CURO Group Holdings Corp.

Good day and welcome to the Kuro Holdings fourth quarter 2022 conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Tamara Schultz, Chief Accounting Officer. Please go ahead.

Thank you, and good morning, everyone. Before the market opened today, Curo released its results for the fourth quarter 2022, which are available on the Investors section of our website at ir.curo.com. With me on today's call are Curo's Chief Executive Officer, Doug Clark, and Chief Financial Officer, Izzy Doblin. Before I turn the call over to Doug, I'd like to note that today's discussion will contain forward-looking statements based on the business environment as we currently see it. As such, it does include certain risks and uncertainties. Please refer to our press release issued this morning and our Forms 10-K and 10-Q for more information on the specific risk factors that could cause our actual results to differ materially from the projections described in today's discussion. Any forward-looking statements that we make on this call are based on assumptions asked of today, and we undertake no obligation to update or revise these statements as a result of new information or future events. In addition to U.S. GAAP reporting, we report certain financial measures that do not conform to generally accepted accounting principles. We believe these non-GAAP measures enhance the understanding of our performance. Reconciliation between these GAAP and non-GAAP measures are included in the tables found in today's press release. Before we begin, I'd like to remind you that we have provided a supplemental investor presentation that we will reference in our remarks and that you can find it in the events and presentation section of our IR website. With that, I would like to turn the call over to Doug.

Thanks, Tamara. Good morning, everyone, and thank you for joining Izzy and I today for our first earnings call here at Curo. December wrapped up a transformational year for Curo. While the first three quarters of the year were largely focused on the logistical aspects of the acquisitions and divestiture, in the fourth quarter, we were able to focus on the operational execution of our new businesses and begin to put into motion our playbook to generate long-term, sustainable returns for our investors. While I'll leave it to Izzy to run through the Q4 results, let me start by laying out the framework for how we will be managing the business in 2023 and beyond. In December, we streamlined our organizational structure and created clear alignment and accountability. We will responsibly grow our loan portfolio, but we are taking a disciplined approach focused on resilient credit and will not chase volume for volume's sake. Turning to slide four of the deck, we ended the year with gross loan receivable balances of close to $2.1 billion. This represents a 10% increase and 35% increase of where we ended the third quarter 2022 and December 2021, respectively. The fourth quarter growth was largely driven by our Flexity business coming out of a strong holiday shopping season in Canada. We saw more modest growth in our direct lending businesses as the steps we have taken to tighten underwriting continue to take hold. Beginning in the first half of 2022, we began tightening credit particularly in our lower credit tiers and increased pricing on certain products. We did this in reaction both to the growing uncertainty in the macroeconomic environment and rising interest rates. And remember, with our U.S. consumer base, especially in the lower credit segments, they acutely feel the impacts of inflation. Unemployment rates for our customers remain at historically low levels. And while they have notionally benefited from the rise in minimum wages, the macroeconomic impact of inflation on this borrowing base lowers net monthly incomes, therefore creating smaller net disposable income margins. In addition, the excess savings our borrowers were able to build during the pandemic due to the various government stimulus programs has evaporated, and they have since returned to the levels we had seen prior to the pandemic. On the loan collection and servicing front, we have moved later stage servicing out of the branches and created a centralized team with expertise to help these borrowers. We have also rolled out additional loss mitigation tools to help get our customers back on track and minimize our losses. Turning to slide five, we expect NCOs to peak by the end of Q1 as the tightening we did across the portfolios, coupled with the improvement in servicing that I just mentioned, takes hold. While it's still early, we are encouraged by the early-stage delinquency improvements we are seeing across all of our businesses. And if you look at the top of slide six, you can see the improvements in delinquencies across our portfolio segments. In fact, our high-large loan portfolios, our current 31-plus delinquencies, are showing a 15% to 20% improvement over Q3. On the small loan side, our 31-plus delinquencies are relatively flat. Of our large loan balances as of the end of December, over 50% were originated in the second half of 2022 post credit tightening. On the first heritage portfolio, recent credit performance is encouraging as early stage delinquencies are starting to come down from where they were in the middle of the fourth quarter. And we expect to see further improvement in 2023 as the loan collection and servicing capabilities are centralized with Heights. In the direct lending business in Canada, We also experienced a decline in Q4 delinquencies. Similar to our U.S. direct lending business, we identified a variety of opportunities to help mitigate delinquencies and charge-offs. In Q4, we rolled out additional tools for our consumers, including partial payment options and making it easier for them to make payments using debit cards. Beginning in January, we changed our charge-off policy to 180 days to align with the rest of our charge-off policies across the company. The charge-off policy change in Q1 2023 will result in a one-time lower charge-off for the first quarter, as only loans will be charged off for legal reasons such as bankruptcy or fraud. However, charge-offs will revert to a more normalized rate beginning in the second quarter. We are excited about these changes that are being made to the way we service our Canadian direct lending customers and believe that this will have a meaningful benefit to delinquency and net charge-off rates in later 2023 and into 2024. I'll now turn it over to Izzy to run through our Q4 results, and then I'll close with some thoughts about our business and where we will be focusing our efforts in 2023.

Thanks, Doug, and good morning. Let me start by taking you to our Q4 results on slide 7. For the fourth quarter, revenue was $217 million. The year-over-year decrease was 3% despite an increase in receivables. The decrease was primarily driven by a sale of our legacy business and transition towards a lower risk and more sustainable business model. This is further evidenced by the decrease in net interest margin post-charge-offs from 39% to 18%. Interest expense of $55 million was up 93% over the prior year, representing an increase in debt to support receivable growth and an increase in interest rates. Operating expenses was $126 million in Q4 and included $13 million of restructuring expenses, primarily associated with our previously announced store closures in Canada and the U.S. and other cost-saving initiatives. Other expenses of $148 million primarily represents a goodwill impairment associated with our U.S. direct lending and Canada point-of-sale segments. Net charge-offs of $74 million representing a charge-off ratio of 15%. The charge-off ratio is sequentially higher, as expected, driven by higher delinquency rates in the second and third quarter. As Doug shared in his earlier comments, recent delinquency trends point to lower charge-offs in the future. Provision bills and other credit changes were $21 million for the quarter. Our net loss for the quarter was $186 million, or $4.60 per share, compared to a net loss of $29 million, or 72 cents per share, in the fourth quarter of 2021. Excluding the impact of goodwill impairment and restructuring expenses, our pre-tax loss ex-provision was $48 million. Pre-provision income will be a key metric for us as we move into 2023 because I believe it to be a good measure to evaluate the underlying performance of our company without the quarterly volatility caused by loan loss provisioning, especially as we will be adopting CECL in the first quarter of 2023. Before we move off this page, I want to highlight some additional metrics that we will also be focused on in the future. First, we added net interest margin post-charge-offs. Quite simply, this is a risk-adjusted return on our assets. We like this metric because it holds us accountable to ensure we are getting the appropriate returns commensurate with the credit risk we are underwriting, while also balancing out the cost of funding. Another metric we are introducing is an OPEX ratio. I'll speak to that later in the presentation. Turning to slide 8, you can see how the business results for our segments build up to these key metrics I just mentioned. As Doug discussed earlier, internally, we really don't differentiate between the direct lending businesses. By that, I mean we have the same teams developing strategy, managing, and running those businesses. The primary difference is which side of the border the customer resides and how we choose to finance the business. While all the centralized expenses that support the direct lending business fit in the U.S. segment, these expenses should be looked at on a total direct lending basis. This does not apply to our point-of-sale or flexity business, where their operating expenses are largely self-contained. The net charge-off ratio is 21% for a direct lending business and 4% for a Canadian point-of-sale business. Net interest margin post-charge-offs are 25% and 7% respectively. On slide 9, you will see the allowance bill this quarter. This is largely driven by loan growth and credit normalization we discussed. Also, I'll note on January 1st, we adopted the CECL allowance model for our credit losses. This will replace our current incurred loss accounting model. While we are still finalizing the details, we expect the adoption of this accounting requirement to result in a day one allowance bill of between $130 to $140 million. We will recognize this non-cash accounting adjustment through our opening retained earnings. Turning to slide 10. Our fourth quarter net risk margin post-charge-offs was 18%. The large year-over-year decrease is attributable to the strategic shift we made in early Q3 when we sold our high-yielding, yet higher credit loss, legacy U.S. business. The decline from last quarter is due to credit tightening across all of our businesses and a mixed shift in our U.S. offerings as large loans became a bigger percentage of the overall portfolio as we focused on better credit quality in the face of macroeconomic uncertainty. On slide 11, we will turn our attention to expenses. For the fourth quarter, our reported expenses were $126 million and includes $13 million of restructuring charges that I mentioned earlier. In the fourth quarter, we took actions that eliminated $20 million of expenses and are reinvesting these savings in 2023 to improve the capabilities in our operations to help support execution of our strategy. On the right-hand side, you can see our operating expense ratio. The Canadian point-of-sale business continues to build scale, and the direct lending platform is starting to show incremental progress. This will be a key metric for us going forward to measure improvement on the efficiency of our operations. Turning to slide 12 is a summary of our debt facilities and interest rate sensitivity. Effectively, two-thirds of our debt is fixed but still impacted by the increase in base rates. Our corporate debt has a fixed rate of 7.5% and maturity five years from now, and our lending activities are supported by various facilities with multiple counterparties in the U.S. and Canada. To note, in the first quarter, our Canadian revolver was terminated. On slide 13, we will focus our attention on our leverage and liquidity. Our leverage has continued to increase as we transition our business model and continue to grow our balance sheet. Our interest coverage ratio has also decreased over the last several quarters with lower profitability and higher interest expense. In the appendix, we have provided the details of how we view the calculations. With the growth in our business, we have also seen our debt facility capacity decrease. We're actively working on adding an additional $100 million in liquidity and capacity in Q1. Finally, on slide 14 is a quick overview of our outlook for first quarter. Until Doug and I get more familiar with the company, we will provide an outlook for the upcoming quarter and focus on key areas where we are driving results. For Q1 2023, we expect receivables to end at between $2 and $2.05 billion and revenue of $195 million and $215 million. Net charge-offs are expected to be 15% to 17% on a normalized basis. Our reported charge off amounts of Q1 will be lowered by approximately $20 million, or 14 to 16%, as we harmonize our charge off ratios and policies across the direct lending businesses. Our reported operating expense in Q1 is expected to be flat versus Q4 2022. With that, I will turn it back over to Doug to share closing remarks.

Thanks, Izzy. As I've just passed my 90-day mark as CEO, I wanted to share my thoughts on our overall business and what excites me about the path we are laying out for long-term value creation for our investors. Our direct lending business, comprised of Heights First Heritage and our Canadian segments, provide a tremendous platform for growth. As we continue to mature our capabilities in each of these segments, we anticipate attractive growth, improving delinquencies and charge-offs, and expanding margins. We have a terrific team of talented professionals in place, and I am highly confident in our ability to execute our strategy and deliver meaningful results to our shareholders and investors. The Flexitive team has built a great product and platform in Canada. However, as a largely prime book that operates on high volumes with thinner margins than our core business, it may benefit from lower cost of funds. As such, we continue to evaluate all options as it relates to our Flexity business to help increase profitability. 2022 was a tumultuous year for Curo as we completed our strategic transformation. We did not deliver on the results that we intended and that our investors deserve. We understand that we must perform better. On slide 15, we've laid out our long-term vision for Curo. Across all of our lines of business, we will be focused on ensuring steady yields on our lending product, stabilizing losses, improving our cost structure, and strengthening our overall liquidity. Both Izzy and I need to spend more time with our businesses before we are ready to share our long-term targets. So the bullet points on the slide captures our areas of focus and where we will be leading the company as we continue to formulate our longer vision. This concludes our prepared remarks and we'll now ask the operator to begin Q&A.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question today comes from Moshi Orenbush with Credit Street. Please go ahead.

Thanks, and welcome, gentlemen. Thanks, and especially Izzy. Good to talk to you again. The first thing I guess I was hoping to get a little more clarification on is when you said, you know, talking about additional or other options with respect to Flexity, are you talking about options with respect to funding or are you talking about options with respect to kind of ownership of the business? Kind of give us a little more, flesh that out a little bit.

Well, Moshe, this is Doug. Thanks. Great talking to you again. Certainly we are considering all alternatives for the business. It's clear that with our cost of funding, we are not necessarily the best partner for Flexity. As said, they have a fantastic platform, and we really want them to be able to realize everything that they've got in their strategy. And so we're actively seeking a partner for them that can help them grow. Got it.

There was some discussion over the last couple of quarters about trying to enhance the yield, both from this kind of hoping that some of the existing customers would be borrowing and then kind of migrating into the non-prime consumer. Is there any change there? Has that happened at all? Can you give us a little bit of an update?

There's been a slight increase in the number of consumers going to the revolving product in the Flexity business, but nothing material as of yet as we think about long-term yield on that product.

Got it. And then I guess I was sort of hoping that there would be a reduction in expenses as opposed to flat. You talked about reinvesting the savings, I guess. Can you kind of give us a thought about how to think about the evolution of your of your operating expenses, you know, a little bit past Q1?

Yeah, sure. Hey, and Moshe, good to talk to you again. I'm sure we'll be chatting later in the day as well. Yeah, in terms of our expenses, kind of what we have done, we've announced the store closures, we've taken some corporate expenses out. So that is helping our overall expenses be lower in 2023 by roughly $20 million. We have done that. The reinvestments are primarily in terms of collection operations. It is in store wages for our employees. It's investment from the, you know, moving from data centers to cloud. But overall, our goal is to ensure that that OpEx ratio improves. 90% of our expenses are fixed or close to it. So as a result, the structural changes in those expense reductions are just going to take longer than just, you know, going in and cutting expenses right and left. That being said, you know, we feel pretty good that OPEX ratio over time will and needs to improve. And we'll probably discuss that a little bit more on our next Q1 call when Doug and I have been able to spend more time going through the expense space in the business.

Got it. Then the last one, I guess, I was trying to understand the comments about, you know, kind of improving delinquency that, guidance in the first quarter for losses, which you said, you know, it was, you said fourth quarter was 15 and that, that on a normalized, if you kind of, you know, hadn't made the change 15 to 17 for the first quarter. So, um, I guess in kind of squaring that, I thought you had said that, that, you know, fourth quarter was, was sort of the peak. So maybe could you just kind of discuss how you're, you're thinking about those charge offs and, um, You know, since you're kind of only giving guidance one quarter out, like, what will it take to, you know, to see reduced charge-offs? And, you know, when can we, you know, what's the timeframe?

This is Doug. I think the 31-plus delinquency is your best indicator of future charge-offs, which is why we shared those charts. So obviously with a 180-day charge-off window, what's rolling into Q4 was the Q3-ish type delinquencies oftentimes. So if you track our delinquency chart, that's why we would say charge-offs seem to be peaking in Q1, and then we would, as those 31-plus delinquency buckets come through, roll through, we would anticipate lower charge-offs beyond that. Got it.

Okay. Thank you.

The next question comes from John Hecht with Jefferies. Please go ahead.

Hey, morning, Doug and Izzy. Good to chat. Thanks very much. I guess just making sure I understand the moving parts with the provision in Q1. I mean, you have your CECL bill, I think you said 130, 140. That's a capital charge, obviously, not a provision. That's correct. And then we should just think beyond that, the provision will account for charge-offs and then as well as any maybe loan growth. Is that kind of the way to think about provision in Q1?

In total, yeah. So, it's a combination, John, of charge-offs and the allowance bill, right? And on the allowance bill, we're transitioning to CECL. As you can imagine, I'm trying to get comfortable getting my arms around it, how that will perform as our business mix changes. So we're not providing any guidance on it, but the way you're thinking about it is correct. The allowance bill going forward will roughly be based on loan growth or even the changing expectations, good and bad, on the portfolio.

And then I just want to make sure the 15% to 70% net charge-off rate you're guiding to it's actually going to be the results on a, I guess, on a reported basis are going to be $20 million below that because of the change in the timing? Okay. And so will Q2 then be a catch-up quarter where there's, like, they'll be elevated for that change in timing, or will that just get balanced over the course of the year?

No, it just gets back to normal in Q2. So it's just Q1. Maybe, John, if I describe the change, effectively it's harmonizing our policies at First Heritage from a 90-day charge-off to a 180-day charge-off. So, effectively, there is a period where, you know, you're going to have the balance to stay on the receivables and not, what do you call it, go through charge-offs. Sorry, on the CDL, not First Heritage. I was corrected. I'm learning a bit. And it's just the first heritage platform? Sorry, the Canadian, the Canadian direct lending platform. That's it.

Okay. And then it sounds like you're right-sized some branches in the core. I mean, how do we think about branch versus non-branch activity now in terms of mix as well as kind of yields and overall performance?

John, are you saying as far as number of branches or can you clarify your question? Sure.

I guess the mix of the different channels and branches, I guess you've changed some of the product sets. You've got the Canadian business and a couple of different legacy U.S. store platforms. Is the mix now kind of in the branch network, is that pretty much the way you see the channels going forward, or should there be other changes that we should think about?

Well, no, I think it's predominantly a branch-based business. We have a small portfolio in Canada that is online only. As we, you've heard the word I've used, mature, we mature our credit risk fraud capabilities. We anticipate growing our online channel in Canada, but that is not in the next two queues. So overall, it will remain a primarily branch-based business in 2023. Okay.

And my last question is just you talked about your goals for liquidity in the near term, but just thinking about overall the changes in interest rates. I mean, I know that the forward curve expects a few more smaller rate hikes, but has the impact of the changes in the rate market, whether it's on yields of products and or your cost of capital, has that largely been embedded in your margins or are there other things to consider that we should be thinking about over the next few quarters?

No, it's largely been embedded. John, good question. Most of our rate exposure is fixed. Like a third of it is exposed. So if you think about roughly close to $2.5 billion in debt, $800 would be still exposed to variable rates. So it'd take a pretty meaningful increase from where we are now for that to meaningfully impact margins.

Great. I really appreciate that, guys. Thanks very much.

The next question comes from John Rowland with Channing. Please go ahead.

Good morning, guys. Good morning, John. Izzy, welcome. Thank you. So I guess I'm just trying to wrap my head around kind of the path to profitability and how that relates to flexity. You know, I had, you know, I don't want to say been under the impression, but, you know, thought that, One of the paths to improved results was just a slowdown in growth in Flexity and getting more customers into the portion of the contracts that are, you know, actually paying. Is that now kind of not on the table because Flexity just wants to continue to grow and they need a better funding source than what Kiro can provide? I'm just curious, you know, between the two options of slowing growth, one, and basically looking to offload the business, two, is one now off the table?

I wouldn't necessarily say that, John. I think we're evaluating the first option, which is finding a strategic partner for them to continue to accelerate. Again, they have a great solution that they've built, and I think with the right partner, they can continue to accelerate that business. So that is our priority. If that's unsuccessful, then, of course, we're going to have to look at how to return to profitability in a quicker manner on our Flexity platform.

Okay. All right. And then just one question on the guidance. You said operating expenses would be flat sequentially, but there were a bunch of restructuring expenses. If I look at the adjusted earnings table and the financial supplement, are we talking about operating expenses on a normalized basis, or are we talking about operating expenses including the restructuring costs?

On a reported basis.

So that includes all the restructuring. Is the restructuring going to continue, or is that just the run rate?

No, we're going to have a little bit more remaining in the first couple of quarters here. John's still kind of working through that. I would say the abundance of caution, I would just assume a flat operating run rate into Q1. Okay. All right. Thank you.

The next question comes from Vincent Kaincic with Stevens. Please go ahead.

Hey, good morning. Thanks for taking my questions on Izzy. Good to talk to you again. So I wanted to focus on the U S business. So understanding that there's a lot of moving pieces and you've been in the seat for a short period of time, but Doug, you know, having come from the heights business, maybe if you could kind of talk about where we are now and you know, where you see that path to profitability and you know, sort of what a normalized business looks like for the U.S. side. Thank you.

Yeah. Thanks, Vincent. So, we have two platforms in the U.S., First Heritage and Heights, and you'll continue to hear me talk about maturing our capabilities. Those business models are both immature in many ways, and I kind of introduced the We introduced late-stage collections, centralized collections teams. We're still refining our underwriting capabilities. We're still implementing a single platform for the business. So we have a lot of technology work, and we will be expanding our secured lending business. So what I would say when it comes to... Heights in particular, there's growth through product mix, but there's also growth through improved NCO margins. We talked about the declining delinquencies. I do believe that we'll continue to have a stabilization of that and improve our margin in that business. And in Heights' case, we opened up, I believe, 39 branches last year, so we'll continue to look and work towards a branch expansion program. On the First Heritage business platform, it is, I guess, more immature than Heights, and so that creates that many more opportunities. So aligning their underwriting philosophies to Heights, if you go back to Heights historical information, when prior to Kiro's acquisition, Heights grew their portfolio by, I believe it was about 30% in 2021. one over 2020, something like that. And a lot of it was addressing the underwriting philosophy and making sure we right-sized loans to risk. And so that's a huge opportunity for First Heritage. And then, of course, secured lending, as I mentioned, for Heights will be an opportunity to expand and eventually potentially branch expansion.

Okay, great. That's super helpful. Thank you. And then switching to liquidity to kind of follow up there, Izzy. So if you could talk about kind of the environment out there for getting liquidity, what do you think is sort of the right size for, you know, where you want to position the liquidity and balance sheet going forward? Thank you.

Yeah, Avison, great question. And, you know, it's definitely something we've been thinking about. You know, one of the, I'll answer in the following way before I get to the punchline. You know, one of the things you do see in the disclosures made and you follow the company, the unit economics are strong, right? So, in terms of making a loan, we can generate good excess spread. Doug's outlined where we can see improvement in that as well as we mature some of the operations and collections processes across our U.S. businesses. That's number two. I think the biggest thing is making sure that when we expand and grow our business, we have the capacity to do that. We are our lending partners. That being said, our performance are still within the covenants and within acceptable limits with our facilities. So talking to all our lending partners, we are seeing that we will have access to liquidity and capacity to grow the business in a way that makes sense. And that's important because As you probably are thinking through it, that's our path to profitability, right? I will say that right now in Q1, my goal is to raise $100 million in capacity slash liquidity. We're making good progress. We have great support of our lenders and our bondholders. They see the performance of the asset. So, you know, fingers crossed, we should be able to execute on that at least in near term. And then in Q1, on our Q1 call, as Doug laid out, we will talk about a net leverage kind of goal for us down the road, which will encompass kind of where I see like long-term liquidity and capacity needs to be.

Great. That's very helpful. Thanks very much.

As a reminder, if you have a question, please press star then 1 to enter the question queue. The next question is a follow-up from Moshi Orangush from Credit Suite. Please go ahead. Moshi, your line is now open.

Great. Just wanted to follow up on that Cecil commentary. In the first quarter, it likely would – you'd probably – after having the day one add, given you expect loans to be lower, that unless there's an adverse change in credit quality, you would probably see that reserve falling in Q1, right? I mean, that's – It could happen, yeah.

Yeah. There's a mix also, right? So even though overall loans are falling, I think we see growth in one versus the other. We're still kind of working through that. But that's a fair – I mean, you can reach that conclusion. Got it. Right.

Okay. All right. Just wanted to clarify that. Good. Thank you.

The next question comes from John Rowan with Channy. Please go ahead.

Sorry, guys. Just one follow-up here. Obviously, Izzy, it sounds like you're tasked with generating some liquidity for the company. I mean, is selling Flexity – or possibly selling Flexity part of that liquidity equation? You know, just forget about, you know, whether or not that creates earnings. Is that part of, you know, the model to generate liquidity?

Yeah, not in the near term. You know, in the near term, we're clearly working with our lenders to create the right capacity for growth. You know, one of the things when you think about Flexity, the biggest thing is making sure we have the right advanced rates and the right capacity because it is a prime business with lower losses. So in the first Q outlook and everything, that is not considered as part of our liquidity generating initiative.

Okay. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Doug Clark for any closing remarks.

Yeah, thanks, everyone, for joining us this morning. As stated, Izzy and I look forward to sharing more of our plans in the upcoming Q1 earnings call. Hope everyone has a great day. Thanks.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.