $ 4,277 $ 4,173
Number of loans 245 2,282 3,662 5,186
Liquidity and Capital Resources
The Company's cash flows are summarized as follows:
Nine months ended
December 31,
(In thousands)
2022 2021
Cash provided by (used in):
Operating activities $ (933 ) $ 1,902
Investing activities 13,018 6,757
Financing activities (15,946 ) (35,106 )
Net decrease in cash $ (3,861 ) $ (26,447 )
The Company's primary use of working capital for the quarter ended December 31,
2022 was funding the purchase of Contracts, which are financed substantially
through cash from principal and interest payments received, and the Company's
line of credit.
Please refer to "Note 5 - Credit Facility" for disclosure on the Company's prior
credit facility with Wells Fargo under the WF Credit Agreement, which disclosure
is incorporated herein by reference.
On January 18 , 2023, the Company through its subsidiaries, entered into a Loan
and Security Agreement (the "Loan Agreement") with Westlake, pursuant to which
Westlake is providing the Company a senior secured revolving credit facility in
the principal amount of up to $50 million (the "Credit Facility").
The availability of funds under the Credit Facility is generally limited to an
advance rate of between 70% and 85% of the value of the Company's eligible
receivables. Outstanding advances under the Credit Facility will accrue interest
at a rate equal to the secured overnight financing rate (SOFR) plus a specified
margin, subject to a specified floor interest rate. For the quarter ending March
31, 2023 , the Company expects to incur interest payments between $0.7 million
and $0.9 million . Unused availability under the Credit Agreement will accrue
interest at a low interest rate. The commitment period for advances under the
Credit Facility is two years. We refer to the expiration of that time period as
the "Maturity Date."
The Loan Agreement contains customary events of default and negative covenants,
including but not limited to those governing indebtedness, liens, fundamental
changes, and sales of assets. The Loan Agreement also requires the Company to
maintain (i) a minimum tangible net worth equal to the lower of $40 million and
an amount equal to 60% of the outstanding balance of the Credit Facility and
(ii) an excess spread ratio of no less than 8.0%. Pursuant to the Loan
Agreement, the Company granted a security interest in substantially all of their
assets as collateral for their obligations under the Credit Facility. If an
event of default occurs, Westlake could increase borrowing costs, restrict the
the Company's ability to obtain additional advances under the Credit Facility,
accelerate all amounts outstanding under the Credit Facility, enforce their
interest against collateral pledged under the Loan Agreement or enforce such
other rights and remedies as they have under the loan documents or applicable
law as secured lenders.
If the Company prepays the loan and terminate the Credit Facility prior to the
Maturity Date, then the Company would be obligated to pay Westlake a termination
fee in an amount equal to a percentage of the average outstanding principal
balance of the Credit Facility during the immediately preceding 90 days. If the
Company were to sell its accounts receivable to a third party prior to the
Maturity Date, then the Company would be obligated to pay Westlake a fee in an
amount equal to a specified percentage of the proceeds of such sale.
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On
OnMay 27, 2020 , the Company obtained a loan in the amount of approximately$3.2 million from a bank in connection with theU.S. Small Business Administration's ("SBA") Paycheck Protection Program (the "PPP Loan"). Pursuant to the Paycheck Protection Program, all or a portion of the PPP Loan may be forgiven if the Company uses the proceeds of the PPP Loan for its payroll costs and other expenses in accordance with the requirements of the Paycheck Protection Program. The Company used the proceeds of the PPP Loan for payroll costs and other covered expenses and sought full forgiveness of the PPP Loan. The Company submitted a forgiveness application toFifth Third Bank , the lender, onDecember 7, 2020 and submitted supplemental documentation onJanuary 16, 2021 . OnDecember 27, 2021 SBA informed the Company that no forgiveness was granted. The Company filed an appeal with SBA onJanuary 5, 2022 . OnMay 6, 2022 theOffice of Hearing and Appeals SBA (OHA) rendered a decision to deny the appeal. The Company subsequently repaid the outstanding principal balance of$3.2 million plus accrued and unpaid interest of$65 thousand onMay 23, 2022 . The Company has begun its restructuring process to substantially decrease operating expenses and is developing a strategy with respect to its long-term use of cash. The related disclosure contained in "Restructuring and Change in Operating Strategy" is incorporated herein by reference.
Off-Balance Sheet Arrangements
The Company does not engage in any off-balance sheet financing arrangements.
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