Introduction

Regional Management (NYSE:RM) caters to borrowers with low credit scores, offering an alternative to predatory payday loans. Though the company boasts higher returns than traditional banks, a closer look reveals significant credit risk and increasing financial leverage. Considering these factors alongside competition offering similar products, a hold recommendation seems prudent. While the non-prime lending market holds potential for growth, Regional Management might struggle to secure a strong position without a more competitive edge and could be vulnerable to economic downturns.

Business Model

Regional Management Corp is a financial company specializing in lending to people with near-prime or lower credit scores. The company’s offer mainly consists of fully amortizing consumer credits, alongside insurance and ancillary services, which represent $44.5 million of 2023 revenue (less than 10% of total revenue). Regional classifies its loans into two categories, depending on the borrowed quantity:

1. Small Loans are for clients that borrow between $500-2,500 with terms of up to 48 months; in 2023, they carried an average annual percentage rate (APR) of 45.2% and represented over 27% of net finance receivables. Non-essential household goods and vehicles collateralize these loans.

2. Large Loans are for clients with better credit scores. They have cash proceeds of around $2,501-25,000 and terms of up to 60 months. These loans carried an average APR of 29.07% and represented over 70% of net finance receivables in 2023. Non-essential household goods and vehicles collateralize these loans.

Regional Management relies on its branches (346 branches across 19 states) to physically offer its lending services to customers. However, the company is exploring online loan originations while relying on online marketing affiliates to attract more customers. Regarding its growth strategies, Regional is aiming for aggressive growth through a multi-pronged approach. It plans to expand its physical presence by opening new branches in existing regions and entering new states; it has a presence only in 19 states out of 50. The company is investing in improving its digital channels and online loan application process. At the same time, Regional Management is focused on maintaining strict credit controls and controlling G&A expenses to ensure profitability.

Industry and Competitive Landscape

Between 25-37% of all Americans had near-prime or lower credit scores in 2022; thus, there were around 83.33-123.32 million people whose consumer credit needs were hardly met by traditional financial institutions, such as banks, thrifts, and regular credit card providers. Consequently, these non-prime credit users have limited access to consumer credit products, depending on payday, pawn and title loans with average APRs that may surpass 300%, and subprime credit cards with a maximum APR of 36% because of a legal cap.

According to the FICO Blog, the average FICO Score has increased steadily since late 2005, with few corrections. From my perspective, the higher average means fewer customers with poor credit scores, so the industry may have decreased during the last 20 years with few exceptions.

Nonetheless, according to the Federal Reserve Bank of New York, in October 2023, the average FICO score decreased from 718 to 717 as delinquency rates continued to rise, especially the credit card delinquency rate, which is higher than the pre-pandemic level.

Moreover, the transition into serious delinquency is significant for credit cards, reaching over 6% of total credit card debt balance while rising fast.

As a product of higher interest and delinquency rates, banks continue to tighten their credit conditions to offer new credits. Even if fewer banks are tightening their lending standards, they continue to tighten so fewer people have access to their credit services, and, given the current delinquency and interest rates, I don’t expect they will start to loosen standards for a while.

However, even if macroeconomic challenges may restrict the use of credit by many people, the total debt outstanding continues to rise but at a slower rate than during 2021.

Additionally, as I stated in my Parfare analysis, 60% of Americans live paycheck to paycheck, while two out of every five can’t face a $400 emergency expense. The poor financial health of many Americans makes them vulnerable to adverse macroeconomic situations and emergencies, increasing the risk of delinquency and limiting the options available to face these situations. For instance, as many as 12 million Americans use payday loans yearly, even when the average APR is 391%.

Regional Management offers collateralized loans with lower APRs than payday, pawn, and title loans to non-prime borrowers while reporting to credit bureaus, so clients can progressively improve their credit scores and access better credit terms. Generally, payday loan payments are not reported to any of the three credit bureaus, so borrowers cannot improve their credit scores by paying back these loans. Consequently, in my opinion, the product offered by Regional is far superior to payday loans as they have lower APR and allow borrowers to improve their credit scores.

In this sense, the company had 538,400 active accounts as of December 31, 2023. In the last five years, active accounts have risen 6.04% annually, while small loans and large loan balances have grown at CAGRs of 2.43% and 23.81%. Consequently, the company still has room to grow as its products can take market share from payday loans, which are used by 12 million people in the US.

Moreover, the company has a presence in 19 states, leaving another 31 states where the company can expand its operations and continue to grow its business. However, the potential growth for the different states is more limited, as the company has already expanded to states with some of the lowest average FICO scores. These states are Texas, Alabama, North Carolina, and South Carolina.

Nonetheless, besides payday loans, there is competition from other companies and products, such as subprime credit cards and companies similar to Regional Management. Some of those companies are:

Moreover, there are unsecured and secured subprime credit cards with a legal cap of an APR of 36%. Looking at the top subprime credit cards by CardRates, unsecured cards charge 29-35.99% APR, which is a little higher than the average rates for personal loans for 300-629 credit score borrowers, according to Bankrate.

Based on the data above, I think it’s clear that Regional Management doesn’t have any competitive advantage that allows it to charge higher interest rates than the competition, as most of these products are seen as commodities. The uncompetitive average APR of Small Loans could explain why its balance has grown slowly while Large Loans skyrocketed. Nonetheless, Regional Management can offer its products (at least Large Loans) at competitive prices while being profitable.

On this basis, the company’s 10-year median ROE is 12.8%, with a maximum of 32% in 2021 and a minimum of 5.1% in 2023; in the last ten years, the ROE only fell below 10% in three years: 2014, 2020, and 2023. Comparing the company with commercial banks, its return has been higher in the last ten years as most commercial banks didn’t reach a 10% ROE, even though they were generally more leveraged than the company.

In this context, Regional’s 10-year median ROA is 3.7%, while commercial banks struggle to reach a ROA of 1%. Only in 2023 was Regional’s ROA lower than 1%. Nevertheless, the higher returns come with a higher credit risk, as these loans are more likely to be defaulted on by their borrowers as they have low credit scores. So, even if returns are higher, they don’t come from a strong competitive position but from assuming higher risk.

Balance Sheet Analysis

Analyzing the balance sheet, the company has been increasing its financial leverage (assets to equity) since 2018, starting at 3.4 to 5.6, so it has increased its financial risk in the last five years. Most new debt was issued between 2020 and 2022 through the securitization of finance receivables (representing 82.46% of total outstanding debt). In the notes of the 10K Reports, we can find that Regional Managements made some warranties about the quality of these receivables, which commit Regional to repurchase them in case the assumptions of the receivable quality turn out to be inaccurate. Therefore, a significant deterioration in the quality of financial receivables may cause a liquidity crisis. In this scenario, the company would only have $550 million of unused revolving credit funds to meet $1,154 million of outstanding securitized debt; hence, the company would have to look for other funding sources, which will come with higher interest rates, if any.

The default risk has become more critical as net credit losses have increased in the last three years. In 2023, net credit loss (charge-off minus recoveries) increased above $200 million, representing roughly 12% of net finance receivables.

In this context, the delinquency and non-accrual rates are back to pre-pandemic levels, so the quality of receivables is lower than in the last three years, in line with higher net credit losses.

Regarding the quality of loan loss reserve, the reserve has always been low compared to net credit losses, signaling that the reserve is just a thin layer of protection against future losses. The protection against future losses increased during the pandemic but fell below one in 2023. Furthermore, even if the provision for credit losses to net credit loss ratio has been higher than 1, meaning that the management has estimated precisely the future credit losses, it has decreased considerably from 2020, when the company was more conservative in estimating its credit losses; hence, I think there may be a probability that the company started to use more aggressive decisions at the moment of assessing the provision for credit losses just to maintain profitability. Thus, assets and profits may be slightly overstated in my opinion.

Risks

Credit Risk

Regional Management lends to low-credit-score users, who tend to default more on their debt than people with higher credit scores. Therefore, Regional’s loans bear a higher credit risk than those of many other lending companies, so in an adverse macroeconomic environment, profitability is likely to fall as it did in 2023.

Financial Leverage

The company increased leveraged during the pandemic, increasing the risk of failure as it’s more vulnerable to adverse shifts in delinquency rates. Moreover, as the company has committed to repurchasing securitized receivables in case of underperforming, if something ‘breaks’ in the economy, I believe the company as a going concern may be threatened due to possible liquidity issues.

Competition

Despite Regional’s products having competitive advantages over payday loans, other companies offer similar products and subprime credit cards. Regional Management small loans haven’t grown as fast as large loans, as they have an uncompetitive APR compared to the market offering. Nonetheless, the company has fared well against competition, achieving a return on equity higher than 10% while being less leveraged than banks.

Valuation

For my discounted dividend model, I expect ROE to be equal to its historical median except for 2024, as I expect the company to keep struggling with higher delinquency rates. The book value per share will increase at the ROE rate less the dividend paid. Dividend payments will remain flat, as I expect the company to use net income to increase its operations in other markets. Moreover, the terminal value will be a P/B of 0.9, as it has been its historical P/B according to Macrotrends.

Finally, given the lack of competitive advantages, the higher credit risk, and the higher financial leverage, I think a discount rate of 17.50% (approximately a 12.85% premium over the 10-year treasury rate) is tailored to the risk characteristics of the investment.

Given these premises, I believe the intrinsic value of Regional Management Corp is $23.94 per share, so the company is fairly valued at a price of $24.83 per share. Consequently, my recommendation is a ‘Hold.’

Conclusion

Regional Management Corp offers loans to borrowers with low credit scores, but high-interest rates and increasing competition raise questions about its long-term prospects. While the company boasts higher returns than traditional banks, this comes with significant credit risk and financial leverage. Despite potential growth in the non-prime lending market, Regional Management may struggle to compete effectively without a more substantial advantage and may be vulnerable to economic downturns. Therefore, my investment recommendation is a ‘Hold.’