The fiscal year ended March 31, 2019 marked our 34th year in business and our 32nd year as a public company. Although most of those years produced excellent results and record returns, the last several years have resulted in meager and even negative earnings. Fiscal year 2019, in fact, resulted in a material net loss. However fiscal year 2019 was also a very important and even transformative year for Nicholas Financial. It was a year in which we faced our challenges head on and addressed the policy and strategy mistakes instituted during fiscal years 2015 through 2017. We secured stability of liquidity, improved our infrastructure and technological capabilities, added new product lines and ultimately improved the overall health and stability of our great Company. Shortly after the end of the fiscal year, we closed on the acquisition of Metrolina Credit Company – the first major transaction in the history of Nicholas Financial and one that was immediately accretive to earnings.
When I returned to Nicholas Financial in December of 2017, I took over a company which was very much on the decline. The many challenges we faced then included too many strategic and
Doug Marohn
President & CEO
operational policies that ran counter to our current plan for success. These counter-productive policies created a lack of any real brand identity, no obvious value proposition to our core clients (the independent preowned car dealer), a toxic legacy portfolio with uncontrolled losses comprised of lower yields and other deficient underwriting aspects. Other circumstances that were detrimental to success of Nicholas at the time included an archaic customer servicing platform, a strained relationship with our bank group, operational expenses that were two and three times those of our competitors, and a shrinking portfolio that just exacerbated all of these other challenges. From the day I walked back through the doors of Nicholas Financial on December 12, 2017, our strategy has been to systematically address each one of these challenges and to build the base necessary to return this unique and excellent Company back to the successful organization it had been for three decades prior. I am happy and proud to report to you that line by line, item by item, that is exactly what we accomplished in fiscal year 2019.
The letter I wrote to you a year ago laid out the many policies and strategies enacted in previous years that were simply counter to those in place when we enjoyed 30 years of impressive and often record returns. We showed how most of our existing portfolio was built on several years of aggressive underwriting with loose controls, deficient pricing and improper structure. We produced a chart showing how the key performance indicators (KPI’s) from fiscal years 2015 through 2017 deteriorated to unsustainable levels that were damaging to profitability and detrimental to what simply makes sense.
To answer that, it is important to look at the core principles on which Nicholas Financial was originally founded. These are the exact reasons why we were so successful for so long. First and foremost, we began as a company that offered true “common sense” lending in the subprime space. We focused on financing primary transportation to and from work for the subprime customer. We did not finance luxury vehicles, second cars or weekend / recreational units. We only financed basic transportation for our customers, and as such we focused on modest amounts financed over shorter terms and with reasonable payments.
We also proved early on that our renewed commitment to common sense lending in this space produced improved yield through increased rate and discount. Additional benefits included lower exposure through reduced amount financed, shortened monthly terms and improved loan to value, while at the same time maintaining level credit profile aspects of our borrowing customer. Since that letter a year ago, we have continued to improve on each of those KPI’s. We have increased the average rate to 23.5%, increased the average discount to approximately 8% and reduced the average amount financed to under $10,000. We have also shortened the average term to less than 48 months, reduced the LTV to about 100% and have kept the average FICO range in line with (and in some cases better than) our historical credit profiles of the last 10 years. The chart below illustrates the material improvement on our underwriting metrics since December 2017.
The premise for these changes was that we would reduce our losses through better underwriting and deal structure. This theory has proven to be absolutely correct. In each of the quarters reported since my return, we have experienced vastly improved loss timing curves on the pools of business produced. The following write-off charts represent the two most seasoned pools and illustrate the improved portfolio performance.
Another failed policy that was instituted at Nicholas a few years ago was extending the charge-off parameters in terms of allowable delinquency. Whereas we had historically charged-off accounts when they went over 120 days past due, the Company changed that in 2016 to charging off after 180 days past due. This change exacerbated the negative performance of our portfolio.
Not only did that policy impact the timing of repossessions, it also impacted the way our employees serviced and collected the accounts. Too often, there was not a focus on collection efforts for accounts “only” 60 or 90 days past due. This created an unmanageable build-up of late stage delinquency, made up of accounts that could have been addressed and resolved earlier.
In fiscal year 2019, we made the purposeful and strategic decision to return to the traditional 120-day charge off policy, which resulted in a one-time charge-off of approximately $6.4 million. The decision also had an impact on our provision expense of approximately $4.9 million. Had we not made this decision, we would have had positive net earnings of well over $1 million for the fiscal year.
This return to the traditional 120-day charge off policy affords us many positives despite the negative impact on our fiscal year 2019 financials. This change brings us more in line with industry standards. It also creates a greater sense of urgency when servicing past due accounts. The 120-day charge off policy benefits our customers as well, in that if we do have to repossess a vehicle due to delinquency, we are doing it earlier in the account life. Since the customer is only 2 or 3 payments past due versus 4 or 5, it makes it much more feasible for a customer to redeem the vehicle, if they have the ability and are willing to do so. In the event of a repossession that does not get redeemed, the collateral is typically in much better condition than if it were repossessed later in the delinquency cycle.
We are also already seeing an increase in recovery dollars on charged-off accounts and anticipate that to continue. Finally, it allows for a much more transparent snapshot of the portfolio.
Continuing on the topic of servicing, Nicholas Financial had used an internally built software application for our loan servicing since inception of the Company. The system was extremely secure, experienced virtually no down time and was a great “work horse” overall. It was not without limitations, as the aging technology at its core made integrating third-party vendors more difficult, and the available workforce familiar with the dated software platform was becoming increasingly scarce.
Other reasons for moving to a more contemporary system include limited reporting tools and a perceived lack of user friendliness for the borrowing customer as they accessed their account. After vetting many available platforms, we made the decision to convert our Loan Management System to GOLDPoint Systems in June of 2018. We completed the conversion from our internal system to the GOLDPoint system in February of 2019.
The conversion to GOLDPoint Systems provides Nicholas Financial with a significantly improved technological foundation that provides countless benefits, including materially improved reporting capabilities, a streamlined capability to interface with vendor partners and 3rd party products,
enhanced user functionality and management tools as well as a vastly more robust customer portal. We jokingly refer to our old system as the “Pong” video game from the 1980’s and GOLDPoint as being more akin to “Fortnite”.
One of the biggest challenges beyond simply executing on our business model, was our ability to maintain sufficient capital and liquidity for the long-term. For many years the Company had enjoyed a very positive and stable relationship with its bank group.
However, the current state of the Company and the recent performance of our portfolio were such that we were constantly being issued pricing increases, short term renewals and covenant restrictions that made operations and strategic planning more and more uncertain. We knew it was time to find a partner who not only understood our business but also recognized our long history of success and – more importantly – believed emphatically in our direction and future. On March 29, 2019, we were excited to announce our new credit facility with funds managed by affiliates of Ares Management Corporation that replaced our warehouse line with the previous bank group.
The new Ares Management facility was a big win for Nicholas across the board. The $175 million facility affords us sufficient capital and liquidity to fund our business. The three-year term gives us the security and stability to allow us to focus on the business of the business, instead of the uncertainty of constantly negotiating short term renewals. The terms and conditions are attractive and provide us with much more flexibility in dealing with our capital requirements. The freedom of a long-term facility with what we feel are improved terms and pricing have us focused directly forward instead of constantly looking over our shoulder.
Being cognizant of our increasing operational expense percentages, as a result of our shrinking portfolio due to the increased focus on deal structure and pricing over volume, we made some hard decisions in the 4th quarter. We exited two states (Virginia and Texas) entirely for the time being. Unfortunately, the four offices in these two states have been drags on our P&L for years and we simply could not continue allocating resources to these unprofitable operations. We also identified several select offices for consolidation in multi-branch markets. As of the date of this letter, we have reduced our branch count in the Raleigh and Charlotte
As of the date of this letter, we have reduced our branch count in the Raleigh and Charlotte markets of North Carolina and in Atlanta, Georgia, while still maintaining one or more branches in each of these markets.
In addition to the market exits and consolidations, we are excited to report we are still actively looking to grow our network in viable new markets. We are currently generating business and building portfolios in Columbia, South Carolina and Milwaukee, Wisconsin. We intend to open full-service branches in both markets in the not too distant future. There are several other markets under consideration for potential expansion, as well.
One of our more exciting ventures in fiscal year 2019 has been our initiatives to grow our Direct Loan business. What was primarily a product we only offered in Florida is now also in place in North Carolina, Georgia and Ohio. These loans are principally offered to our existing and former customer base. For the most part the Direct loan accounts have performed extremely well, with delinquencies and losses as low as half of what we’ve seen in our Indirect portfolio. Recently we have initiated the process of getting licensed to offer this product in all the other states in which we operate. We hope to be able to offer this product in every branch across our network by the end of the year.
At the conclusion of the fiscal year, we were able to look back over the previous 12 months with a sense of accomplishment. We had faced our challenges head-on and were able to execute on solutions that we believe are positive for our Company now and for years to come. But we were not done there.
On April 30, 2019 – the first month of the new fiscal year 2020 – we announced with great pride and enthusiasm the acquisition of Metrolina Credit Company. Metrolina was my home for the four years prior to rejoining Nicholas. As their President and CEO from 2014 through 2017, I was intimately aware of Metrolina’s operations, portfolio, personnel, culture and potential. The consolidation of two companies so similarly aligned made for an exciting transaction that was immediately accretive to Nicholas. The acquisition of Metrolina not only added over $22 million of performing receivables to our portfolio but it also removed a direct competitor from the Carolinas. The synergy between the two companies allowed us to immediately assimilate a talented group of Metrolina employees and expanded our Carolina dealer base significantly.
Interestingly, all our major accomplishments were closely intertwined and most likely could not have happened without the combined interaction. We needed to convert to a more technologically advanced loan management system.
We needed to secure a different credit facility that provided security and stability. We needed to find a way to stem the shrinking of our portfolio. What we found out is we could not have closed the new credit facility without having converted to our new servicing platform, due to the sophisticated reporting requirements of an ABS facility. Subsequently, the new credit facility allowed us the capital and flexibility of use to act quickly when the potential Metrolina Credit Company acquisition surfaced. This was something we could not have accomplished under our previous credit line.
Now that fiscal year 2019 is behind us, we look forward to fiscal year 2020 and beyond. Armed with improved infrastructure, more stability of funding, and a shot in the arm from our acquisition of Metrolina, we are charging into 2020 with more momentum than I can remember at Nicholas. Our focus now is to not only acquire good quality loans that are well priced and structured but to also increase the volume of loans purchased, allowing us to grow the Company again. Everything we have done in this past year was executed with the intention of getting us to the place we are now. There are still many challenges ahead of us both internally and externally. It will not be an easy row to hoe for the foreseeable future. However, we are now poised to focus on offense as much as defense, so we can grow our business, our portfolio and our returns for our investors.
We thank all of you who have invested in Nicholas. We truly appreciate your support and continued belief in our Company. On behalf of our Board of Directors, our management team and all our wonderful and dedicated employees, thank you for your confidence, support and trust.
Doug Marohn
President & Chief Executive Officer
July, 2019