OLD MARKET CAPITAL Corp: Form 10-Q for the period ended Sep 30, 2023

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”, "forecast", “will”, "would", “may”, “plan,” “believe”, “intend” and similar expressions are intended to identify forward-looking statements. Although Nicholas Financial, Inc., including its subsidiaries (collectively, the “Company,” “we”, “us”, or “our”) believes that the expectations reflected or implied in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. As a result, actual results could differ materially from those indicated in these forward-looking statements. Forward-looking statements in this Quarterly Report may include, without limitation statements about (1) the closing of the transaction contemplated by the Purchase Agreement with Westlake Financial; (2) the approval by the Court of the settlement of the litigation involving Mr. Jeremiah Gross; (3) the expected benefits, costs and timing of the Company’s restructuring and change in operating strategy, including its servicing arrangement with Westlake Portfolio Management, LLC (collectively with its affiliate Westlake Capital Finance, LLC, “Westlake”) (including without limitation the servicing fees, classified as administrative costs), its loan agreement with Westlake (the "WL Loan agreement") (including without limitation anticipated interest payments thereunder), and its restructuring activities; (4) the availability and use of excess capital (including by acquiring loan portfolios or businesses or by investing outside of the Company’s traditional business); (5) the continuing impact of COVID-19 on our customers and our business after the termination of curtailment of government programs aimed at ameliorating such impact, (6) projections of revenue, income, and other items relating to our financial position and results of operations, (7) statements of our plans, objectives, strategies, goals and intentions, (8) statements regarding the capabilities, capacities, market position and expected development of our business operations, and (9) statements of expected industry and general economic trends. These statements are subject to certain risks, uncertainties and assumptions that may cause results to differ materially from those expressed or implied in forward-looking statements, including without limitation:

• the risk that the contemplated sale of substentially all of the Company’s assets to Westlake Financial may not close, or the risk that the

anticipated short- and/or long-term benefits of such sale may not be realized, whether in whole or in part;

• the risk that approval by the Court of the settlement of the litigation involving Mr. Jeremiah Gross may not be granted,

either on terms and conditions satisfactory to the Company or at all;

• the risk that the anticipated benefits of the restructuring and change in operating strategy, including the servicing and financing arrangements with Westlake, an affiliate of Westlake Financial (including without limitation the expected reduction in overhead, streamlining of operations or reduction in compliance risk), do not materialize to the extent expected or at all, or do not materialize within the timeframe targeted by management;
• the risk that the actual servicing fees paid by the Company under the Westlake loan servicing agreement (the " Servicing agreement"), which the Company is classifying as administrative costs on its financial statements, exceed the range estimated;
• the risk that the actual interest payments made by the Company under the WL loan agreement exceed the range estimated;
• risks arising from the loss of control over servicing, collection or recovery processes that we have controlled in the past and potentially, termination of these services by Westlake (a failure of Westlake to perform their services under the Servicing Agreement in a satisfactory manner may have a significant adverse effect on our business);
• the risk that the actual costs of the restructuring activities in connection with the consolidation of workforce and closure of offices exceed the Company’s estimates or that such activities are not completed on a timely basis;
• the risk that the Company underestimates the staffing and other resources needed to operate effectively after consolidating its workforce and closing offices;
• uncertainties surrounding the Company’s success in developing and executing on a new business plan;
• uncertainties surrounding the Company’s ability to use any excess capital to increase shareholder returns, including without limitation, by acquiring loan portfolios or businesses or investing outside of the Company’s traditional business;
• the ongoing impact on us, our employees, our customers and the overall economy of the COVID-19 pandemic and measures taken in response thereto;
• the ongoing impact on us, our customers and the overall economy of the Russian invasion of Ukraine and related economic sanctions and the burgeoning hostilities between Israel and Hamas in the Gaza Strip;
• availability of capital (including the ability to access bank financing);
• 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;
• fluctuations in the economy;
• the degree and nature of competition and its effects on the Company’s financial results;
• fluctuations in interest rates;
• 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;
• our ability to successfully develop and commercialize new or enhanced products and services;
• the sufficiency of our allowance for credit losses and the accuracy of the assumptions or estimates used in preparing our financial statements;
• increases in the default rates experienced on our automobile finance installment contracts (“Contracts”) or direct loans (“Direct Loans”);
• higher borrowing costs and adverse financial market conditions impacting our funding and liquidity;
• regulation, supervision, examination and enforcement of our business by governmental authorities, and adverse regulatory changes in the Company’s existing and future markets, including the impact of the Dodd-Frank Wall 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;
• fraudulent activity, employee misconduct or misconduct by third parties, including representatives or agents of Westlake;
• media and public characterization of consumer installment loans;
• failure of third parties to provide various services that are important to our operations;
• alleged infringement of intellectual property rights of others and our ability to protect our intellectual property;
• litigation and regulatory actions;
• our ability to attract, retain and motivate key officers and employees;
• use of third-party vendors and ongoing third-party business relationships, particularly our relationship with Westlake;
• cyber-attacks or other security breaches suffered by us or Westlake;
• disruptions in the operations of our or Westlake’s 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; and
• the risk factors discussed under “Item 1A – Risk Factors” in our Annual Report on Form 10-K, and our other filings made with the U.S. Securities and Exchange Commission (“SEC”).

Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or expected. All forward-looking statements included in this Quarterly Report are based on information available to the Company as the date of filing of this Quarterly Report, and the Company assumes no obligation to update any such forward-looking statement. Prospective investors should also consult the risk factors described from time to time in the Company’s other filings made with the SEC, including its reports on Forms 10-K, 10-Q, 8-K and annual reports to shareholders.

Restructuring and Change in Operating Strategy

The Company announced on Form 8-K filed on November 3, 2022 a change in its operating strategy and restructuring plan with the goal of reducing operating expenses and freeing up capital. As part of this plan, the Company has shifted from a decentralized to a regionalized business model in which each of its originators focused on a specific region in the Company’s smaller target market footprint, and the Company has entered into the Servicing Agreement with Westlake Portfolio Management, LLC (“WPM”, and, collectively with its affiliate, Westlake Capital Finance, LLC, “Westlake”). An affiliate of Westlake, Westlake Services, LLC, is the beneficial owner of approximately 6.8% of the Company’s common stock.

The Company does not intend to continue any significant Contract purchase and origination activities, except on a much smaller scale, than it has historically, and its servicing, collections and recovery operations have been outsourced to Westlake. The Company has also ceased all originations of Direct Loans.

The Company anticipates that execution of its evolving restructuring plan will free up capital and permit the Company to allocate excess capital to increase shareholder returns, whether by acquiring loan portfolios or businesses or by investing outside of the Company’s traditional business. The overall timeframe and structure of the Company’s restructuring remains uncertain.

Although the Company no longer employs the branch-based model, its business remains focused on servicing its core product of financing primary transportation to and from work for the subprime borrower, which historically had been conducted through the local independent automobile dealership. The Company's strategy included risk-based pricing (rate, yield, advance, term, collateral value) and a commitment to the underwriting discipline required for optimal portfolio performance. The Company’s principal goals are to increase its profitability and its long-term shareholder value. During fiscal 2023, the Company focused on the following items:

• restructuring the Company’s business by downsizing and streamlining operations and reducing

expenses;

• outsourcing servicing, collections and recovery operations;
• discontinuing our local branch model in favor of a regionalized business model;
• optimizing our technology to better fit the Company’s restructured operations; and
• terminating our live checks program for prospective new customers

In fiscal 2023, the Company also restructured and consolidated its operations by closing all of its 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, and Wisconsin. As a result, as of September 30, 2023, the Company only had two offices in two states – its headquarters in Florida and its central business operations hub in South Carolina.

Although the Company had been 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, and Tennessee during fiscal 2023 the Company has cancelled, not renewed, or otherwise terminated all of such Direct Loan licenses.

Consequently, the Company has not originated any new Direct Loans since the end of the third quarter of fiscal 2023 and the Company does not intend to originate any new Direct Loans going forward. However, the Company expects its third-party service provider to continue to service the Company’s existing Direct Loans. The Company’s total Direct Loans portfolio comprises approximately 12% of its total portfolio, and the Company expects its total Direct Loans portfolio to be reduced over time as such Direct Loans are paid off for otherwise liquidated until there are no Direct Loans in the Company’s portfolio, which at the current rate of such activity is expected to occur sometime during the fiscal year ending March 31, 2027.

Following the restructuring and consolidation of the Company’s operations, the Company does not expect to expand in either its current markets or any new markets.

Restructuring Activities

The closing of branches and consolidation of the workforce pursuant to the restructuring plan were substantially completed by March 31, 2023. The Company recorded the majority of lease terminations and employee-related charges in the second half of Fiscal Year 2023. The Company expects significant annual operating cost savings to substantially exceed the upfront costs associated with the restructuring.

Westlake Loan Agreement

On January 18, 2023, the Company, through its subsidiaries, entered into a Loan and Security Agreement (the “WL Loan Agreement”) with Westlake, pursuant to which Westlake is providing the Company a senior secured revolving credit facility in the principal amount of up to $50 million (the “WL Credit Facility”).

The availability of funds under the WL Credit Facility is generally limited to an advance rate of between 70% and 85% of the value of the Company’s eligible receivables. Outstanding advances under the WL Credit Facility will accrue interest at a rate equal to the secured overnight financing rate (SOFR) plus a specified margin, subject to a specified floor interest rate. Unused availability under the WL Credit Agreement will accrue interest at a low interest rate. The commitment period for advances under the WL Credit Facility is two years. We refer to the expiration of that time period as the “Maturity Date.”

The WL Loan Agreement contains customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, and sales of assets. The WL Loan Agreement also requires the Company to maintain (i) a minimum tangible net worth equal to the lower of $40 million and an amount equal to 60% of the outstanding balance of the WL Credit Facility and (ii) an excess spread ratio of no less than 8.0%. Pursuant to the WL Loan Agreement, the Company granted a security interest in substantially all of their assets as collateral for their obligations under the WL Credit Facility. If an event of default occurs, Westlake could increase borrowing costs, restrict the Company's ability to obtain additional advances under the WL Credit Facility, accelerate all amounts outstanding under the WL Credit Facility, enforce their interest against collateral pledged under the WL Loan Agreement or enforce such other rights and remedies as they have under the loan documents or applicable law as secured lenders. Subject to Company’s compliance with certain terms and conditions, the lender waived its rights and remedies under the Agreement applicable to the excess spread ratio covenant and collateral performance indicator through September 30, 2024.

If the Company prepays the loan and terminate the WL Credit Facility prior to the Maturity Date, then the Company would be obligated to pay Westlake a termination fee in an amount equal to a percentage of the average outstanding principal balance of the WL Credit Facility during the immediately preceding 90 days. If the Company were to sell its accounts receivable to a third party prior to the Maturity Date, then the Company would be obligated to pay Westlake a fee in an amount equal to a specified percentage of the proceeds of such sale.

On January 18, 2023, in connection with entering into the WL Loan Agreement, the Company terminated its credit agreement with Wells Fargo (the “WF Credit Agreement”), and the indebtedness under that agreement (consisting of a revolving line of credit in a maximum principal amount of $60 million (with an outstanding balance of approximately $43 million)) was repaid in full. The Company did not incur any termination penalties in connection with the termination of the WF Credit Agreement.

Critical Accounting Estimates

The Company’s critical accounting estimate (i.e., that involves a significant level of estimation uncertainty and has or is reasonably likely to have a material impact on the Company’s financial condition or results of operations) relates to the allowance for credit losses, which reflects the difference between the amortized cost basis and the present value of the expected cash flows of finance receivables.

There has been one change in our critical accounting policies from those disclosed in our Annual Report on 2023 Form 10-K related the Company's adoption of ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and subsequent amendments to the guidance: ASU 2018-19 in November 2018, ASU 2019-04 in April 2019, ASU 2019-05 in May 2019, ASU 2019-10 and -11 in November 2019, ASU 2020-02 in February 2020 and ASU 2022-02 in March 2022.

Allowance for Credit Losses (ACL)

The Company adopted ASU 2016-13 for measurement of current expected credit losses on April 1, 2023. An impairment model required by ASU 2016-13 is not prescriptive in the methodology used to determine the expected credit loss estimate. Therefore, management has flexibility in selecting the methodology. However, the expected credit losses must be estimated over a financial asset's remaining expected life, adjusted for prepayments, utilizing quantitative and qualitative factors. The estimate of current expected credit losses is based on relevant information about past events, current conditions, and reasonable and supportable economic forecasts that affect the collectability of the reported amounts. Historical loss experience is the starting point for estimating expected credit losses. Adjustments are made to historical loss experience to reflect differences in asset-specific risk characteristics, such as underwriting standards, portfolio mix or asset terms, and differences in economic conditions - both current conditions and reasonable and supportable forecasts. When the Company is not able to make or obtain reasonable and supportable forecasts for the entire life of the financial asset, it has estimated expected credit losses for the remaining life after the forecasted period using an approach that reverts to historical credit loss information.

The Company selected a discounted cash flow (DCF) model to estimate its base allowance for credit losses. Management has elected to use this approach after analysis and consideration. Below are a few of the key decision points that contributed to the election:

• DCF models, being periodic in nature, allow for effective incorporation of a reasonable and supportable forecast in a directionally consistent and objective manner.
• The analysis aligns well with other calculations/actions outside the ACL estimation, which will mitigate model risk in other areas and allow for symmetrical application. For example, fair value (exit price notion), profitability analysis, internal rate of return calculations, stress testing, and other forms of cash flow analysis.
• Peer data is available for certain inputs, such as probability of default and loss given default if first-party data is not available or meaningful. This is made possible by the periodic nature of the model.

DCF methodologies work properly with an amortizing approach. In order to estimate expected credit losses using methods that project future principal and interest cash flows (that is, a discounted cash flow method), the Company discounts expected cash flows at the financial asset’s effective interest rate. When a discounted cash flow method is applied, the allowance for credit losses must reflect the difference between the amortized cost basis and the present value of the expected cash flows.

The Company applies historical loss experience to forecast expected credit losses. Historical information about losses generally provides a basis for the estimate of expected credit losses. The Company also considers the need to adjust historical information to reflect the extent to which current conditions differ from the conditions that existed for the period over which historical information was evaluated. These adjustments to historical loss information may be qualitative or quantitative in nature.

Reasonable and supportable macroeconomic forecasts are required for the Company’s ACL model. The Company reviews macroeconomic forecasts to use in its ACL. The projected change in creditworthiness is modeled using information provided by FOMC, such as unemployment rate and GDP. The Company adjusts the historical loss experience by relevant qualitative factors for these expectations.

As loans receivable are originated, provisions for credit losses are recorded in amounts sufficient to maintain an ACL at an adequate level to provide for estimated losses over the remaining expected life of the finance receivables. The Company uses its historical loss experience and macroeconomic factors to forecast expected credit losses.

While the Company utilizes a systematic methodology in determining its allowance, the allowance is based on estimates, and ultimate losses may vary from current estimates. The estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known.

After adoption, all changes in the ACL, net of charge-offs and recoveries, are recorded as “Provision for credit losses” in the unaudited Condensed Consolidated Statements of Income (Loss).

Introduction

The Company finances primary transportation to and from work for the subprime borrower. We do not finance luxury cars, second units or recreational vehicles, which are the first payments customers tend to skip in time of economic insecurity. We finance the main and often only vehicle in the household that is needed to get our customers to and from work. The amounts we finance are much lower than most of our competitors, and therefore the payments are significantly lower, too. The combination of financing a “need” over a “want” and making that loan on comparatively affordable terms incentivizes our customers to prioritize their account with us.

For the three months ended September 30, 2023, the dilutive loss per share were $1.44 as compared to dilutive loss per share of $0.44 for the three months ended September 30, 2022. Net loss was $10.5 million for the three months ended September 30, 2023 as compared to net loss of $3.2 million for the three months ended September 30, 2022. Interest and fee income on finance receivables decreased 48.3% to $6.3 million for the three months ended September 30, 2023 as compared to $12.2 million for the three months ended September 30, 2022. Provision for credit losses increased 39.3% to $12.4 million for the three months ended September 30, 2023 as compared to $8.9 million for the three months ended September 30, 2022.

For the six months ended September 30, 2023, the dilutive loss per share was $1.22 as compared to dilutive loss per share of $0.68 for the six months ended September 30, 2022. Net loss was $8.9 million for the six months ended September 30, 2023 as compared to net loss of $4.9 million for the six months ended September 30, 2022. Interest and fee income on finance receivables decreased 44.8% to $13.4 million for the six months ended September 30, 2023 as compared to $24.3 million for the six months ended September 30, 2022. Provision for credit losses increased 49.3% to $13.1 million for the six months ended September 31, 2023 as compared to $12.6 million for the six months ended September 30, 2022.

Non-GAAP financial measures

From time-to-time the Company uses certain financial measures derived on a basis other than generally accepted accounting principles (“GAAP”), primarily by excluding from a comparable GAAP measure certain items the Company does not consider to be representative of its actual operating performance. Such financial measures qualify as “non-GAAP financial measures” as defined in SEC rules. The Company uses these non-GAAP financial measures in operating its business because management believes they are less susceptible to variances in actual operating performance that can result from the excluded items and other infrequent charges. The Company may present these financial measures to investors because management believes they are useful to investors in evaluating the primary factors that drive the Company’s core operating performance and provide greater transparency into the Company’s results of operations. However, items that are excluded and other adjustments and assumptions that are made in calculating these non-GAAP financial measures are significant components to understanding and assessing the Company’s financial performance. Such non-GAAP financial measures should be evaluated in conjunction with, and are not a substitute for, the Company’s GAAP financial measures. Further, because these non-GAAP financial measures are not determined in accordance with GAAP and are, thus, susceptible to varying calculations, any non-GAAP financial measures, as presented, may not be comparable to other similarly titled measures of other companies.

Note: All income performance indicators expressed as percentages have been annualized.

(1) Average finance receivables represent the average of finance receivables throughout the period. (This is considered a non-GAAP financial measure).

(2) Average indebtedness represents the average outstanding borrowings under the Credit Facility. (This is considered a non-GAAP financial measure).

(3) Portfolio yield represents interest and fee income on finance receivables as a percentage of average finance receivables. Net portfolio yield represents (a) interest and fee income on finance receivables minus (b) interest expense minus (c) the provision for credit losses, as a percentage of average finance receivables. (This is considered a non-GAAP financial measure).

(4) Operating expenses as presented include restructuring cost of approximately $0.2 millions and $0.3 millions for the three and six months ended September 30, 2023, respectively. Operating expenses net of restructuring cost (a non-GAAP financial measure), as a percentage of average finance receivable would have been 16.5% and 13.7% for the three and six months ended September 30, 2023, respectively.

(5) Pre-tax yield represents net portfolio yield minus operating expenses (marketing, salaries, employee benefits, depreciation, and administrative), as a percentage of average finance receivables. (This is considered a non-GAAP financial measure).

(6) Net charge-off percentage represents net charge-offs (charge-offs less recoveries) divided by average finance receivables outstanding during the period. (This is considered a non-GAAP financial measure).

(7) Allowance percentage represents the allowance for credit losses divided by finance receivables outstanding as of ending balance sheet date.

(8) 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.

Analysis of Credit Losses

Implementation of ASU 2016-13

We adopted ASU 2016-13 on April 1, 2023, as further described in "Significant Accounting Policies" to the unaudited Condensed Consolidated Financial Statements. Upon implementation of ASU 2016-13, we recognized a decrease to our opening retained earnings balance of approximately $0.2 million, which reflects an increase to the allowance for credit losses (ACL) of approximately $0.2 million.

ASU 2016-13 introduces a new accounting model to measure credit losses for financial assets measured at amortized costs. In contrast to the previous incurred loss model, ASU 2016-13 requires credit losses for financial assets measured at amortized cost to be determined based on the total current expected credit losses over the life of those financial assets or group of assets.

Our process for determining the ACL considers a customer's willingness and ability to pay along with other risk characteristics, including loan size, effective interest rate, loan term, geographic location, expected loss patterns, loan modification programs and other macroeconomic factors. In addition to our quantitative ACL, we also incorporate qualitative adjustments that may relate to risks and changes in current economic conditions that may not be reflected in quantitatively derived results.

Prior to adoption of ASU 2016-13 the Company used a trailing twelve-month charge-off analysis to calculate the allowance for credit losses and took 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 believed that the allowance for credit losses reflected the current trends of incurred losses within the portfolio and was aligned with the portfolio’s performance indicators.

If the allowance for credit losses was determined to be inadequate, then an additional charge to the provision was 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 judgment 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.

Beginning March 31, 2018, the Company allocated a specific reserve for the Chapter 13 bankruptcy accounts using a look back method to calculate the estimated losses. Based on this look back, management calculated a specific reserve of approximately $253 thousand for these accounts as of September 30, 2023.

The provision for credit losses increased to $12.4 million for the three months ended on September 30, 2023, from $8.9 million for the three months ended on September 30, 2022, largely due to adoption of ASU 2016-13. Prior to April 1, 2023, the Company recorded losses based on the trailing twelve-month charge-offs, and applied this calculated percentage to ending finance receivables to calculate estimated probable credit losses for purposes of determining the allowance for credit losses. Upon adoption of ASC 326 on April 1, 2023, expected credit losses were determined by comparing the amortized cost of finance receivables with the present value of the estimated future principal and interest cash flows. The current period provision reflects the change in the difference between the amortized cost basis and the present value of the expected cash flows of finance receivables.

The net charge-off percentage increased to 58.2% for the three months ended on September 30, 2023, from 4.9% for the three months ended on September 30, 2022. Similarly, the net charge-off percentage increased to 28.8% for the six months ended on September 30, 2023, from 9.4% for the six months ended on September 30, 2022, primarily driven by increased delinquencies and loan defaults. (See the Portfolio Summary table in the “Introduction” above for the definition of net charge-off percentage.) Management attributes these increased delinquencies and loan defaults primarily to the fact that the beneficial impact of the government’s prior COVID-19-related assistance to the Company’s customers had subsided at a time when those customers began facing increased inflationary pressures affecting their cost of living, and expects that the net charge-off percentage will remain, for the foreseeable future, at levels higher than those experienced in prior years for the same reasons.

The delinquency percentage for Contracts more than 29 days past due, excluding Chapter 13 bankruptcy accounts, as of September 30, 2023 was 16.6%, an increase from 11.2% as of September 30, 2022. The delinquency percentage for Direct Loans more than 29 days past due, excluding Chapter 13 bankruptcy accounts, as of September 30, 2023 was 15.5%, an increase from 7.3% as of September 30, 2022. The changes in delinquency percentage for both Contracts and Direct Loans was driven primarily by market and economic pressure and its adverse impact on consumers.

In accordance with our policies and procedures, certain borrowers qualify for, and the Company offers, one-month principal payment deferrals on Contracts and Direct Loans.

Three months ended September 30, 2023 compared to three months ended September 30, 2022

Interest and Fee Income on Finance Receivables

Interest and fee income on finance receivables, which consist predominantly of finance charge income, decreased 48.3% to $6.3 million for the three months ended September 30, 2023, from $12.2 million for the three months ended September 30, 2022. The decrease was primarily due to a reduction in originations of Contracts and discontinued originating Direct Loans pursuant to the Company's restructuring plan.

The portfolio yield decreased to 25.4% for the three months ended September 30, 2023, compared to 27.4% for the three months ended September 30, 2022. The net portfolio yield decreased to (25.4)% for the three months ended September 30, 2023, compared to 5.31% for the three months ended September 30, 2022. The substantial deterioration in net portfolio yield was primarily a result of increased provision for credit losses stemming from a rapid increase in charge-offs.

Operating Expenses

Operating expenses decreased 41.6% to $4.3 million for the three months ended September 30, 2023 compared to $7.4 million for the three months ended September 30, 2022. The decrease in operating expenses was primarily attributable to the restructuring initiative associated with branch closures and transition of the servicing process to Westlake under the Servicing Agreement. These factors had a direct beneficial effect and led to the decrease in salary and wages as a result of the Company’s headcount reduction.

The Company's operating expenses as a percentage of average finance receivables increased to 17.2% for the three months ended September 30, 2023, compared to 16.5% for the three months ended September 30, 2023, mainly due to rapidly declining portfolio balances. Management expects that the operating expenses will decline in conjunction with the servicing fees payable to Westlake under the Servicing Agreement.

Provision Expense

The provision for credit losses increased 39.3% to $12.4 million for the three months ended September 30, 2023 from $8.9 million for the three months ended September 30, 2022, largely due to increased credit losses. Similarly, the net charge-off percentage increased to 58.2% for the three months ended September 30, 2023 from 12.4% for the three months ended September 30, 2022.

Interest Expense

Interest expense decreased to $0.3 million for the three months ended September 30, 2023 from $1.0 million for the three months ended September 30, 2022, primarily due to a reduction in outstanding debt. The following table summarizes the Company’s average cost of borrowed funds:

SOFR rates have increased to 5.1%, which represented the daily SOFR rate as required under the WL Credit Agreement, as of September 30, 2023 compared to 2.1% as of September 30, 2022 governed by the Wells Fargo Credit Facility.

Income Taxes

The Company recorded an income tax benefit of approximately $0.1 million for the three months ended September 30, 2023 compared to an income tax benefit of approximately $1.0 million for the three months ended September 30, 2022. The Company’s effective tax rate decreased to 1.4% for the three months ended September 30, 2023 from 23.4% for the three months ended September 30, 2022. The lower effective tax rate for the three months ended September 30, 2023 is primarily attributable to the establishment of a valuation allowance subsequent to September 30, 2022.

Six months ended September 30, 2023 compared to six months ended September 30, 2022

Interest and Fee Income on Finance Receivables

Interest and fee income on finance receivables, which consist predominantly of finance charge income, decreased 44.8% to $13.4 million for the six months ended September 30, 2023, from $24.3 million for the six months ended September 30, 2022. The decrease was primarily due to a reduction in originations of Contracts and discontinued originating Direct Loans pursuant to the restructuring plan.

The portfolio yield decreased to 22.2% for the six months ended September 30, 2023, compared to 27.2% for the six months ended September 30, 2022. The net portfolio yield decreased to (0.66)% for the six months ended September 30, 2023, compared to 11.4% for the six months ended September 30, 2022. The substantial deterioration in net portfolio yield was primarily a result of increased provision for credit losses stemming from a rapid increase in charge-offs.

Operating Expenses

Operating expenses decreased 49.3% to $8.5 million for the six months ended September 30, 2023 compared to $16.8 million for the six months ended September 30, 2022. The decrease in operating expenses was primarily attributable to the restructuring initiative associated with branch closures and transition of the servicing process to Westlake under the Servicing Agreement. These factors had a direct beneficial effect and led to the decrease in salary and wages as a result of the Company’s headcount reduction.

The Company's operating expenses as a percentage of average finance receivables decreased to 14.1% for the six months ended September 30, 2023, compared to 18.8% for the six months ended September 30, 2023. Management expects that the operating expenses will decline in conjunction with the servicing fees payable to Westlake under the Servicing Agreement.

Provision Expense

The provision for credit losses increased 4.0% to $13.1 million for the six months ended September 30, 2023 from $12.6 million for the six months ended September 30, 2022, largely due to increased credit losses. Similarly, the net charge-off percentage increased to 28.8% for the six months ended September 30, 2023 from 9.4% for the six months ended September 30, 2022.

Interest Expense

Interest expense decreased to $0.8 million for the six months ended September 30, 2023 from $1.5 million for the six months ended September 30, 2022, primarily due to a reduction in outstanding debt. The following table summarizes the Company’s average cost of borrowed funds:

Income Taxes

The Company recorded an income tax benefit of $0 for the six months ended September 30, 2023 compared to an income tax benefit of approximately $1.6 million for the six months ended September 30, 2022. The Company’s effective tax rate decreased to 0.0% for the six months ended September 30, 2023 from 24.4% for the six months ended September 30, 2022. The lower effective tax rate for the six months ended September 30, 2023 is primarily attributable to the establishment of a valuation allowance subsequent to September 30, 2022.

Contract Procurement

As of September 30, 2023, the Company purchased Contracts in the states listed in the table below. The Contracts purchased by the Company are predominantly for used vehicles for the three-month and six-month periods ended September 30, 2023 and 2022, less than 1% were for new vehicles.

The following tables present selected information on Contracts purchased by the Company.

Direct Loan Origination

The following table presents selected information on Direct Loans originated by the Company.

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Liquidity and Capital Resources

The Company’s cash flows are summarized as follows:

The Company’s primary use of working capital for the six months ended September 30, 2023 was payments related to servicing the loans and repayment of the Company’s line of credit.

Please refer to “Note 5 – in the Annual Report on Form 10-K” for disclosure on the Company’s prior credit facility with Wells Fargo under the WF Credit Agreement, which disclosure is incorporated herein by reference.

On January 18, 2023, the Company through its subsidiaries, entered into a Loan and Security Agreement (the “ WL Loan Agreement”) with Westlake, pursuant to which Westlake is providing the Company a senior secured revolving credit facility in the principal amount of up to $50 million (the “WL Credit Facility”).

The availability of funds under the WL Credit Facility is generally limited to an advance rate of between 70% and 85% of the value of the Company's eligible receivables. Outstanding advances under the WL Credit Facility will accrue interest at a rate equal to the secured overnight financing rate (SOFR) plus a specified margin, subject to a specified floor interest rate. Unused availability under the WL Credit Agreement will accrue interest at a low interest rate. The commitment period for advances under the WL Credit Facility is two years. We refer to the expiration of that time period as the “Maturity Date.”

The WL Loan Agreement contains customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, and sales of assets. The WL Loan Agreement also requires the Company to maintain (i) a minimum tangible net worth equal to the lower of $40 million and an amount equal to 60% of the outstanding balance of the WL Credit Facility and (ii) an excess spread ratio of no less than 8.0%. Pursuant to the WL Loan Agreement, the Company granted a security interest in substantially all of their assets as collateral for their obligations under the WL Credit Facility. If an event of default occurs, Westlake could increase borrowing costs, restrict the Company's ability to obtain additional advances under the WL Credit Facility, accelerate all amounts outstanding under the WL Credit Facility, enforce their interest against collateral pledged under the WL Loan Agreement or enforce such other rights and remedies as they have under the loan documents or applicable law as secured lenders. Subject to Company’s compliance with certain terms and conditions, the lender waived its rights and remedies under the Agreement applicable to the excess spread ratio covenant and collateral performance indicator through September 30, 2024.

If the Company prepays the loan and terminates the WL Credit Facility prior to the Maturity Date, then the Company would be obligated to pay Westlake a termination fee in an amount equal to a percentage of the average outstanding principal balance of the Wl Credit Facility during the immediately preceding 90 days. If the Company were to sell its accounts receivable to a third party prior to the Maturity Date, then the Company would be obligated to pay Westlake a fee in an amount equal to a specified percentage of the proceeds of such sale.

The Company has substantially completed its restructuring process to substantially decrease operating expenses and is developing a strategy with respect to its long-term use of cash. The related disclosure contained in “Restructuring and Change in Operating Strategy” is incorporated herein by reference.

Off-Balance Sheet Arrangements

The Company does not engage in any off-balance sheet financing arrangements.

Significant Developments

See the disclosure in Note 12 – Subsequent Events to the condensed consolidated financial statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q, which disclosure is hereby incorporated herein by reference.

Evaluation of Disclosure Controls and Procedures

In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s management evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act).

Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were not effective at a reasonable level of assurance as of September 30, 2023 because of a material weakness in our internal control over financial reporting relating to the design of the controls over accounting for credit losses in accordance with FASB ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) (CECL), including the operation of these controls.

We are taking certain measures to remediate the material weakness related to the design of the controls related to application of the CECL accounting standard, including designing and implementing formal procedures and controls related to secondary review of data input, model calculations, journal entries, and financial statement disclosures.

While we believe that our efforts for remediation, once implemented, will improve the effectiveness of our internal control over financial reporting, these remediation efforts have been ongoing and will require more time to operate for management to be able to conclude that the design is effective to remediate the material weakness identified. We may conclude that additional measures will be necessary to remediate the material weakness in our internal control over financial reporting, which may necessitate additional evaluation and implementation time.

Notwithstanding the material weakness, the Company has concluded that the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q present fairly, in all material respects, the financial position and results of operations of the Company as of and for the three and six months ended September 30, 2023 in conformity with generally accepted accounting principles in the United States of America.

Changes in internal control over financial reporting

In connection with the adoption of CECL, management is in the process of establishing and is refining its internal procedures and controls to ensure finance receivables are appropriately accounted for in the accordance with FASB ASC Topic 326 and that required disclosures are complete and accurate. This includes procedures and controls over inputs and assumptions used in the estimation process, the use of third parties, and other risk-based considerations.

Other than as described above, during the most recent fiscal quarter, there has been no change in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

In addition to the Risk Factor below and the other information set forth in this Quarterly Report on Form 10-Q, especially in the section entitled “PART I – Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Forward Looking Statements,” you should carefully consider the factors discussed in Part I “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2023, which could materially affect our business, financial condition or future results of operations. The risks described in the Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

As part of its restructuring and change in operating strategy, the Company has outsourced its servicing, collection and recovery operations and is substantially dependent on Westlake for the generation of revenue and debt financing.

As part of the Company’s restructuring and change in operating strategy, in December 2022, Westlake began servicing all receivables held by the Company under its Contracts and Direct Loans, except for charged-off and certain other receivables. The Company expects to add additional Contract receivables to the receivables pool covered under the Servicing Agreement with Westlake from time to time in the future, but will no longer originate Direct Loans. As a result, the Company has significantly reduced its footprint, closing all of its branches and retaining only 16 employees as of September 2023.

In January 2023, two of the Company’s subsidiaries entered into a WL Loan Agreement with Westlake, pursuant to which Westlake is providing a senior secured revolving credit facility in the principal amount of up to $50 million. This facility replaced the Company’s prior facility with Wells Fargo.

Additional details on the Servicing Agreement, restructuring activities and WL Loan Agreement are incorporated herein by reference to “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Restructuring and Change in Operating Strategy” in this Quarterly Report on Form 10-Q.

• The Company’s restructuring and change in operating strategy is subject to various risks, including without limitation: the risk that anticipated benefits of the restructuring and change in operating strategy, including the servicing and financing arrangements with Westlake (including without limitation the expected reduction in overhead, streamlining of operations or reduction in compliance risk), do not materialize to the extent expected or at all, or do not materialize within the timeframe targeted by management;
• the risk that the actual servicing fees paid by the Company under the Westlake Servicing Agreement, which the Company is classifying as administrative costs on its financial statements, exceed the range estimated;
• the risk that the actual interest payments made by the Company under the WL Loan Agreement exceed the range estimated;
• risks arising from the loss of control over servicing, collection or recovery processes that we have controlled in the past and potentially, termination of these services by Westlake (a failure of Westlake to perform their services under the Servicing Agreement or the WL Loan Agreement in a satisfactory manner may have a significant adverse effect on our business);
• the risk that the actual costs of the restructuring activities in connection with the consolidation of workforce and closure of offices exceed the Company’s estimates or that such activities are not completed on a timely basis;
• the risk that the Company underestimates the staffing and other resources needed to operate effectively after consolidating its workforce and closing offices;
• uncertainties surrounding the Company’s success in developing and executing on a new business plan; and
• uncertainties surrounding the Company’s ability to use any excess capital to increase shareholder returns, including without limitation, by acquiring loan portfolios or businesses or investing outside of the Company’s traditional business.

The materialization of any of these risks may adversely affect our results of operations or financial position, potentially to a material extent.