CURO Group Holdings Corp.

Good morning, ladies and gentlemen, and welcome to the Curo Q2 2023 conference call. At this time, all lines are in listen-only mode. Following the presentation, we'll conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Thursday, August 3rd, 2023. I would now like to turn the conference over to Nick Panarese. Please go ahead.

Thank you and good morning, everyone. Curo released its second quarter 2023 results before market opened today, which, along with supplemental information, are available on our investor website at ir.curo.com. With me today are Curo's Chief Executive Officer, Doug Clark, and Chief Financial Officer, Izzy Dawood. Today's discussion will contain forward-looking statements based on the business environment as we currently see it. As such, it includes certain important risks and uncertainties. Please refer to our press release issued this morning and our Form 10Q and Form 10K for more information on the specific risk factors that could cause our actual results to differ materially from the matters described in today's discussion. Any forward-looking statements made on this call are based on assumptions as 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 US GAAP reporting, we present in the supplemental materials 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 appendix to the supplemental materials. With that, I would like to turn the call over to Doug.

Thanks, Nick. Good morning, everyone, and thank you for joining us today. During the second quarter, we continued to execute on the business plan we outlined in the first quarter. Our core fundamentals, receivables, revenue, net charge-offs, and operating expenses came in more favorable versus our previous Q2 expectations. This was accomplished as we focused on responsible growth, maintaining credit quality, tightening operating expenses, and commencing certain marketing programs. On slide three of the earnings presentation, you can see some of these accomplishments from the quarter. While we remained disciplined with loan originations, given the still uncertain macro environment, we started putting the capital we raised in late May to work. We grew receivables by 4% quarter over quarter during what is generally a seasonally slower quarter. We also made significant progress on multiple operational initiatives, including continued modernization of our technology infrastructure, which includes transitioning to the cloud and converting our U.S. branches into a single loan management system, which we expect to be completed late in 2023. We also pursued continued enhancements of the digital customer experience and introduced improvements to our credit risk capabilities. These initiatives will allow us to refine our focus on responsible growth in our direct lending business. As reflected in the press release, we have reached an agreement to sell our Flexity business for approximately 55 million Canadian, which we believe is the best option for our company. Our consolidated results this quarter included a full quarter of Flexity, and Q3 will also include partial results. And we anticipate Q4, our consolidated financial results, will no longer include Flexity. Turning to slide four, we ended the quarter with over $2.1 billion in gross loans receivable. a 4% increase versus the prior quarter. We will continue to balance solid demand with responsible growth, particularly as we gradually pick up our marketing efforts in Q3. Within the U.S., we focused our growth initiatives towards our near prime large loan and secured loan portfolios as we continue to improve the overall risk profile of our U.S. portfolio through these efforts. In our direct lending business in Canada, we also saw solid demand for our open-ended product with both new and existing customers. Our U.S. loan management system conversion will simplify management of U.S. branch operations using a single platform and will create a more stable operating platform that enables rapid deployment of system enhancements. This conversion will also allow us to scale our operating model to a holistic lending approach for both small and large loans across all U.S. branches. which should increase efficiency, enable growth, and improve servicing. We continue to work on introducing new secured lending products in both the U.S. and Canada, such as an auto-secured product that we expect to roll out later this year. These products should allow us to reduce overall credit risk while increasing our average balances with secured customers. Alongside our increase in secured lending, we remain committed to increasing our mix of larger balance and longer duration products which will continue to de-risk and simplify the predictability of our business results. Despite the ongoing macroeconomic uncertainty in the US and Canada, our consumers continue to hold up relatively well in terms of demand and credit performance. While we have not seen unexpected consumer stress, our team continuously monitors our customer data as well as industry-wide trends to ensure we stay ahead of any potential negative outcomes. As a reminder, our direct lending portfolio was split between the US and Canada, each of which are impacted by different macroeconomic factors. Turning to slide five, our credit quality continues to improve, driven by tightening and underwriting we began in 2022, along with the positive impacts from the enhancements to our customer servicing capabilities. Excluding the change in charge of policy we made in our direct lending business last quarter, The net charge-off ratio improved by 270 basis points, showing improvement in both the U.S. and in Canada. Moving to slide six, you can see the delinquency trends also remain consistent with the prior quarter. To summarize, through the first half of this year, we have made meaningful progress towards executing with excellence and strengthening our foundation and responsible growth. We are encouraged by the growth opportunities that we see in both the U.S. and in Canada. I will now turn it over to Izzy to give you more detail on our Q2 results, and then I'll close with some final thoughts.

Thanks, Doug, and good morning, everyone. As Doug highlighted, we maintained positive momentum in Q2, evidenced by solid core results that were more favorable than our expectations. Second quarter gross loan receivables of $2.14 billion were slightly above both the prior quarter and the high end of our guidance, but they remained below year-end 2022. Slide 8 of the earnings presentation shows summary results for the quarter. Revenue of $209 million was flat sequentially, but towards the higher end of our expectations. The flat quarter-over-quarter results were driven mainly by continued execution of our strategy to migrate towards longer-term and lower-risk products. Our net risk margin post-charge-offs, a key indicator of our risk-adjusted return on our assets, was flat versus prior quarter at 14%, excluding the impact of the change in charge-off policy during Q1. Net revenue post-provision expense was $130 million versus $146 million in the prior quarter, primarily driven by a higher provision for loan loss expense due to a catch-up in provisions, as Q1 2023 was artificially lower due to changes in direct lending charge-off policies. Our pre-tax loss post-provision was $57 million or $48 million, excluding $9 million in debt modification fees. Interest expense continues to be impacted by rising benchmark rates as well as higher debt levels, increasing to $66 million from $59 million sequentially. Reported operating expenses of $108 million decreased 8% sequentially from $118 million. Excluding a $10 million one-time restructuring charge recognized in Q123, operating expenses are flat sequentially despite the impact of our annual merit increase, inflationary pressure on wages, increased originations and servicing costs due to loan growth, and higher expenses from system conversions in Q2. Our operating expense ratio improved to 21% from 23% sequentially. Other expenses of $12 million primarily represent debt modification expenses and miscellaneous expenses related to the sale of a legacy U.S. direct lending business and catapult losses. Net charge-offs of $68 million increased sequentially from $59 million, and our reported net charge-off rate was 13% versus 11.5% sequentially. On a normalized basis, charge-offs decreased by 214 basis points. We remain optimistic that our focus on responsible asset growth and the actions we have taken on collections should continue to drive relatively stable credit quality. Net loss of the quarter was $59.3 million, or $1.45 per diluted share. Pre-provision net income remained relatively flat at $23 million this quarter. Turning to our segment results on slide nine. If you recall, last quarter we realigned our external presentation to match how we manage our direct lending business. We combined our U.S. direct lending and Canada direct lending into one direct lending segment and also removed the reporting of adjusted net income, essentially providing performance detail by geography. This simplifies the process of modeling the company going forward. On slide 10, you can see more detail on our allowance. There was no significant change in allowance as a percent of gross loans since adopting CECL last quarter. The $13 million increase in dollar allowance was primarily driven by Canada point-of-sale loan growth and the updated Fed forecast for unemployment in the CECL model. Turn to slide 11. Net interest income increased sequentially and net interest margin remained stable versus prior quarter, when excluding the change in the charge-off policy for Q1, even as interest expense increased sequentially. Let's turn to slide 12 and go through a bit more detail on operating expenses. On the left side of the page, you can see that during Q2 our consolidated operating expenses on a reported basis continue to improve to $108 million from $118 million sequentially. Excluding the impact of restructuring expenses in Q1, expenses are flat sequentially and below our expectations, partially driven by delayed advertising and marketing expenses as we are finishing our branch conversions. However, we expect to increase advertising and marketing expenses in Q3. On the right-hand side of the page, you can see our operating expense ratio trends by our two businesses. Similar to last quarter, our operating expense ratio and direct lending continue to improve, though we had a modest uptick in our Canada point-of-sale business. As we have highlighted before, one of our key priorities is to improve operating efficiency over the long term by driving scale and continued expense management, which allows us to invest in branch conversions and other efficiency efforts. On slide 13, you can see our leverage and liquidity summary. On the left-hand side, net leverage increased in Q2 due to additional liquidity and capital raised in May 2023, and our interest coverage ratio ticked down slightly. On the right-hand side of the slide, total cash and capacity also improved. Lastly, moving to our outlook for the second quarter on slide 14. For Q3 2023, we expect receivables to be in the range of $2.15 to $2.25 billion, and for revenue to be in the range of $210 billion to $220 million. Net charge-offs are expected to be between 12.5% and 15.5%. Our operating expense is expected to be in the range of $108 million to $118 million on a reported basis. With that, I will turn it back over to Doug for some final comments.

Thanks, Izzy. The Curo team continued to execute our strategy during Q2, and I remain very enthusiastic about our long-term opportunity. With overall consumer credit performance in line with our expectations, we do have the confidence to continue to move forward with responsible growth. With that, I would like to open up the call for Q&A. Operator?

Good morning, guys. Thanks very much. Congrats on the strategic result for Flexity. I guess one question is, you guys are growing. Despite seasonality, the portfolio grew. Where are you getting new customers and any characteristics around customer acquisition costs or the type of customers you're getting?

John, you know, we grew pretty modestly really for the U.S. direct lending business. And I'm not going to exclude Flexity. Most of our, if you look at the growth segments, Flexity grew like 50 some million last quarter, while the direct lending grew about 18 million. We are just now starting to ease back into the marketing program. So most of that growth is pure organic growth of, you know, either graduating customers or customers tapping in existing credit capabilities. So in Q3, again, we'll start easing it back into the marketing programs that we have that align to our kind of credit risk appetite.

Okay. So it's just, it sounds more organic at this point. And then maybe, I think you guys gave some longer term balance sheet leverage goals. You know, now that you're in the process of selling flexibility, you're going to get a little liquidity from that. You know, how do we think about balance sheet leverage into the later part of this year?

Yeah, John, I'll take that question. Yeah, effectively, as part of what we discussed in the capital raise in May and the flexibility solution, Once it closes, you know, that gives us the amount of capital and liquidity to basically get us to profitability and then eventually us covering our recourse interest as well. So how the math works out is, you know, after all the tangible book value adjustments as Flexity has grown, balances and stuff, we expect to net about 50 to 60 million USD in proceeds from the Flexity sale, net when it's closed. And that gives us the run rate to grow the balance sheet, to add, you know, what you call the right leverage, and then basically, you know, slowly work our way into profitability. You've seen it, like, in every quarter we've made improvements, and we expect that trajectory to continue. Our overall goal still is, if you look at – I think it's in the appendix – to hit that direct lending – NIM let net charges of 26 to 31 percent, OpEx in that 26 to 30 percent. And we've talked about this in the past, I think, John, with you and others, you know, the magic number roughly is about a billion five in assets. And we're very, very careful how we get there because just rushing to get there, you know, we don't want to make sure we don't take on undue risk that doesn't give us the right risk adjusted returns. So, no, it's basically still Not still, but it's on the path to our execution to get to the right point where, you know, hopefully in three to four years we can refinance the debt we have.

Okay, super helpful in terms of the framework there. And then just, I mean, you guys talk about this, delinquencies look like they're stable, it's not improving. I mean, you've tightened credit. I mean, Izzy just even referred to some of your expectations there. But, I mean, anything to shout out there or does it just feel like the consumers kind of stabilizing as we kind of are deep into this inflation and interest rate cycle and not much to, maybe not much to focus on and not much to variability for the near term in terms of the credit from your perspective.

Yeah, John, this is Doug again. Yeah, I think you're exactly right. I think we're seeing a very stabilized credit environment. Obviously we took a lot of actions last year that are, that are, that are coming through in the numbers today. But as we sit here today, we're not seeing any unusual stress on the consumer. Demand remains solid. You know, our consumer isn't necessarily the headline consumer that you're seeing as far as the tech layoffs, et cetera, as you know. So we're not seeing anything unusual right now, but obviously we can always closely monitor it and look at it on a regular basis.

Great, guys. Thanks very much.

Your next question comes from Vincent Canetick from Stevens. Please go ahead.

Hey, good morning. Thanks very much for the questions and good core results this quarter. It was also good to see the Flexity sale executed. And so I was wondering, kind of broad question, is there any other transition items or large strategic items that you think needs to get done from here in terms of strategic or business reviews or balance sheet changes or anything like that, or are we kind of steady state going forward? Thank you.

Thanks, Vincent. Yeah, very steady state, head down, chopping wood, quite frankly. You know, we just need to execute the plan, and that means really being tight and efficient on our expense structure, making sure we're taking appropriate risk on the credit box and starting to grow back into our balance sheet. So, Really, this Flexity transaction will be kind of the last, I think, in the deal side for a while for Curo.

Okay, that's great. Thank you. And then kind of related to that, the target ranges that you have, and it's slide 16 of your deck, all those target ranges, in order to get to those ranges, are there anything that really needs to happen in terms of getting scale, or does the macroeconomic environment need to improve with your consumer, or are we already kind of underwriting or operating at that level? It's just kind of a matter of time. Thank you.

Yeah, sure, Vincent. By the way, a really good question. I think there's two parts to it. So in our long-term direct lending target, there was the OPEX ratio. I believe it's about 23% to 26%, and Q2, we printed 30%. I think there it's managing expenses, so basically growing scale versus expenses not going up. So I think we're on our path there. We continue to see opportunities, and most of it should drop to the bottom line, but there's still room to invest where it drives future efficiency. So that's one half of the equation. The second one is our NIMP post charge-off target of 26% to 31%. Today we're at 19%, and there I think it's the things Doug just mentioned, getting into Lower yielding, lower risk products that improve our overall yield growth in Canada, which has a higher spread. Those are probably two of the bigger drivers, so NCO reduction as well as a little yield enhancement net-net with the right growth gets us to our 26 to 31 direct lending. As I mentioned, it's kind of a through-the-cycle target, so it's not happening overnight, but that's the progress that we're measuring ourselves against quarter by quarter.

Okay, great. That's super helpful. Thanks very much.

Your next question comes from John Rowan from Jenny. John, please go ahead.

Good morning, guys. Just to be clear, you said the magic number is $1.5 billion. I assume that's $1.5 billion in direct loan portfolio to turn profitable?

Yeah, around there, just about. Obviously, it can be all based on the mix of Canada versus U.S., But that's kind of, in my mind, kind of where we kind of need to get to.

Okay. And then you mentioned an auto-secured product. I'm just trying to figure out what kind of product this is, right? Is it a high-rate kind of traditional auto title loan, or is it a fully secured, high-balance, low APR installment loan secured by an auto title loan?

Yeah, the latter, John. I mean, we're focused on, you know, and we run, you know, just as a point, we've been running secure programs in the US for some time, but of our total book of 1.2, you know, less than 20% is actually secured. So when you kind of think about long term growth opportunities, getting into the lower APR, lower charge of wider margin, higher balance programs, that's certainly something we're focused on. We've been doing it for several years at the Heights Business, we're expanding it to First Heritage, we're introducing it in Canada. But yes, it's the lower APR, lower charge off program.

Okay. And then lastly, for me, the third quarter guidance that you provided, does that assume the inclusion of Flexity or the divestiture? Because it seems like you're going to complete the deal before the end of the third quarter, which is why the third quarter would include part of it. I just want to make sure I understand what's in that guidance figure.

Yeah, right now it assumes we have flexibility through all of Q3. Right now anticipate closing would be sometime in September. Obviously, the biggest step is outside of control. It's on the Competition Bureau in Canada, which we believe should be a regular process. So we're going to have flexibility probably for probably half of September, if not most of it, so that the guidance includes that. If anything changes there, we'll probably put something out to adjust the estimates for Q3.

Okay, great. Thank you very much.

There are no further questions at this time. I'll now turn it back to Izzy DeWood for closing remarks.

Yeah, thank you, operator. Just a couple of things in our prepared remarks. As you saw, the Flexity announcement came late, so there was a fair amount of scrambling on our end. There are a couple of things that I just want to reiterate. One is, obviously, the net cash proceeds we expect, again, after all is said and done, with the closing adjustment somewhere between $50 million, $60 million USD on our Flexity Sale as it continues to support the growth of that business, and we've seen tremendous progress there. And the second item, which is our year-end forecast for cash, which I've mentioned on the last call, of $100 million to $140 million USD, that remains intact as well. So we are on track on both those elements, and obviously the Flexity Sale has a big role to play in that as well. So with that, I'll turn it back over to the operator.

Thank you, ladies and gentlemen. This concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.