The alternative financial services sector is a highly fragmented one, serving some 30% of American households, spread across the entire country. Nonprime consumers are not well understood, particularly by the media, which often characterizes them as unsophisticated, unintelligent, and incapable of understanding alternative financial service products. Nothing could be further from the truth, as my own experience with these consumers, and dozens of studies on the subject, have proven that they know exactly what they are doing, and understand the terms of the contracts presented to them.
Regional Management (RM) is one of the mid-sized players in the market, with a 26-year history, and 264 storefronts across 8 states. Regional Management is one of the last true "household lenders", most of which had been gobbled up by the mid-1990's. These were the AVCO's of the world, which had many branch offices around the country, and would extend credit lines in the low five-figures to families. These businesses filled a niche that banks didn't have much interest in - a true neighborhood lender where you could set up a revolving account that you might draw upon when needed. The lines were often unsecured, and provided a palatable option to those who didn't want to leverage the equity in their homes.
AVCO, for example, had been around for decades and had over 1,200 offices worldwide. Consumers would pay around 20% annually for loans, and AVCO would profit from the spread, as it borrowed the funds at around 10%. By the mid-1990's, AVCO was one of the largest consumer finance companies, employing over 7,000 workers. Loans at that point were primarily used for purchases of cars, consumer goods, and real estate. However, as mentioned, AVCO and others were purchased by larger financial institutions and then were put out to pasture.
Regional's Clientele
The nonprime consumer that uses Regional Management's products are not the same as those who use payday loans. Those loans average around $400, and are short-term in nature, secured only by the borrower's next paycheck. Regional focuses on installment loans, usually of higher principal and longer duration. This is an entirely different class of customer. Payday borrowers are truly living paycheck-to-paycheck, and need to the money for emergency expenses such as a car repair. Wage stagnation amidst stealth inflation is increasingly forcing this client to turn to payday loans to help make ends meet.
The nonprime installment consumer is on better footing from a financial standpoint, but often lacks good credit. Banks will not lend to them. Credit cards are difficult to come by. Regional fills that gap by offering a range of products to fit this consumer's need. This client is also easier to work with in regards to credit underwriting and delinquent payments. Regional's long history of underwriting allows them to better assess a customer's ability to make the loan payments on time. Regional traditionally will defer or refinance payments if the customer is up to date. In 2012, the company only refinanced 0.8% of total loan volume, demonstrating strength in its underwriting standards.
The nonprime consumer psychology is important to understand for companies like Regional. These folks, and I've met many of them, feel embarrassed to have to ask for help. To that end, the nonprime lender tries to make the process quick and convenient - assessing background, employment and credit information in under a half hour. The best lenders also create a more personal relationship with the client, unlike most banks, allowing the borrower to feel more at ease.
Loan Products and Yields
Regional's loan products are fixed rate, with fixed term, and with fully amortizing equal monthly installment payments, repayable at any time without penalty. The company's
small installment loans range from $300 to $2,500, with terms of up to 36 months. Although nominally secured with non-essential household goods, the truth is the collateral is rarely taken in the event of default, and the company doesn't even file a UCC. Instead, the company will collect a non-file fee and use it to purchase insurance in the event of default. In FY12 (we're still waiting on the company's 2013 10-k), the average loan size was $1,515 over 17 months. The vast majority (over 70%) of these loans were originated in South Carolina, Texas, and North Carolina. The average APR is 51.1%, which is fair and typical for a nonprime consumer, and represents 45% of the company's portfolio.
About a third of Regional's business in this segment is driven by their "live check" marketing program. Customers that have met pre-screening criteria get a check in the mail, which they can fill out, sign, and bring in to their local branch. These are just like the checks you receive from your credit card company. It's a pro-active approach towards generating clients, by offering them a loan rather than relying on the customer's decision to walk into a store to get one.
Regional's large installment loans range from $2,500 to $20,000, with terms of between 18 and 60 months, but these are secured by a car in addition to non-essential household goods. FY12 average loan size was $5,454 for 32 months. The weighted average yield on this part of the portfolio was 28.3%, not much higher than a standard credit card. Unlike traditional auto title loans, the cost to the consumer is much less and the loan is in place for a much longer period of time. In FY12, well over 80% of these loans were made in the Carolinas and Alabama, and represent 8% of the company's portfolio.
The company also provides nonprime auto loans up to $27,500, generally with
terms of between 36 and 72 months, also secured by the purchased vehicle. The company actually offers the loans directly through a network of 3,400 dealers in its geographic footprint. This model is particularly lucrative as the company doesn't have to expend a lot of overhead since the dealer facilitates much of the paperwork. Weighted average yield was 22.2% in FY12. Well over 80% of these loans were also in the Carolinas and Texas.
The same is true for its Furniture and Appliance Purchase Loans. These loans are offered up to $7,500, with terms of between six and 48 months, which are secured by the purchased items. The company has partnered with 625 furniture and appliance retailers. It also offers optional payment protection insurance relating to its loan products - another high margin segment, yielding 20.4% in FY12 and representing 6% of the company's portfolio.
Regional's business as neighborhood lender becomes clear when one looks at the average branch operating income contribution (2012 10-K, p. 14). Operating income continues to increase at branches well past the fifth year, almost tripling the contribution in the fifth year from what it earned in years one through three. In other words, once Regional settles in, people come to know they are there, use them and more importantly, tell their friends and return themselves. That explains why 70% of loan payments are made in person at the branch. That alone shows the value of human connection.
Risks
There is a lot of competition in this space, and plenty of financiers willing to put up money for people to buy cars and appliances. However, Regional's approach of staking out neighborhoods and servicing people as neighbors distinguishes them from the rest. The market is also large enough to handle the increasing numbers of consumers moving into this market. Whereas payday lending has effectively stagnated, and is even shrinking, installment lending is picking up considerably. People who had previously been prime credit consumers fell into nonprime during the financial crisis. Americans remain highly leveraged, so when credit cards get maxed out, the next obvious stop are installment providers.
Nevertheless, Regional's operations compete with other installment lenders. Their business should benefit from the recent crackdown by the FDIC and OCC on online lenders and their Third Party Payment Processors. With those companies now crippled, customers who were using those loans in Regional's geographic footprint will move back into the storefronts for payday and installment loans. Other competition includes issuers of non-prime credit cards. Unlike payday loans, where all the providers in a given state essentially charge the same amount, there is pricing competition in the installment space. Their furniture and appliance financing competes with rent-to-own stores.
Another risk is that much of Regional's business is concentrated in three states. I personally do not foresee any legislative risks in theses states (in fact, NC actually just permitted rate increases), but it's something to be aware of.
From a regulatory standpoint, installment lenders are being left alone. The media, consumer activists, and regulators are focused on payday lending (for misguided reasons, but for reasons nonetheless). Installment lending gets very little press at all. It's not something the CFPB would likely consider a product that sees "sustained use" - which is a code word for "rolling over loans repeatedly". The CFPB hasn't examined the installment lenders yet, as they wisely appear to be collecting data and research still on the nonprime consumer in general.
Fundamentals
Regional's fundamentals are solid and improving. The company's gross receivables stand at $552 million as of 9/30/13, serving 309,000 individual borrowers. On average, branch receivables reach $911,000 in the first year of operation, doubling in years 1-3, adding another $500,000 in years 305, and tapering off to about $2.5 million after the fifth year. These receivables translate into branch of profit of $36,000 in year 1, explode to $187,000 in years 1-3, nearly double to $338,000 in years 3-5, and top out at around $509,000 after five years.
Presently, the firm's branch count is diversified across these maturities. 51 have been opened less than a year, 53 have been open 1-3 years, 22 have been open 3-5 years, and 95 have been open more than five years. Thus, significant embedded growth remains in some 60% of the store base. The company continues to open de novo stores, as well.
Between 2007 and 2012, total revenue has a CAGR of 19.2%, resulting in net income CAGR of 52.2%. Throughout, net charge offs have been declining, from 7.8% in 2007 to 6.5% each of the last three years.
Same-store revenues are on fire, up 13.8% per quarter over the last seven quarters. This is due to higher average loan balances, again driven by the aforementioned need for increasing household leverage. Provision for credit losses is at about 20% of total revenue, which is about standard for this sector. The company has a revolving credit facility. It recently did a secondary offering for 2 million shares to help finance its growth.
I like companies that generate tons of free cash flow. A company like this can put that money to work as lending capital and earn great returns on it, without having to take down more debt. The company has virtually no capex. Operating cash flow was $57.5 million in FY12. For the first nine months of FY13, it was $49.2 million, so I expect the full year number to vastly exceed FY12.
You can choose to value this company in a number of ways. I generally use a simple P/E basis. Analysts expect 15% long term growth, and that's a number I would agree with. A 15x estimate on FY14 EPS of $2.95 would suggest fair value at $44, and the stock presently trades at $33. This seems like a bargain to me in the small cap arena, with a 33% upside from here, and long term solid growth.
Another valuation depends on my personal knowledge of this space. The $419 million market cap puts it at about 2.6x TTM revenue and 6.5x OCF. This is 20-25% below what some private placements and M&A activity have fetched amongst some of the private companies in the space.
Either way, Regional looks substantially undervalued to me, with a good story ahead of it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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