NICHOLAS FINANCIAL INC MANAGEMENT REPORT ON FINANCIAL POSITION AND RESULTS OF OPERATIONS (Form 10-Q)
Forward-looking information
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. AlthoughNicholas 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) the projected impact of the novel coronavirus disease ("COVID-19") outbreak on our customers and our business, (2) projections of revenue, income, and other items relating to our financial position and results of operations, (3) statements of our plans, objectives, strategies, goals and intentions, (4) statements regarding the capabilities, capacities, market position and expected development of our business operations, and (5) 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:
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the ongoing impact on us, our employees, our customers and the overall economy
of the COVID-19 pandemic and measures taken in response thereto, including
without limitation the successful delivery of vaccines effective against the
different variants of the virus, for which future developments are highly
uncertain and difficult to predict;
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availability of capital (including the ability to access bank financing);
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recently enacted, proposed or future legislation and the manner in which it is
implemented, including tax legislation initiatives or challenges to our tax
positions and/or interpretations, and state sales tax rules and regulations;
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fluctuations in the economy;
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the degree and nature of competition and its effects on the Company's financial
results;
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fluctuations in interest rates;
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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;
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demand for consumer financing in the markets served by the Company;
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our ability to successfully develop and commercialize new or enhanced products
and services;
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the sufficiency of our allowance for credit losses and the accuracy of the
assumptions or estimates used in preparing our financial statements;
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increases in the default rates experienced on automobile finance installment
contracts ("Contracts");
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higher borrowing costs and adverse financial market conditions impacting our
funding and liquidity;
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our ability to securitize our loan receivables, occurrence of an early
amortization of our securitization facilities, loss of the right to service or
subservice our securitized loan receivables, and lower payment rates on our
securitized loan receivables;
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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 Street
Reform 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;
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fraudulent activity, employee misconduct or misconduct by third parties;
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media and public characterization of consumer installment loans;
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failure of third parties to provide various services that are important to our
operations;
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alleged infringement of intellectual property rights of others and our ability
to protect our intellectual property;
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litigation and regulatory actions;
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our ability to attract, retain and motivate key officers and employees;
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use of third-party vendors and ongoing third-party business relationships; • cyber-attacks or other security breaches; • disruptions in the operations of our computer systems and data centers; • 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; • our ability to expand our business, including our ability to complete acquisitions and integrate the operations of acquired businesses and to expand into new markets; and • the risk factors discussed under "Item 1A - Risk Factors" in our Annual Report on Form 10-K, and our other filings made with theU.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 theSEC , including its reports on Forms 10-K, 10-Q, 8-K and annual reports to shareholders.
Disputes and legal issues
See “Item 1. Legal Proceedings” in Part II of this Quarterly Report below.
COVID-19[female[feminine
The temporary expansion of unemployment benefits by the CARES Act, the Coronavirus Response and Relief Supplemental Appropriations Act of 2021 and the American Rescue Plan Act of 2021 to eligible individuals collectively had a beneficial effect on the Company; however, the impact of these benefits has almost entirely disappeared, as our customers no longer qualify for such benefits. The Company continued to experience strong cash collections and experienced positive trending on gross charge-off balances for the three months endedDecember 31, 2021 . 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. Due to COVID-19, the number of deferments increased to 3,114 inApril 2020 from 724 inMarch 2020 . For the year endedMarch 31, 2021 the Company experienced an average monthly number of deferments of 696, which would represent approximately 2.6% of total Contracts and Direct Loans as ofMarch 31, 2021 . For the three months endedDecember 31, 2021 , the average monthly number of deferments was 297, which would represent approximately 1.14% of total Contracts and Direct Loans as ofDecember 31, 2021 . For the nine months endedDecember 31, 2021 , the average monthly number of deferments was 232, which would represent approximately 0.89% of total Contracts and Direct Loans as ofDecember 31, 2021 . The number of deferrals is also influenced by portfolio performance, including but not limited to, inflation, credit quality of loans purchased, competition at the time of Contract acquisition, and general economic conditions.
The Company estimates that the number of one-month principal payment deferrals is now broadly in line with pre-pandemic levels.
However, the extent to which the COVID-19 pandemic eventually impacts our business, financial condition, results of operations or cash flows will depend on numerous evolving factors that we are unable to accurately predict at this time. The length and scope of the restrictions imposed by various governments and success of vaccination efforts among other factors, will determine the ultimate severity of the COVID-19 impact on our business. It is likely that prolonged periods of difficult market conditions could have material adverse impacts on our business, financial condition, results of operations and cash flows. Regulatory Developments OnOctober 5, 2017 , theCFPB issued 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 16 -------------------------------------------------------------------------------- installment loans that involve a payment authorization and an Annual Percentage Rate over 36% ("payment requirements"). The Company does not believe that it will have a material impact on the Company's existing lending procedures, because the Company currently does not make short-term consumer loans or longer-term consumer installment loans with balloon payments that would subject the Company to the Rule's ability to repay requirements. The Company also 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. However, implementation of the Rule's payment requirements may require changes to the Company's practices and procedures for such loans, which could affect the Company's ability to make such loans, the cost of making such loans, the Company's ability to, or frequency with which it could, refinance any such loans, and the profitability of such loans. Further, onJune 6, 2019 , theCFPB amended the Rule to delay theAugust 19, 2019 compliance date for part of the Rule's provisions, including the ability to repay requirements. In addition, onFebruary 6, 2019 , theCFPB issued a notice of proposed rulemaking proposing to rescind provisions of the Rule governing the ability to repay requirements. There were also lawsuits filed challenging various provisions of these Rules, as well as the constitutionality of theCFPB's structure, and the court stayed the compliance date of the Rule while the litigation was pending. TheSupreme Court handed down its decision on the constitutional challenge inJune 2020 , and inJuly 2020 , theCFPB issued a final Rule, which revoked the underwriting provisions of the prior Rule. However, additional lawsuits were filed challenging the payment provisions of the Rule issued in 2020. InAugust 2021 , the court found for theCFPB and dismissed the remaining challenges. As a result, the compliance date for the payments provisions of the Rule is nowJune 13, 2022 Unless rescinded or otherwise amended, the Company will have to comply with the Rule's payment requirements if it continues to allow consumers to set up future recurring payments online for certain covered loans such that it meets the definition of having a "leveraged payment mechanism" under the Rule. If the payment provisions of the Rule apply, the Company will have to modify its loan payment procedures to comply with the required notices and mandated timeframes set forth in the final rule. TheCFPB defines 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 theCFPB's supervisory authority. TheCFPB issued rules regarding the supervision and examination of non-depository "larger participants" in the automobile finance business. TheCFPB's stated 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 theCFPB defines us as a larger participant, we will be subject to examination by theCFPB for, 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 theCFPB promulgates 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 theCFPB , such an examination could likely have a material adverse effect on our business, financial condition and profitability. Moreover, any such examination by theCFPB could 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.
Critical accounting estimate
A critical accounting estimate is an estimate that:
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is made in accordance with generally accepted accounting principles
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involves a significant level of estimation uncertainty, and
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has had or is reasonably likely to have a material impact on the Company's
financial condition or results of operation
The Company's critical accounting estimate 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 six-month net charge-offs as a percentage of average
finance receivables, annualized 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
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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 utilizes the branch model, which allows for Contract purchasing to
be done at the branch level. 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 that the
Company purchases have common risk characteristics. The Company utilizes its
District Managers to evaluate their respective branch locations for adherence to
these underwriting guidelines, as well as approve underwriting exceptions. The
Company also utilizes field auditors to assure adherence to its underwriting
guidelines. Any Contract that does not meet the Company's underwriting
guidelines can be submitted by a branch manager for approval from the Company's
District Managers or senior management.
introduction
For the three months endedDecember 31, 2021 , the net dilutive loss per share increased to$0.09 as compared to net dilutive earnings per share of$0.49 for the three months endedDecember 31, 2020 . Net loss was$0.7 million for the three months endedDecember 31, 2021 as compared to a net income of$3.8 million for the three months endedDecember 31, 2020 . Revenue decreased 15.4% to$12.2 million for the three months endedDecember 31, 2021 , as compared to$14.5 million for the three months endedDecember 31, 2020 , due to realized and unrealized gains of$1.3 million on equity investments in the prior year quarter and a 6.6% decrease in finance receivables. For the nine months endedDecember 31, 2021 , the net dilutive earnings per share increased to$0.34 as compared to net dilutive earnings per share of$0.85 for the nine months endedDecember 31, 2020 . Net income was$2.6 million inclusive of$1.9 million of interest expense related to the unamortized debt issuance costs on the extinguishment of the prior credit facility for the nine months endedDecember 31, 2021 as compared to a net income of$6.5 million which included realized and unrealized gains of$1.3 million on equity investments for the nine months endedDecember 31, 2020 . Total revenue decreased 12.5% to$37.4 million for the nine months endedDecember 31, 2021 as compared to$42.7 million for the nine months endedDecember 31, 2020 , due to a 12.1% decrease in average finance receivables, compared to the prior year period. The Company finances primary transportation to and from work for the subprime borrower. The Company does not finance luxury cars, second units or recreational vehicles, which are the first payments customers tend to skip in time of economic insecurity. The Company finances the main and often only vehicle in the household that is needed to get our customers to and from work. The amounts we finance are much lower than most of our competitors, and therefore the payments are significantly lower, too. The 18 -------------------------------------------------------------------------------- combination of financing a "need" over a "want" and making that loan on comparatively affordable terms incentivizes our customers to prioritize their account with us. Three months ended Nine months ended December 31, December 31, (In thousands) (In thousands) 2021 2020 2021 2020 Portfolio Summary Average finance receivables (1)$ 176,949 $ 192,966 $ 179,333 $ 203,996 Average indebtedness (2)$ 64,824 $ 101,522 $ 72,002 $ 112,476 Interest and fee income on finance receivables$ 12,240 $ 13,180 $ 37,406 $ 41,395 Interest expense 2,613 1,442 4,923 4,660 Net interest and fee income on finance receivables$ 9,627 $ 11,738 $ 32,483 $ 36,735 Gross portfolio yield (3) 27.67 % 27.32 % 27.81 % 27.06 % Interest expense as a percentage of average finance receivables 5.91 % 2.99 % 3.66 % 3.05 % Provision for credit losses as a percentage of average finance receivables 3.79 % 1.35 % 2.83 % 4.58 % Net portfolio yield (3) 17.97 % 22.98 % 21.32 % 19.43 % Operating expenses as a percentage of average finance receivables 20.04 % 15.35 % 18.68 % 14.96 % Pre-tax yield as a percentage of average finance receivables (4) (2.07 )% 7.63 % 2.64 % 4.47 % Net charge-off percentage (5) 5.67 % 6.30 % 4.70 % 5.94 % Finance receivables$ 176,173 $ 188,626 Allowance percentage (6) 2.06 % 4.81 % Total reserves percentage (7) 6.00 % 8.76 %
Note: All three-month and nine-month revenue performance indicators expressed as a percentage have been annualized.
(1)
Average finance receivables represent the average of the month-end finance receivables throughout the period. (2) Average indebtedness represents the average outstanding borrowings at day-end under the Credit Facility throughout the period. Average indebtedness does not include the PPP loan. (3) Gross 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. (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. (5) Net charge-off percentage represents net charge-offs (charge-offs less recoveries) divided by average finance receivables outstanding during the period. (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.
Mining strategy
The Company remains committed to its branch-based model and its core product of financing primary transportation to and from work for the subprime borrower through the local independent automobile dealership. The Company strategically employs the use of centralized servicing departments to supplement the branch operations and improve operational efficiencies, but its focus is on its core business model of decentralized operations. The Company's strategy also includes risk-based pricing (rate, yield, advance, term, collateral value) and a commitment to the underwriting discipline required for optimal portfolio performance as opposed to chasing competition for the sake of simply generating volume. The Company's principal goals are to increase its profitability and its long-term shareholder value. During fiscal 2022, the Company is focusing on the following items:
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maintain our commitment to the local branch model;
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expanding the local branch model into new states; • identifying additional ancillary products to enhance profitability and asset performance; • continuing to focus on strategic acquisitions or bulk portfolio purchases to accelerate total revenue; • ensuring that Direct Loans are available in all our existing branch offices based on the applicable regulatory requirements. The Company continues to focus on selecting the right markets to have branch locations. As ofDecember 31, 2021 , the Company operated brick and mortar branch locations in 18 states -Alabama ,Florida ,Georgia ,Idaho ,Illinois ,Indiana ,Kentucky ,Michigan ,Missouri ,North Carolina ,Nevada, Ohio ,Pennsylvania ,South Carolina ,Tennessee ,Texas ,Utah andWisconsin . The Company also originated business in its expansion states ofKansas without a physical branch in such markets. The Company is currently licensed to provide Direct Loans in 14 states-Alabama ,Florida ,Georgia (over$3,000 ),Illinois ,Indiana ,Kansas ,Kentucky ,Michigan ,Missouri ,North Carolina ,Ohio ,Pennsylvania ,South Carolina , andTennessee . The Company solicits current and former customers in these states for the purpose of providing Direct Loans to such customers, and intends to continue the expansion of its Direct Loan capabilities to the other states in which it acquires Contracts. Even with this targeted expansion, the Company expects its total Direct Loans portfolio to remain between 8% and 15% of its total portfolio for the foreseeable future. Analysis of Credit Losses The Company uses a trailing six-month charge-off analysis, annualized, to calculate the allowance for credit losses. Management believes that using the trailing six-month charge-off analysis, annualized, will more quickly reflect changes in the portfolio as compared to a trailing twelve-month charge-off analysis. In addition, the Company 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 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. 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 Company defines a Chapter 13 bankruptcy account as a Troubled Debt Restructuring ("TDR"). BeginningMarch 31, 2018 , the Company allocated a specific reserve using a look back method to calculate the estimated losses. Based on this look back, management calculated a specific reserve of approximately$77,000 and$118,000 for these accounts as ofDecember 31, 2021 andDecember 31, 2020 , respectively. The provision for credit losses increased to$1.7 million for the three months endedDecember 31, 2021 as compared to$0.7 million for the three months endedDecember 31, 2020 . A smaller provision for credit losses taken during the three months endedDecember 31, 2020 was attributable to an alignment of total loss reserves with the declining trend of net charge-off percentage (see note 5 in the Portfolio Summary table in the "Introduction" above for the definition of net charge-off percentage). Net charge-offs decreased to 4.70% for the fiscal year endedDecember 31, 2021 from 5.94% for the fiscal year endedDecember 31, 2020 , primarily resulting from the Company's active management of the portfolio. The delinquency percentage for Contracts more than twenty-nine days past due, excluding Chapter 13 bankruptcy accounts, as ofDecember 31, 2021 was 10.28%, a decrease from 11.49% as ofDecember 31, 2020 . The delinquency percentage for Direct Loans more than twenty-nine days past due, excluding Chapter 13 bankruptcy accounts, as ofDecember 31, 2021 was 4.28%, a decrease from 5.23% as ofDecember 31, 2020 . The changes in delinquency percentage for both Contracts and Direct Loans was driven primarily by the Company's continued focus on local 20 --------------------------------------------------------------------------------
branch service. Based on these actions, improved service and tighter underwriting policies, management has seen an improvement in delinquency rates.
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. For further information on deferrals, please see the disclosure under "COVID-19" above.
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 7.6% to$12.2 million for the three months endedDecember 31, 2021 , from$13.2 million for the three months endedDecember 31, 2020 . The decrease was primarily due to a 8.3% decrease in average finance receivables to$176.9 million for the three months endedDecember 31, 2021 , when compared to$193.0 million for the corresponding period endedDecember 31, 2020 . The decrease in finance receivables was primarily the result of a reduction in the aggregate dollar amount and volume of Contracts purchased, as the Company continued implementing its strategic focus of financing primary transportation to and from work for the subprime borrower. Continuing this operating strategy allowed us, despite continuing competitive pressure, to acquire Contracts at similar yields (albeit lower discounts) during the three months endedDecember 31, 2021 , compared to the corresponding period endedDecember 31, 2020 , although the combined effect of the same average yield and lower discount could not entirely offset the reduction in the aggregate dollar amount of Contracts purchased. The gross portfolio yield increased to 27.67% for the three months endedDecember 31, 2021 , compared to 27.32% for the three months endedDecember 31, 2020 . The net portfolio yield decreased to 17.97% for the three months endedDecember 31, 2021 , compared to 22.98% for the three months endedDecember 31, 2020 . The net portfolio yield decreased primarily due to the increase in the provision for credit losses, as described under "Analysis of Credit Losses".
Functionnary costs
Operating expenses increased to$8.9 million for the three months endedDecember 31, 2021 compared to$7.4 million for the three months endedDecember 31, 2020 . The increase in operating expenses was primarily attributed to administrative, salaries and employee benefits expenses. Operating expenses as a percentage of average finance receivables, increased to 20.04% for the three months endedDecember 31, 2021 from 15.35% for the three months endedDecember 31, 2020 due to a proportionally greater decline in finance receivables.
Provision charge
The provision for credit losses increased to$1.7 million for the three months endedDecember 31, 2021 from$0.7 million for the three months endedDecember 31, 2020 . A smaller provision for credit losses taken during the three months endedDecember 31, 2020 was attributable to an alignment of total loss reserves with the rapidly declining trend of net charge-off percentage.
Interest charges
Interest expense was$2.6 million for the three months endedDecember 31, 2021 , of which the Company recognized approximately$1.9 million of interest expense related to previously incurred but unamortized debt issuance costs on the extinguishment of the Ares credit facility, and$1.4 million for the three months endedDecember 31, 2020 . The following table summarizes the Company's average cost of borrowed funds, exclusive of debt origination costs: Three months endedDecember 31, 2021 2020
Variable interest under the line of credit facility 0.41% 1.93% Credit spread under the line of credit facility
2.82 % 3.75 % Average cost of borrowed funds 3.23 % 5.68 % SOFR rates have decreased to 0.05%, which represents the one-month SOFR rate as required under our Wells Fargo Credit Facility, as ofDecember 31, 2021 compared to 0.14%, which represents the one-month LIBOR rate as required under our Line of Credit, as ofDecember 31, 2020 . For further discussions regarding interest rates see "Note 5-Credit Facility". 21 --------------------------------------------------------------------------------
Income Taxes
The Company recorded a tax saving of approximately
End of nine months
Interest income and loan portfolio
Interest and fee income on finance receivables, decreased 9.6% to$37.4 million for the nine months endedDecember 31, 2021 from$41.4 million for the nine months endedDecember 31, 2020 . The decrease was primarily due to 12.1% decrease in average finance receivables to$179.3 million for the nine months endedDecember 31, 2021 when compared to$204.0 million for the corresponding period endedDecember 31, 2020 . The decrease in average finance receivables was primarily the result of a reduction in the aggregate dollar amount and volume of Contracts purchased, as the Company continued implementing its renewed strategic focus of financing primary transportation to and from work for the subprime borrower. This shift in focus also allowed us to acquire Contracts at higher yields during the nine months endedDecember 31, 2021 compared to acquisitions during the corresponding period endedDecember 31, 2020 , although the increase in average yield could not entirely offset the reduction in the aggregate dollar amount of Contracts purchased. The gross portfolio yield increased to 27.81% for the nine months endedDecember 31, 2021 , compared to 27.06% for the nine months endedDecember 31, 2020 . The net portfolio yield increased to 21.32% for the nine months endedDecember 31, 2021 compared to 19.43% for the nine months endedDecember 31, 2020 , respectively. The net portfolio yield increased primarily due to a decrease in the provision for credit losses, as described under "Analysis of Credit Losses".
Functionnary costs
Operating expenses increased to approximately$25.1 million for the nine months endedDecember 31, 2021 from approximately$22.9 million for the nine months endedDecember 31, 2020 . Operating expenses as a percentage of average finance receivables increased to 18.7% for the nine months endedDecember 31, 2021 from 15.0% for the nine months endedDecember 31, 2020 . These increased percentages were attributed to an increase in administrative, and salaries and employee benefits expense as well as a decrease in the average finance receivables balances.
Provision charge
The provision for credit losses decreased to$3.8 million for the nine months endedDecember 31, 2021 from$7.0 million for the nine months endedDecember 31, 2020 , largely due to a 12.1% decrease in the average finance receivables and a decrease in the net charge-off percentage to 4.7% for the nine months endedDecember 31, 2021 from 5.9% for the nine months endedDecember 31, 2020 .
Interest charges
Interest expense was$4.9 million for the nine months endedDecember 31, 2021 , of which the Company recognized approximately$1.9 million of interest expense related to previously incurred but unamortized debt issuance costs on the extinguishment of the Ares credit facility, and$4.7 million for the nine months endedDecember 31, 2021 . The following table summarizes the Company's average cost of borrowed funds, exclusive of debt origination costs: Nine months endedDecember 31, 2021 2020
Variable interest under the line of credit facility 0.80% 1.77% Credit spread under the line of credit facility
3.44 % 3.75 %
Average cost of borrowed funds 4.24 % 5.52 %
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Income Taxes
The Company recorded an income tax expense of approximately
Procurement
As ofDecember 31, 2021 , the Company purchases Contracts in the states listed in the table below. The Contracts purchased by the Company are predominantly for used vehicles; for the three-month periods endedDecember 31, 2021 and 2020, less than 1% were for new vehicles. The following tables present selected information on Contracts purchased by the Company. Three months ended Nine months ended As of December 31, December 31, December 31, 2021 2021 2020 2021 2020 Number of Net Purchases Net Purchases State branches (In thousands) (In thousands) FL 11$ 3,388 $ 3,549 $ 9,621 $ 11,585 OH 6 2,539 2,466 8,677 7,517 GA 5 2,247 2,126 7,664 7,590 KY 3 1,003 1,023 3,802 3,225 MO 2 1,135 1,022 3,920 3,264 NC 3 1,752 862 4,710 3,138 IN 2 1,071 547 3,150 2,149 SC 3 1,376 611 3,587 2,812 AL 2 911 728 2,695 1,702 MI 2 800 510 2,103 1,506 NV 1 557 378 1,751 978 TN 1 486 636 1,449 1,954 IL 1 356 267 1,102 681 PA 1 622 272 1,354 819 TX 1 516 - 1,178 - WI 1 312 88 832 155 ID 1 186 169 560 256 UT 1 69 17 300 43 AZ - 154 - 210 - KS - - 14 - 14 Total 47$ 19,480 $ 15,285 $ 58,665 $ 49,388 Three months ended Nine months ended December 31, December 31, (Purchases in thousands) (Purchases in thousands) Contracts 2021 2020 2021 2020 Purchases$ 19,480 $ 15,285 $ 58,665 $ 49,388 Average APR 23.1 % 23.4 % 23.1 % 23.5 % Average discount 6.8 % 7.5 % 6.8 % 7.4 % Average term (months) 47 46 47 46 Average amount financed$ 11,228 $ 10,307 $ 10,906 $ 10,132 Number of Contracts 1,735 1,483 5,389 4,878 23
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Direct Loan Origination
The following table presents selected information on Direct Loans originated by
the Company.
Three months ended Nine months ended
December 31, December 31,
Direct Loans (Originations in thousands) (Originations in thousands)
Originated 2021 2020 2021 2020
Purchases/Originations $ 8,505 $ 4,605 $ 21,282 $ 10,864
Average APR 31.8 % 30.9 % 30.6 % 29.6 %
Average term (months) 24 22 25 24
Average amount financed $ 3,661 $ 3,641 $ 4,173 $ 4,054
Number of loans 2,282 1,265 5,186 2,744
Cash and capital resources
The Company’s cash flows are summarized as follows:
Nine months ended
December 31,
(In thousands)
2021 2020
Cash provided by (used in):
Operating activities $ 1,824 $ 8,266
Investing activities 6,835 26,845
Financing activities (35,106 ) (30,534 )
(Decrease) net increase in cash
The Company’s primary use of working capital for the quarter ended
OnNovember 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 "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 "Credit Agreement"). The Ares Credit Facility was paid off in connection with entering into the Credit Facility. Pursuant to the Credit Agreement, the lenders have agreed to extend to the Borrowers a line of credit of up to$175,000,000 . The availability of funds under the 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 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 Credit Facility is three years (the expiration of that time period, the "Maturity Date"). Pursuant to the Credit Agreement, the Borrowers granted a security interest in substantially all of their assets as collateral for their obligations under the Credit Facility. Furthermore, pursuant to a separate collateral pledge agreement, NDS pledged its equity interest in NFI as additional collateral. The 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 occurs, the lenders could increase borrowing costs, restrict the Borrowers' ability to obtain additional advances under the Credit Facility, accelerate all amounts outstanding under the Credit Facility, enforce their interest against collateral pledged under the 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 Credit Facility following the occurrence of an event of default under the loan documents, or the Borrowers prepay the loan and terminate the 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$175,000,000 , 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. 24 --------------------------------------------------------------------------------
The Company will continue to depend on the availability the Credit Facility, together with cash from operations, to finance future operations. The availability of funds under the Credit Facility generally depends on availability calculations as defined in the Credit Agreement. See also the disclosure in Note 5. Credit Facility in this Form 10-Q, which is incorporated herein by reference. OnMay 27, 2020 , the Company obtained a loan in the amount of$3,243,900 from a bank in connection with theU.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, but there can be no assurance that the Company will obtain any forgiveness of the PPP Loan. The Company submitted the forgiveness application toFifth Third Bank , the lender, onDecember 7, 2020 and submitted supplemental documentation onJanuary 16, 2021 . OnDecember 27, 2021 SBA informed the Company that forgiveness in the amount of$0.00 is appropriate. The Company filed an appeal with SBA onJanuary 5, 2022 . The Company cannot predict whether the appeal will be successful. While the Company awaits the SBA response to the appeal, the loan payments are deferred. Unless the Company is successful on appeal, the outstanding principal balance plus accrued and unpaid interest (accruing at the rate of 1.00% per annum) is due onMay 22, 2022 . The PPP Loan is unsecured. The PPP Loan may be prepaid at any time prior to maturity with no prepayment penalties. The related promissory note contains events of default and other provisions customary for a loan of this type.
Off-balance sheet arrangements
The Company does not engage in any off-balance sheet financing arrangements.
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