NICHOLAS FINANCIAL INC MANAGEMENT REPORT ON FINANCIAL POSITION AND RESULTS OF OPERATIONS (Form 10-Q)
This Quarterly Report on Form 10-Q contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are based on management's current beliefs and assumptions, as well as information currently available to management. When used in this document, the words "anticipate", "estimate", "expect", "will", "may", "plan," "believe", "intend" and similar expressions are intended to identify forward-looking statements. Although
Nicholas Financial, Inc., including its subsidiaries (collectively, the "Company," "we," "us," or "our") believes that the expectations reflected or implied in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. As a result, actual results could differ materially from those indicated in these forward-looking statements. Forward-looking statements in this Quarterly Report may include, without limitation: (1) statements about the expected benefits, costs and timing of the Company's restructuring and change in operating strategy, including its servicing arrangement with Westlake Portfolio Management, LLC("Westlake") (including without limitation the servicing and termination fees) and its exit and disposal activities; (2) the continuing impact of COVID-19 on our customers and our business, (3) projections of revenue, income, and other items relating to our financial position and results of operations, (4) statements of our plans, objectives, strategies, goals and intentions, (5) statements regarding the capabilities, capacities, market position and expected development of our business operations, and (6) statements of expected industry and general economic trends. These statements are subject to certain risks, uncertainties and assumptions that may cause results to differ materially from those expressed or implied in forward-looking statements, including without limitation:
the risk that the anticipated benefits of the restructuring and change in operating strategy, including the servicing arrangement 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;
the risk that the actual servicing fees paid by the Company under the Westlake servicing agreement, which the Company expects to classify as administrative costs on its financial statements, exceed the amounts estimated;
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;
the risk that the Company may underestimate the personnel and other resources needed to operate effectively after consolidating its workforce and closing offices;
uncertainties surrounding the Company’s success in developing and executing a new business plan;
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;
the risk that the lenders under the Wells Fargo credit facility (“WF Credit Facility”) may declare the Company’s obligations under the agreement immediately due and payable;
the continued impact on us, our employees, our customers and the overall economy of the COVID-19 pandemic and the measures taken in response; ;
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 of
Ukraineand related economic sanctions;
the availability of capital (including the ability to access bank financing);
recently enacted, proposed or future legislation and how it is being implemented, including tax law initiatives or challenges to our tax positions and/or interpretations, and state tax rules and regulations sales;
• fluctuations in the economy;
the degree and nature of competition and its effects on the Company’s financial results;
interest rate fluctuations;
effectiveness of our risk management processes and procedures, including the effectiveness of the Company's internal control over financial reporting and disclosure controls and procedures;
demand for consumer finance in the markets served by the Company;
our ability to successfully develop and market new or improved products and services;
the adequacy of our allowance for credit losses and the accuracy of assumptions or estimates used in the preparation of our financial statements;
increases in default rates experienced on our installment auto finance contracts (“Contracts”) or direct loans (“Direct Loans”);
higher borrowing costs and adverse capital market conditions affecting our funding and liquidity;
regulation, supervision, examination and enforcement of our business by governmental authorities, and adverse regulatory changes in the Company's existing and future markets, including the impact of the
Dodd-Frank Wall StreetReform and Consumer Protection Act (the "Dodd-Frank Act") and other legislative and regulatory developments, including regulations relating to privacy, information security and data protection and the impact of the Consumer Financial Protection Bureau's(the "CFPB") regulation of our business;
fraudulent activity, employee misconduct, or misconduct of third parties, including representatives or agents of Westlake;
the media and public characterization of consumer installment loans;
the inability of third parties to provide various services important to our operations;
alleged violation of the intellectual property rights of others and our ability to protect our intellectual property;
litigation and regulatory actions;
our ability to attract, retain and motivate key executives and employees;
the use of third party suppliers and ongoing business relationships with third parties, in particular our relationship with Westlake;
cyberattacks or other security breaches suffered by us or Westlake;
disruptions to the operations of our computer systems and data centers or those of Westlake;
the impact of changes in accounting rules and regulations, or their interpretation or application, which could materially and adversely affect the Company's reported consolidated financial statements or necessitate material delays or changes in the issuance of the Company's audited consolidated financial statements;
uncertainties associated with management turnover and the effective succession of senior management;
our ability to realize our intentions regarding strategic alternatives, including the failure to achieve anticipated synergies; the risk factors discussed under "Item 1A - Risk Factors" in our Annual Report on Form 10-K, and our other filings made with the
U.S. Securities and Exchange Commission("SEC"). Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or expected. All forward-looking statements included in this Quarterly Report are based on information available to the Company as the date of filing of this Quarterly Report, and the Company assumes no obligation to update any such forward-looking statement. Prospective investors should also consult the risk factors described from time to time in the Company's other filings made with the SEC, including its reports on Forms 10-K, 10-Q, 8-K and annual reports to shareholders.
Restructuring and change of operational strategy
Change in operating strategy
November 2, 2022, the Company announced 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 is shifting from a decentralized to a regionalized business model, but continues to remain committed to its core product of financing primary transportation to and from work for the subprime borrower through the local independent automobile dealership. The Company intends to scale down Contract originations to focus on certain regional markets and will no longer originate Direct Loans. The Company's servicing, collections and recovery operations will be outsourced. The Company's operating strategy also includes risk-based pricing and a prudent underwriting discipline required for optimal portfolio performance. The Company expects that this plan will reduce overhead, streamline operations and reduce compliance risk, while maintaining the Company's underwriting standards. The Company further anticipates that execution of this 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 Company's 18 --------------------------------------------------------------------------------
its main objectives are to increase its profitability and long-term value.
Westlake maintenance contract
As part of the restructuring plan,
company (“NFI”) and indirect wholly-owned subsidiary of the Company, has entered into a loan service agreement (the “Service Agreement”) with
Pursuant to the Servicing Agreement, on or around the "Closing Date" (expected to occur prior to early
December 2022), Westlake will begin servicing all receivables held by NFI 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." NFI 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 NFI. 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, NFI 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, NFI 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 expects to classify such fees as administrative costs on its financial statements. Estimates of such administrative costs applied to the initial receivables are provided below. Any additional receivables will also be subject to such servicing fees and presented as administrative costs on the Company's financial statements. Collections of amounts made after accounts have been charged off are split between NFI and Westlake. NFI 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 NFI's prior written consent. If certain events specified in the Servicing Agreement occur ("Servicer Termination Events"), NFI is entitled to terminate Westlake's rights and obligations and appoint a successor servicer under the agreement. The Servicing Agreement will become effective after NFI has transferred the relevant receivables files to Westlake and expires upon the earliest to occur of (i) the date on which NFI 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 NFI 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 the restructuring plan and change in operating strategy disclosed above, the Board of Directors of the Company determined on
November 2, 2022to close 34 of its 36 branches. Consolidation of workforce associated with these closures is expected to impact approximately 173 employees, representing 82% of the Company's workforce as of such date. The expected total charges to be incurred by the Company are between $11.1 millionand $12.4 million, consisting of cash expenditures between $11.0 millionand $12.3 million, and approximately $0.1 millionof non-cash impairment charges associated with lease obligations. Of these expected total charges, the Company estimates incurring, in the first year following implementation of the restructuring plan, between $4.3 millionand $4.6 millionof administrative costs, between $0.2 millionand $0.3 millionof employee-related costs, including severance expenses, and between $3.3 millionand $3.4 millionfor lease terminations, and, in the second through fifth year following such implementation, between $3.2 millionand $4.0 millionof administrative costs in the aggregate. These administrative costs relate solely to the initial receivables described in the previous section and do not include any additional receivables. The closing of branches and consolidation of the workforce is expected to be completed by January 31, 2023. The Company expects that the majority of lease terminations and employee-related charges will be recorded 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.
As noted earlier, Title X of the Dodd-Frank Act established the
19 -------------------------------------------------------------------------------- became operational on
July 21, 2011. Under the Dodd-Frank Act, the CFPBhas regulatory, supervisory and enforcement powers over providers of consumer financial products, such as the Contracts and the Direct Loans that we offer, including explicit supervisory authority to examine, audit, and investigate companies offering a consumer financial product such as ourselves. Although the Dodd-Frank Act expressly provides that the CFPBhas no authority to establish usury limits, efforts to create a federal usury cap, applicable to all consumer credit transactions and substantially below rates at which the Company could continue to operate profitably, are still ongoing. Any federal legislative or regulatory action that severely restricts or prohibits the provision of consumer credit and similar services on terms substantially similar to those we currently provide could if enacted have a material, adverse impact on our business, prospects, results of operations and financial condition. Some consumer advocacy groups have suggested that certain forms of alternative consumer finance products, such as installment loans, should be a regulatory priority and it is possible that at some time in the future the CFPBcould propose and adopt rules making such lending or other products that we may offer materially less profitable or impractical. Further, the CFPBmay target specific features of loans by rulemaking that could cause us to cease offering certain products. Any such rules could have a material adverse effect on our business, results of operations and financial condition. The CFPBcould also adopt rules imposing new and potentially burdensome requirements and limitations with respect to any of our current or future lines of business, which could have a material adverse effect on our operations and financial performance. On October 5, 2017, the CFPBissued a final rule (the "Rule") imposing limitations on (i) short-term consumer loans, (ii) longer-term consumer installment loans with balloon payments, and (iii) higher-rate consumer installment loans repayable by a payment authorization. The Rule requires lenders originating short-term loans and longer-term balloon payment loans to evaluate whether each consumer has the ability to repay the loan along with current obligations and expenses ("ability to repay requirements"). The Rule also curtails repeated unsuccessful attempts to debit consumers' accounts for short-term loans, balloon payment loans, and installment loans that involve a payment authorization and an Annual Percentage Rate over 36% ("payment requirements"). The Rule has significant differences from the CFPB'sproposed rules announced on June 2, 2016, relating to payday, vehicle title, and similar loans. On February 6, 2019, the CFPBissued two notices of proposed rulemaking regarding potential amendments to the Rule. First, the CFPBis proposing to rescind provisions of the Rule, including the ability to repay requirements. Second, the CFPBis proposing to delay the August 19, 2019compliance date for part of the Rule, including the ability to repay requirements. These proposed amendments are not yet final and are subject to possible change before any final amendments would be issued and implemented. We cannot predict what the ultimate rulemaking will provide. The Company does not believe that these changes, as currently described by the CFPB, would have a material impact on the Company's existing lending procedures, because the Company currently underwrites all its loans (including those secured by a vehicle title that would fall within the scope of these proposals) by reviewing the customer's ability to repay based on the Company's standards. Any regulatory changes could have effects beyond those currently contemplated that could further materially and adversely impact our business and operations. The Company will have to comply with the final rule's payment requirements since it allows consumers to set up future recurring payments online for certain covered loans such that it meets the definition of having a "leveraged payment mechanism". The payment provisions of the final rule are expected to go into effect on August 19, 2019. If the payment provisions of the final rule apply, the Company will have to modify its loan payment procedures to comply with the required notices within the mandated timeframes set forth in the final rule. The CFPBdefines a "larger participant" of automobile financing if it has at least 10,000 aggregate annual originations. The Company does not meet the threshold of at least 10,000 aggregate annual direct loan originations, and therefore would not fall under the CFPB'ssupervisory authority. The CFPBissued rules regarding the supervision and examination of non-depository "larger participants" in the automobile finance business. The CFPB'sstated objectives of such examinations are: to assess the quality of a larger participant's compliance management systems for preventing violations of federal consumer financial laws; to identify acts or practices that materially increase the risk of violations of federal consumer finance laws and associated harm to consumers; and to gather facts that help determine whether the larger participant engages in acts or practices that are likely to violate federal consumer financial laws in connection with its automobile finance business. At such time, if we become or the CFPBdefines us as a larger participant, we will be subject to examination by the CFPBfor, among other things, ECOA compliance; unfair, deceptive or abusive acts or practices ("UDAAP") compliance; and the adequacy of our compliance management systems. We have continued to evaluate our existing compliance management systems. We expect this process to continue as the CFPBpromulgates new and evolving rules and interpretations. Given the time and effort needed to establish, implement and maintain adequate compliance management systems and the resources and costs associated with being examined by the CFPB, such an examination could likely have a material adverse effect on our business, financial condition and profitability. Moreover, any such examination by the CFPBcould result in the assessment of penalties, including fines, and other remedies which could, in turn, have a material effect on our business, financial condition, and profitability.
Disputes and legal issues
See “Item 1. Legal Proceedings” in Part II of this quarterly report below.
Critical accounting policy
The Company's critical accounting policy 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. 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 judgement 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.
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 ended
September 30, 2022, the dilutive loss per share was $0.44as compared to dilutive earnings per share of $0.21for the three months ended September 30, 2021. Net loss was $3.2 millionfor the three months ended September 30, 2022as compared to net income of $1.6 millionfor the three months ended September 30, 2021. Interest and fee income on finance receivables decreased 2.6% to $12.2 millionfor the three months ended September 30, 2022as compared to $12.6 millionfor the three months ended September 30, 2021. Provision for credit losses increased 538.4% to $8.9 millionfor the three months ended September 31, 2022as compared to $1.4 millionfor the three months ended September 30, 2021. For the six months ended September 30, 2022, the dilutive loss per share was $0.68as compared to dilutive earnings per share of $0.44for the six months ended September 30, 2021. Net loss was $4.9 millionfor the six months ended September 30, 2022as compared to net income of $3.3 millionfor the six months ended September 30, 2021. Interest and fee income on finance receivables decreased 3.4% to $24.3 millionfor the six months ended September 30, 2022as compared to $25.2 millionfor the six months ended September 30, 2021. Provision for credit losses increased 490.6% to $12.6 millionfor the six months ended September 31, 2022as compared to $2.1 millionfor the six months ended September 30, 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 in
SECrules. 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. 21 -------------------------------------------------------------------------------- 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. Three months ended Six months ended September 30, September 30, (In thousands) (In thousands) 2022 2021 2022 2021 Portfolio Summary Average finance receivables (1) $ 178,636 $ 178,873 $ 178,902 $ 180,364Average indebtedness (2) $ 65,824 $ 72,044 $ 63,340 $ 75,611Interest and fee income on finance receivables $ 12,249 $ 12,572 $ 24,313 $ 25,166Interest expense 975 1,121 1,543 2,309 Net interest and fee income on finance receivables $ 11,274 $ 11,451 $ 22,770 $ 22,857Gross portfolio yield (3) 27.43 % 28.11 % 27.18 % 27.91 % Interest expense as a percentage of average finance receivables 2.18 % 2.51 % 1.72 % 2.56 % Provision for credit losses as a percentage of average finance receivables 19.94 % 3.12 % 14.03 % 2.36 % Net portfolio yield (3) 5.31 % 22.48 % 11.43 % 22.99 % Operating expenses as a percentage of average finance receivables 16.46 % 17.70 % 18.80 % 18.04 % Pre-tax yield as a percentage of average finance receivables (4) (11.15 )% 4.78 % (7.37 )% 4.95 % Net charge-off percentage (5) 12.38 % 4.88 % 9.43 % 4.23 % Finance receivables $ 175,406 $ 177,013Allowance percentage (6) 4.04 % 2.52 % Total reserves percentage (7)
Note: All three-month and six-month revenue performance indicators expressed as a percentage have been annualized.
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) 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). (5) 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). (6) Allowance percentage represents the allowance for credit losses divided by finance receivables outstanding as of ending balance sheet date. (7) Total reserves percentage represents the allowance for credit losses, purchase price discount, and unearned dealer discounts divided by finance receivables outstanding as of ending balance sheet date.
Credit loss analysis
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 22 --------------------------------------------------------------------------------
identify anomalies in the composition of the portfolio, which would indicate that the calculation is overstated and that management judgment may be required to determine the allowance for credit losses for 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. 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.
The provision for credit losses increased to
$8.9 millionfor the three months ended on September 30, 2022, from $3.6 millionfor the three months ended on June 30, 2022, due to a substantial increase in the net charge-off percentage. The net charge-off percentage increased by approximately 91% to 12.4% for the three months ended on September 30, 2022, from 6.5% for the three months ended on June 30, 2022, and from 4.9% for the fiscal year ended September 30, 2021, primarily resulting from increased delinquencies and loan defaults. (See note 5 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 of September 30, 2022was 11.2%, an increase from 7.6% as of September 30, 2021. The delinquency percentage for Direct Loans more than twenty-nine days past due, excluding Chapter 13 bankruptcy accounts, as of September 30, 2022was 7.3%, an increase from 3.3% as of September 30, 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. The delinquency percentages were exceptionally lower across the industry, current delinquency trends return to the pre-pandemic levels. 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 completed
Interest and commission income on financial receivables
Interest and fee income on finance receivables, which consist predominantly of finance charge income, decreased 2.6% to
$12.2 millionfor the three months ended September 30, 2022, from $12.6 millionfor the three months ended September 30, 2021. The decrease was primarily due to a 8.6% decrease in finance receivables to $175.4 millionfor the three months ended September 30, 2022, when compared to $177.0 millionfor the corresponding period ended September 30, 2021. The decrease in finance receivables was primarily the result of a reduction in volume of Contracts purchased, average discount, and average APR. While the reduction in volume continued a trend established under prior management, the decline in average discount and average APR is primarily the result of Company's operating strategy to stay competitive while maintaining conservative underwriting practices. The gross portfolio yield decreased to 27.4% for the three months ended September 30, 2022, compared to 28.1% for the three months ended September 30, 2021. The net portfolio yield decreased to 5.3% for the three months ended September 30, 2022, compared to 22.5% for the three months ended September 30, 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". 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 decreased to
23 -------------------------------------------------------------------------------- employee benefits expenses. Similarly, operating expenses as a percentage of average finance receivables, also decreased to 16.5% for the three months ended
September 30, 2022from 17.7% for the three months ended September 30, 2021.
The provision for credit losses increased to
$8.9 millionfor the three months ended September 30, 2022from $1.4 millionfor the three months ended September 30, 2021, largely due to an increase in the net charge-off percentage to 12.4% for the three months ended September 30, 2022from 4.9% for the three months ended September 30, 2021. Interest Expense Interest expense was $1.0 millionfor the three months ended September 30, 2022and $1.1 millionfor the three months ended September 30, 2021. The following table summarizes the Company's average cost of borrowed funds: Three months ended Six months ended September 30, September 30, 2022 2021 2022 2021 Variable interest under the Line of Credit facility 2.14 % 1.00 % 1.41 % 1.00 % Credit spread under the Line of Credit facility 2.25 % 3.75 % 2.25 % 3.75 % Average cost of borrowed funds 4.39 % 4.75 %
SOFR rates have increased to 2.50%, which represents the daily SOFR rate as required under our Wells Fargo Line of Credit, as of
September 30, 2022compared to 0.1%, which represents the one-month LIBOR rate as required under our Line of Credit, as of September 30, 2021. For further discussions regarding interest rates see "Note 5. Credit Facility". On October 20, 2022, the Company received a letter from the agent of its lenders notifying the Company that it is instituting the default rate of interest of 2.5% imposed effective as of August 31, 2022in connection with an event of default that occurred by virtue of the Company failure to comply with Section 6.3(a) of the Loan Agreement (EBITDA Ratio) for the calendar month ending August 31, 2022. The effect of the imposition of the default rate of interest was an additional interest expense of approximately $130 thousandfor the quarter ended September 30, 2022. Income Taxes The Company recorded an income tax benefit of approximately $958 thousandfor the three months ended September 30, 2022compared to income tax expense of approximately $536 thousandfor the three months ended September 30, 2021. The Company's effective tax rate decreased to 23.4% for the three months ended September 30, 2021from 25.1% for the three months ended September 30, 2021.
Six months ended
Interest income and loan portfolio
Interest and fee income on finance receivables, decreased 3.4% to
$24.3 millionfor the six months ended September 30, 2022from $25.2 millionfor the six months ended September 30, 2021. The decrease was partly due to a lower average discount and a 0.8% decrease in average finance receivables to $178.9 millionfor the six months ended September 30, 2022when compared to $180.4 millionfor the corresponding period ended September 30, 2021. The decrease in average finance receivables was primarily due to Company's commitment to maintaining its conservative underwriting practices, that typically allow more aggressive competitors to purchase a contract from a dealer. The gross portfolio yield decreased to 27.2% for the six months ended September 30, 2022compared to 27.9% for the six months ended September 30, 2021. The net portfolio yield decreased to 11.4% for the six months ended September 30, 2022compared to 23.0% for the six months ended September 30, 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".
Operating expenses increased to approximately
$16.8 millionfor the six months ended September 30, 2022from approximately $16.3 millionfor the six months ended September 30, 2021. Operating expenses as a percentage of average finance receivables increased to 18.8% for the six months ended September 30, 2022from 18.0% for the six months ended September 30, 2021. The 24 --------------------------------------------------------------------------------
the percentage increase is attributable to an increase in administrative expenses and a decrease in average financial receivable balances.
The disclosure on future operating expenses under "Three months ended
September 30, 2022compared to three months ended September 30, 2021-Operating Expenses" is incorporated herein by reference.
Provision for credit losses increased to
Interest charges were
The Company recorded a tax saving of approximately
September 30, 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 ended September 30, 2022and 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 Six months ended September 30, September 30, September 30, 2022 2022 2021 2022 2021 Number of Net Purchases Net Purchases State branches (In thousands) (In thousands) FL 8 $ 3,878 $ 2,798 $ 8,627 $ 6,232OH 6 3,219 2,885 6,202 6,138 GA 5 1,928 2,403 4,687 5,417 KY 2 1,120 1,135 2,621 2,798 MO 2 1,159 1,332 2,549 2,785 NC 3 1,910 1,827 3,750 2,958 IN 2 1,008 1,071 2,118 2,079 SC 2 977 1,242 2,318 2,212 AL 2 1,460 964 2,526 1,783 MI - 64 513 514 1,303 NV 1 535 656 1,103 1,194 TN 1 619 486 915 964 IL 1 463 307 952 746 PA 1 466 372 1,080 732 TX - 68 328 594 663 WI - 80 234 344 520 ID - 40 203 335 374 UT - 23 86 94 231 AZ - 65 38 89 56 KS - - - 18 - Total 36 $ 19,082 $ 18,880 $ 41,436 $ 39,18525
Three months ended Six months ended September 30, September 30, (Purchases in thousands) (Purchases in thousands) Contracts 2022 2021 2022 2021 Purchases
$ 19,082 $ 18,880 $ 41,436 $ 39,185Average APR 22.7 % 23.0 % 22.8 % 23.1 % Average discount 6.4 % 6.7 % 6.5 % 6.9 % Average term (months) 48 47 48 47 Average amount financed $ 11,964 $ 11,061 $ 11,758 $ 10,745Number of Contracts 1,595 1,707 3,530 3,654 Direct Loan Origination
The following table presents selected information on the direct loans granted by the Company.
Three months ended Six months ended September 30, September 30, Direct Loans (Originations in thousands) (Originations in thousands) Originated 2022 2021 2022 2021 Purchases/Originations
$ 6,527 $ 7,040 $ 14,742 $ 12,777Average APR 30.3 % 30.0 % 30.8 % 30.1 % Average term (months) 25 26 25 26 Average amount financed $ 4,574 $ 4,433 $ 4,351 $ 4,396Number of loans 1,427 1,588 3,417 2,904
Cash and capital resources
The Company’s cash flows are summarized as follows:
Six months ended September 30, (In thousands) 2022 2021 Cash provided by (used in): Operating activities
$ (970 ) $ 1,474Investing activities (1,279 ) 6,722 Financing activities (1,023 ) (18,322 ) Net decrease in cash $ (3,272 ) $ (10,126 )The Company's primary use of working capital for the quarter ended September 30, 2022was funding the purchase of Contracts, which are financed substantially through cash from principal and interest payments received, and the Company's line of credit. On November 5, 2021, NFI and its direct parent, Nicholas Data Services, Inc.("NDS" and collectively with NFI, the "Borrowers"), entered into a senior secured credit facility (the "WF Credit Facility") pursuant to a loan and security agreement by and among the Borrowers, Wells Fargo Bank, N.A., as agent, and the lenders that are party thereto (the "WF Credit Agreement"). The Ares Credit Facility was paid off in connection with entering into the WF Credit Facility. Pursuant to the WF Credit Agreement, the lenders have agreed to extend to the Borrowers a line of credit of up to $175 million. The availability of funds under the WF Credit Facility is generally limited to an advance rate of between 80% and 85% of the value of eligible receivables, and outstanding advances under the WF Credit Facility will accrue interest at a rate equal to the Secured Overnight Financing Rate (SOFR) plus 2.25%. The commitment period for advances under the WF Credit Facility is three years (the expiration of that time period, the "Maturity Date"). Pursuant to the WF Credit Agreement, the Borrowers granted a security interest in substantially all of their assets as collateral for their obligations under the WF Credit Facility. Furthermore, pursuant to a separate collateral pledge agreement, NDS pledged its equity interest in NFI as additional collateral. The WF Credit Agreement and the other loan documents contain customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, investments, and sales of assets. If an event of default 26 -------------------------------------------------------------------------------- occurs, the lenders could increase borrowing costs, restrict the Borrowers' ability to obtain additional advances under the WF Credit Facility, accelerate all amounts outstanding under the WF Credit Facility, enforce their interest against collateral pledged under the WF Credit Facility or enforce such other rights and remedies as they have under the loan documents or applicable law as secured lenders. If the lenders terminate the WF Credit Facility following the occurrence of an event of default under the loan documents, or the Borrowers prepay the loan and terminate the WF Credit Facility prior to the Maturity Date, then the Borrowers are obligated to pay a termination or prepayment fee in an amount equal to a percentage of $175 million, calculated as 2% if the termination or prepayment occurs during year one, 1% if the termination or repayment occurs during year two, and 0.5% if the termination or prepayment occurs thereafter. On October 20, 2022, the Company received a letter from the agent of the lenders under the WF Credit Facility notifying the Company that the agent is instituting the default rate of interest of 2.5% effective as of August 31, 2022in 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 ended August 31, 2022. The effect of the imposition of the default rate of interest was an additional approximately $130 thousandin interest for the quarter ended September 30, 2022. The Company expects that an additional approximately $118 thousandin interest will be incurred per month while the default rate remains in place. For the calendar months ended September 30, 2022and October 31, 2022, the Company also failed to comply with the EBITDA Ratio under the WF Credit Facility. The Company is working with Wells Fargo to address the default, and is also negotiating a refinancing opportunity with an alternative source. There can be no assurances that the Company will be successful in addressing the default or entering into a successor agreement on favorable terms or at all. The Company will continue to depend on the availability the WF Credit Facility, together with cash from operations, to finance future operations. The availability of funds under the WF Credit Facility generally depends on availability calculations as defined in the WF Credit Agreement. See also the disclosure in Note 5. Credit Facility in this Form 10-Q, which is incorporated herein by reference. On May 27, 2020, the Company obtained a loan in the amount of approximately $3.2 millionfrom a bank in connection with the U.S. Small Business Administration's("SBA") Paycheck Protection Program (the "PPP Loan"). Pursuant to the Paycheck Protection Program, all or a portion of the PPP Loan may be forgiven if the Company uses the proceeds of the PPP Loan for its payroll costs and other expenses in accordance with the requirements of the Paycheck Protection Program. The Company used the proceeds of the PPP Loan for payroll costs and other covered expenses and sought full forgiveness of the PPP Loan. The Company submitted a forgiveness application to Fifth Third Bank, the lender, on December 7, 2020and submitted supplemental documentation on January 16, 2021. On December 27, 2021SBA informed the Company that no forgiveness was granted. The Company filed an appeal with SBA on January 5, 2022. On May 6, 2022the Office of Hearing and Appeals SBA(OHA) rendered a decision to deny the appeal. The Company subsequently repaid the outstanding principal balance of $3.2 millionplus accrued and unpaid interest of $65 thousandon May 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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