Elevate Credit, Inc. (NYSE:ELVT) Q3 2022 Results Conference Call November 9, 2022 5:00 PM ET
Company Participants
Daniel Rhea – Director of Public Affairs
Jason Harvison – President and Chief Executive Officer
Steven Trussell – Chief Financial Officer
Conference Call Participants
Moshe Orenbuch – Credit Suisse
Operator
Welcome to the Elevate Credit Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.
I’ll now turn the call over to your host, Daniel Rhea, Chief Communications Officer. Mr. Rhea, you may begin.
Daniel Rhea
Good afternoon, and thanks for joining us on Elevate’s third quarter 2022 earnings conference call. Earlier today, we issued a press release with our third quarter results. A copy of the release is available on our website at investors.elevate.com. Today’s call is being webcast and is accompanied by a slide presentation, which is also available on our website. Please refer now to Slide 2 of that presentation.
Our remarks and answers will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks that could cause actual results to be materially different from those expressed or implied by such forward-looking statements. These risks include, among others, matters that we have described in our press release issued today, along with our annual report on Form 10-K and other filings we make with the SEC. These include impacts related to the current economic environment, including high inflation and interest rates and COVID-19. Please note that all forward-looking statements speak only as of the date of this call, and we disclaim any obligation to update these forward-looking statements.
During our call today, we’ll make reference to non-GAAP financial measures. For a complete reconciliation of historical non-GAAP to GAAP financial measures, please refer to our press release issued today and our slide presentation, both of which have been furnished to the SEC and are available on our website at investors.elevate.com. Joining me on the call today are President and Chief Executive Officer, Jason Harvison; and Chief Financial Officer, Steve Trussell.
I will now turn the call over to Jason.
Jason Harvison
Thank you, Daniel, and hope everyone is doing well. Similar to last quarter, I’ll begin the call with our updated view of the current environment and our strategic response. I’ll then give a brief overview of our results and end my remarks with where Elevate is moving in the future. To recap the last year, our team started in late ’21 with a clear plan to temper growth and bring margins back into focus for 2022. We anticipated at that time a normalization of credit.
What we did not anticipate was the magnitude of inflation in a quickly shifting macro environment, particularly as it strained nonprime Americans. This summer, we’ve pivoted our plan to slow originations further. Additionally, we took proactive steps to lower operating expenses. On the underwriting side, we are implementing new affordability assessments and income verification tools that will not only help with future growth, but can also help with ongoing account management. I’d like to highlight three areas of emphasis.
First, on cost, we have made a difficult but appropriate decision to aggressively right-size our expense base for the current environment by implementing furloughs and additional expense reductions beyond personnel. Second, on credit, in addition to the new underwriting enhancements I just mentioned, we are working diligently to review risk factors in the current portfolio relative what we’re seeing in specific cost-of-living and affordability categories. For example, we are working proactively with higher-risk customers to assist, where possible, to help customers weather the current environment.
Lastly, on revenue, while we mentioned slower growth, we are also actively pursuing opportunities to improve pricing leverage and segmentation based both on product mix and what we’re seeing in a lack of available credit from traditional bank lenders. In sum, it is clear that 2022 and ’23 will be more challenging than we originally expected, but we firmly believe we are positioning the Company well to see the growing opportunity to serve more near-prime consumers when economic visibility increases.
If we start on Slide 4, I’ll reiterate that this is a difficult market for both consumers and lenders. Volatility always makes decision making difficult, but paired with persistently high inflation and a rising probability of recession, strategy needs to pivot. For Elevate, I’m proud that the Company and our teams continue to be nimble in the current market, and we continue to position the Company to best serve both the borrowers that need us and our shareholders. To speak to our strategy holistically, let’s organize across demand, credit, and what we’re doing operationally in today’s shifting market. First, on demand and growth, as you have seen from the banks that have reported results so far, credit availability is shrinking, and this makes our large addressable market that much larger.
That said, Elevate is also highly focused on driving the best returns for its shareholders, and we believe that it is best achieved in this market through measured and selective growth, utilizing new and improved tools to assist with income verification and affordability assessments in real time.
You can see our [indiscernible] in the 3% growth in originations over the last quarter. To be clear, the demand for products significantly exceeds the originations pace, but we believe it is prudent to make loans to borrowers where we have the highest degree of confidence and the best line of sight to strong returns. The natural question, of course, is when do we expect a turn and can accelerate growth? Ultimately, we believe that stabilization in inflation and interest rates will be the first step.
On a daily basis, we are evaluating key internal and external indicators to give us the confidence needed to lean in. Underwriting beyond 2022 already assumes a weakening economic environment with higher unemployment and inflation. The challenge in the short term is what pace or time line is to get to that point? It is important to be transparent about what we know and what we don’t, and given there are unknowns, the right strategy is to be measured and selective with the loans we originate. As a reminder, as volatility eases, we anticipate the ability to lend to a more creditworthy borrower that has been locked out of traditional options previously available.
On that point, let’s talk about credit and what we have seen in our ’21 and now seasoning 2022 vintages. The story here is also about volatility and how the rapid and persistent increase in cost of living has stressed borrowers beyond initial underwriting scenarios. Steve will speak in more detail about our vintages, but clearly, ’21 and ’22 have been difficult, and that backdrop helps to inform our decisions on growth and targeting in the near term. There is more we can do to insulate returns and profitability beyond our speed of originations. Elevate has made difficult decisions this year to proactively reduce our expense base.
Specifically, during Q3, we furloughed approximately 25% of our workforce. We’ll begin seeing the full impact of that decision on our financials starting in the fourth quarter. This action was part of a series of planned reductions to operational expenses that included decreases in executive compensation and elimination of any external vendors and a narrow corporate focus on existing brands. Additionally, we continue to strengthen our credit decisioning by enhancing affordability assessments. Many of these process improvements stem from the challenges we have faced in our ’21 vintage.
We are beginning to see the benefit in our current underwriting and believe there will be long-term value in the use of these tools in the ’23 vintages. To complement these enhancements, we are now evaluating a portfolio yield appropriately aligned with consumer risk performance. To bring that point home, we have consistently lowered yields year after year to reward borrowers. We are now evaluating if the risk portfolio adequately matches the decreases, and we anticipate making changes going forward. Lastly, Elevate and its board of directors are conducting a strategic review process with the intention of maximizing value for our shareholders.
As you know, we have been active investors in our own company through our share repurchase over the past three years and continue to see highly compelling value in our stock. With that, let’s flip to Slide 5, and I can give some additional detail on the current financial health of borrowers and how Elevate innovates the best help this population when more and more financial institutions are turning away. First, as I mentioned, the number of use cases for Elevate’s products is rising and expanding quickly. The average cost of living has greatly outstripped wage growth for our target consumers and is likely to continue in the near term. Additionally, specific factors for certain populations are also set to change rapidly.
For instance, approximately 48 million student loan borrowers will be set to resume payments in January of ’23 and will be doing so at a very stressful time. As a result, Elevate is looking at ways to help non-prime Americans, and let me detail two of those. First, payment flexibility features. Match Pay and skip payment tools were first utilized as self-service tools online during the pandemic. We are expanding these enhancements in more proactive ways and pushing out more directly to borrowers that are exhibiting signs of early stress.
These features are both good for us in protecting the book and good for consumers, as no additional cost is incurred. To date, thousands of consumers have utilized these features that were battle tested in the early stages of COVID. Second, regarding student loans, in light of the student loan deferral period ending, we have proactively begun to reach our consumers with options, should they feel the impact of these resumed payments. We estimate that approximately 20% of the portfolio has some form of student loan debt. However, we do not anticipate repayment on these loans to present a material drag on performance.
Elevate is proud to be the leader in customer-friendly assistant tools and believe that it is more important than ever for both our current customers, as well as a large and growing set of Americans looking for help. Lastly, before I turn the call to Steve, I’d like to clarify Elevate’s funding position as it relates to both our originations growth as well as strategic review. Elevate’s product debt facilities have capacity to originate business in excess of the volumes we are producing today. Steve will detail our corporate debt shortly, but we have added additional liquidity to position us through the current market environment. We are in full compliance with all financial covenants and remain in close contact and have strong working relationships with our lenders.
Similarly, our decision to conduct a strategic review is a function of our mandate to maximize value for our shareholders. Regardless of the conclusions of our review, we believe Elevate is positioned, both strategically and financially, to grow and drive value for shareholders. We are making decisions in real time to unlock greater value for our platform and are very much anticipating a return to profitability in ’23. With that, let me turn the call over to Steve for a review of our financial results.
Steven Trussell
Thanks, Jason, and good afternoon, everyone. Building off of Jason’s comments on portfolio trends, I’ll spend a few minutes detailing out impacts on our financials and actions we have taken. Turning over to Slide 7, I’ll start by discussing the loan portfolio. Combined principal loans receivable totaled $546 million as of September 30, 2022, up 6% from $513 million a year ago and up 3% sequentially from where we ended the second quarter. In light of the challenging macroeconomic environment and uncertain impacts of inflation on our customers, we continue to take a cautionary stance on growth investments for new customers and implemented incremental tightening of underwriting and eligibility.
Relative to the same quarter last year, our growth levels of new customers were lower by approximately 60%. As a reminder, the second half of last year represented a turning point in our growth trajectory post COVID as we significantly ramped up growth investments. Loan growth from existing and former customers also decreased by 7% in the quarter from tightened eligibility and from the overall lower level of new customer growth in prior quarters. Staying on this slide, revenue for the third quarter was up 11% from the third quarter a year ago, due to an increase in the average outstanding loan balance resulting from second-half growth experienced in 2021 and the first half of ’22, while individual product APRs were modestly lower between the periods. The overall portfolio APR was down five points, driven by two key factors.
The first is a lower quarterly APR in RISE due to a reduced mix of new loans in the RISE portfolio, and the second by a higher mix of the Today Card, which, has the lowest APR and now comprises approximately 10% of the combined loan portfolio. As Jason mentioned, we are currently evaluating the risk-based pricing structure and other yield-enhancing opportunities across product lines to ensure these remain in line with target margins.
Looking at the bottom of this slide, adjusted EBITDA was $14.6 million for the third quarter of ’22 as compared to $3 million for the third quarter of 2021. On a pro forma basis, which assumes the adoption of fair value loan accounting at the beginning of 2021, adjusted EBITDA for the third quarter of ’21 would have been approximately $14 million higher with pro forma adjusted EBITDA of $17 million. Relative to Q2 ’22, adjusted EBITDA in the quarter improved by $2 million.
Looking at the bottom right, earnings was a net loss of $15 million for the third quarter of ’22, with a net loss of $11 million reported for the third quarter of 2021. Third quarter 2022 results included a onetime deferred tax asset valuation allowance, impacting net loss by $9.9 million. Incorporating this onetime item, adjusted net loss would have been $5 million. On a pro forma basis, which assumes the adoption of fair-value loan accounting at the beginning of 2021, pro forma net income of approximately $0.2 million, or $200,000, would have been reported for the third quarter of 2021, an increase of approximately $11 million from the reported results. Relative to Q2 2022, adjusted net income improved by approximately $2 million.
Consistent with our comments last quarter, we are taking a cautionary stance on growth and the appropriate actions to mitigate risk, enhance product performance, and improve profitability. Many of these actions have resulted in tightened eligibility, lower line assignments, and lower new loan volumes. We are shifting from our prior guidance of flat to low single-digit year-over-year loan growth to a contraction of 8% to 12% versus year-end ’21 levels. Based on this lower level of loan growth, revenue growth is estimated to be above ’21 levels by approximately 15% to 20%. Our more seasoned vintages are exhibiting softer credit trends in the back half of 2022.
We will be monitoring near-term delinquency trends and are working diligently with customers to provide best-in-market service and assistance, but consistent with our comments from the prior quarter, the range of potential trajectories make guidance on any other earnings component challenging. As it relates to fair value in the quarter, the fair value premium decreased approximately 50 basis points to 9.6% at the end of the third quarter of ’22 from Q2 levels of 10.1%, due to modestly higher credit performance and higher discount rates, partially offset by continued shift in portfolio mix.
On a pro forma basis, the overall premium as of September 30, 2021, was approximately 9.3%, as we ramped up our loan growth starting in the third quarter of ’21, leading to a higher mix of new and therefore riskier customers in the loan portfolio, which carry a lower fair value premium. Turning to credit on Slide 8, consistent with our expectations, total credit losses increased on both a dollar basis, as well as a percentage of revenues year-over-year, driven by the strong growth in loans in the second half of ’21 and their associated seasoning, as well as the continued inflationary pressures on the portfolio. Net charge-offs increased by $35 million from Q3 2021, and as a percentage of revenues, from 35% to 59%.
Sequentially, net charge-offs increased $9 million from Q2 ’22 and increased as a percentage of revenues from 55% to 59%. Looking at the chart on the left, the cumulative loss rate as a percentage of loan originations for the 2020 vintage is the lowest loss rate ever, due to the tightening of underwriting, slowdown in new loan originations, increased government stimulus, and improved payment flexibility tools.
Given the macro and inflationary headwinds being faced, we are pleased to see the ’21 vintages still performing slightly better than 2018 levels, as we stated on our last call. However, the strong growth in the loan portfolio during the second half of ’21 continues to season and impact current year loss rates and earnings. Despite incremental tightening implemented this year, the early ’22 vintages have also seen considerable seasoning and are currently performing worse than early loss targets in ’21 vintage levels, due to the inflationary headwinds.
As Jason and I have both mentioned, we are implementing further credit tightening, underwriting capabilities, and revenue enhancements that are intended to help mitigate these trends going forward. Our quarterly net principal charge-offs as a percentage of our average combined principal loans receivable was 11% for the third quarter of ’22 and remains within our historical experience.
Past-due principal balances totaled 10.9% of the principal loan portfolio as of September 30, 2022, up slightly from 10.3% as of June 30, 2022, and continue to remain within our historical range of 9% to 11%. On this line, we also show the customer acquisition costs through the first nine months of ’22, which is within our target range. We maintain customer acquisition targets that allow us to achieve unit economics.
These targets are between $250 and $300 for RISE and Elastic products and sub-$100 for the Today Card. We continue to pursue diversity in our marketing mix between direct mail, strategic partner, and digital channels. We expect to be within our target range for customer acquisition costs for the remainder of the year and on a full-year basis.
Shifting to Slide 9, operating expenses in total for the third quarter were just above $35 million, lower than the third quarter of ’21 million by $5.8 million, or 14%, and versus the second quarter of ’22 by $4.8 million, or 12%. The sequential decrease in expense was primarily driven by aggressive actions we have taken to lower compensation and professional services expenses as we continue to strive towards an efficiency ratio of 20% to 22% and partially mitigate the impacts of higher credit losses.
The actions we have taken to date are expected to translate to a run rate reduction of 17% versus the first half of ’22. It is worth highlighting that expense management will continue to be a key performance lever that we focus on during this challenging economic environment. Regarding the liquidity and funding, we ended the quarter with a total cash balance of $76 million. The Company paid down its VPC debt facilities by approximately $25 million in the first quarter, while drawing down $80 million on all of its debt facilities and term notes during 2022. The Company had an overall average cost of funds of 9.7% as of September 30, ’22, up from 9.3% as of September 30, 2021.
The majority of our debt has a fixed rate until maturity in January of ’24. On the VPC facility, new borrowings are priced at three-month LIBOR plus 7%, subject to a 1% LIBOR floor. As noted in our quarterly disclosures, in partnership with our primary lender, Victory Park Capital, we amended several components of our loan agreement to accommodate impacts from higher credit losses on debt facility covenants and parent cash levels through the end of the year. We continue to have constructive relationships with all of our lenders as we manage through the impacts of this macroeconomic environment. We have also added further liquidity buffers to ensure we are poised to weather the current environment.
As Jason mentioned, we are in the midst of a strategic review to maximize value to shareholders. That said, we remain optimistic on leaning back into growth and improved profitability as volatility in the market eases and the overall product, credit, and risk enhancements boost the portfolio in 2023.
With that, let me turn the call back over to the operator and to open it up for Q&A.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Moshe Orenbuch from Credit Suisse.
Moshe Orenbuch
Great. I was hoping, Jason and Steve, you could kind of just elaborate a little more, perhaps, on some of the strategic options. Are they kind of at the corporate level? Are there other sorts of things, either with your lenders or that we should be thinking about? Just a little more elaboration there.
Jason Harvison
Yes, Moshe, this is Jason. I would say there’s not a whole lot we can say about those at this moment right now, but I would say they’re more at the corporate level that we’re looking at, but we’ve been in close contact with our lenders as well as we go through the process. So, I think what we’re looking to do is evaluate options that are out there, minimizing kind of distraction from the team because we’re — we have lots to do to continue to push forward with our initiatives we already have on hand and come to a decision if there’s going to be any kind of changes here in the very near future.
Moshe Orenbuch
Great. And as a follow-up, Steve kind of went through fairly good detail the cost reduction. What other steps do you need to take, or what else has to happen in order to, as you said, to return to profitability in 2023? And is that — are you expecting that for full year or by the end of the year? Like how are you thinking about what kind of achievement to profitability are we talking about?
Steven Trussell
Yes. No. Thanks, Moshe. This is Steve. So, as we’re focusing on a number of levers, I would say that the critical path elements are continuing to fine tune our underwriting and credit capabilities.
As noted, we’ve leaned into operating expenses this year and taken action on a number of areas, including compensation and professional services. I think that there’s still more work to be done as we look to get to an efficiency ratio much closer to 20% to 22%. And then, the other side that Jason alluded to is we’re focusing on some pricing enhancements, which we think are critical to continuing to make sure that we’ve got risk-based — appropriate risk-based pricing in place. So, as we look at that path to profitability, again, I think that extends beyond 2022 as we look at the — into ’23.
Moshe Orenbuch
Right. And just to be more precise, when Jason said expectations, you’re saying getting profitable at some point during 2023.
Steven Trussell
That’s correct.
Operator
At this time, we have no further questions.
Jason Harvison
Just want to thank everyone for joining us this evening on our third quarter earnings call. I want to thank the Elevate team and Elevate board for all their support, and we look forward to talking to everyone next quarter. Thanks so much for your support. Take care.
Operator
This concludes today’s conference call. Thank you for attending.
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