Cash Flow and Financing: Determining Reserves for Bad Debts

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Mike Costello and Tom Decosimo presented this power point at the CFSA 2012- 12th Annual Meeting and Conference in the Bahamas on March 9, 2012.

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Cash Flow and Financing: Determining Reserves for Bad Debts

  1. 1. Both Sides of the Lending CounterPRESENTATION TO THE CFSA CONFERENCE
  2. 2. When Debt Goes BadESTIMATING LOSSES FOR BAD DEBT
  3. 3. Bad Debts  Companies generally don’t give the details of how they compute bad debts  There are, however, typical considerations   Historical rates of charge-offs and recoveries (mostly the company’s own, but industry-wide numbers may also be part of the process)   Transaction volume   Age of the stores   Details of state law   Economic conditions
  4. 4. Measuring the Allowance  Most common: income statement measure   Numerator: bad debt expense for the year   Denominator: revenue from the relevant type of loan  Also sometimes seen: balance statement measure   Numerator: amount in the bad debt reserve   Denominator: loans receivable  The allowance is an estimate of the entire portfolio, not a judgment about any one loan   DLLR is an exception, recording increases to the reserve when a default actually occurs
  5. 5. Special Cases  Texas (CSO) structure   The allowance is typically classified as a contingent liability under the letter of credit   This does not affect the amount reserved, only the presentation  Pawn loans   No reserve is accrued   If the customer does not redeem the item, the transaction was really not a loan, but a purchase of inventory, and the books are adjusted to reflect this   The above does not apply to title loans—those have a bad debt reserve.
  6. 6. Values of the Ratios  AEA Advance America   Essentially pure payday-loan   First 9 months 2011: 16.7% (up from 16.2%)   Third Quarter 2011: 20.9% (down from 21.6%)   Appears to be seasonal   Full-year values:   2010, 17.4%   2009, 19.2%   2008, 20.1%   2007, 19.8% (not comparable before that)
  7. 7. Values of the Ratios  CSH Cash America   Three-fifths of revenue is pawn   Consumer loans (both payday and installment)   2010:37.2%   2009: 35.2%   2008: 38.6%   On balance-sheet basis, more reserves for payday (20.8% of receivables) than for installment (16.3% of receivables)
  8. 8. Values of the Ratios  DLLR Dollar Financial (renamed to DFC Global)   Majority of revenue (56.4%) is payday; only installment loans are in a military program (also do pawn, check cashing, and gold buying)   3rd Quarter 2011: 20.2%, up from 15.2%   Annual (July–June):   2010–2011:17.2%   2009–2010: 14.4%   2008–2009: 19.5%   2007–2008: 20.7%   2006–2007: 20.7%   Another interesting note: their non-performing loans went from 22.6% to 26.2% of receivables from 2010-Sept to 2011-Sept, which drove the expense up   Their reports focus more on the balance sheet ratio
  9. 9. Values of the Ratios  EZPW EZCorp   October–September fiscal year; 80% pawn   Like CSH, has a “signature loans” category that covers both payday and installment, but is mostly payday   2011:24.2%   2010: 22.8%   2009: 25.2%   Separate category for auto title loans   2011: 11.2%   2010: 15.4%   2009: 10.6%   Varies in exactly the opposite pattern
  10. 10. Values of the Ratios  FCFS First Cash Financial   12% payday and 2‰ installment, the rest is pawn   2010: 25.4%   2009: 26.0%   2008: 28.2%   9 Months 2011: 30.2%, down from 32.4%   3rd Quarter 2011: 23.1%, down from 26.5%
  11. 11. Values of the Ratios  QCCO QC Holdings   Payday and installment are again not distinguished in the reserve, about 2:1 payday with a tiny bit of check cashing and buy here/pay here   2010: 22.5%   2009: 23.0%   2008: 25.3%   2007: 24.0%   2006: 21.1%
  12. 12. Values of the Ratios  WRLD World Acceptance   Strictly installment loans, and services (e. g. insurance) ancillary to installment lending   April–March fiscal year   2010: 22.6%   2009: 24.1%   2008: 25.8%   2007: 23.1%   2006: 21.0%   April–September 2011: 30.2%, down from 32.4%   3rd quarter 2011: 23.1%, down from 26.5%
  13. 13. When Lenders Borrow CAPITAL STRUCTURES
  14. 14. Comparative Capital Structures100% 90% 80% 70% Common Equity 60% Derivatives 50% Subordinated Debt 40% Senior Notes 30% Other Short-term Debt 20% Revolver 10% Accruals 0%
  15. 15. Advance America  $270 million revolver available   Company may request increase to $365 million with covenants  $79.1 million outstanding, plus $6.5 million in letters of credit (related to Texas)  Premium over LIBOR is from 2½ to 3¼ points, currently at 2½   Determined based on leverage
  16. 16. Cash America  $280 million line of credit, 80% outstanding   LIBOR premium is from 2 to 3¼   Currentlyset at 2½   Method of computing the premium is also not specified   Commitment fee is 25–50 basis points (current 38)  Arrangement also includes a term loan of $50 million, floating interest at 3½ points over LIBOR  Fixed-rate debt:   $136.7 million straight debt, rates from 6.09% to 7.26% and maturities 2012–2021   $106.3 million convertible debt, at 5.25%, matures 2029
  17. 17. DFC Global f/k/a Dollar Financial  Information is as of December 2011  Global revolver of $200 million   Maximum of $75 million in US$; may also be tapped in C$, £, or €   Interest at 4 points over the LIBOR or equivalent rate for the relevant currency   May be capped at a percentage of cash and receivables   $154.3 million outstanding  Scandinavian facilities based on an acquisition   SEK 240 million in term loans at current rate of 4.68%   SEK 20 million out of 85 million in an overdraft facility currently at 4.78%   The above are lender’s cost (3.08%) plus a premium.   Also, €16 million out of 17.5 million at Euribor plus 1.95 points (current 2.59%)
  18. 18. DFC Global f/k/a Dollar Financial cont.  Fixed-rate debt is in three issues   $600 million of 10.375% notes due in 2016 (issued 2009 at 99.5)   $40.7 million of 2.875% convertible notes due in 2027   $90.9 million of 3% convertible notes due in 2028  Derivatives in place:   US$/C$ interest rates, paying a fixed rate on a notional C$322 million and receiving a floating rate on a notional US$280 million (down $43.5 million in fair value)   Collars on 4,500 ozt of gold (near zero fair value)
  19. 19. EZCorp  Information as of December 2011  Revolver is for $175 million, of which $40.5 million was borrowed and $5 million tied up in Texas letters of credit   Premium to LIBOR is 2 to 2¾ points (current 2½)   Commitment fee is 37½ to 50 bp (current 50)   Exact premium is decided by leverage
  20. 20. First Cash Financial  No material debt
  21. 21. QC Holdings  Term loan is for $32 million   Premium over LIBOR is 4¼ points   Must be prepaid with at least 50% of available cash (75% if they are at more than 1:1 leverage)   Matures in 2014  Revolver for up to $27 million   Rate varies from 3¼ to 4¼ points over LIBOR   Commitment fee is 37½ to 62½ bp   Exact premiums depend on leverage  $3 million of subordinated debt   Chairman/CEO holds $2½ million, an outside shareholder has the rest   12% cash interest payment plus 4% in-kind interest (bunny bonds)   Matures in 2015, may be prepaid after the other loans are covered
  22. 22. World Acceptance  Information is as of December 2011  Revolver is up to $300 million, with $279 million borrowed   Interest rate is LIBOR plus 3 points, but a minimum of 4% (which currently controls)   Commitment fee is 40 bp   $20 million is hedged to a synthetic quasi-fixed rate of 5.4%  Subordinated note still has decent backing to it   Line of credit, not revolving   LIBOR plus 4⅞ points   $70 million maximum ($50 million out), decreasing $5 million per year
  23. 23. And on the equity market…WALL STREET AND THE PAYDAY COMPANIES
  24. 24. 4 January 2012104102100 AEA CSFS98 CSH DLLR96 EZPW FCFS94 QCCO WRLD SPY9290
  25. 25. 115 95 85 90 100 105 110 12012-28-201512-30-201501-01-201601-03-201601-05-201601-07-201601-09-201601-11-201601-13-201601-15-201601-17-201601-19-201601-21-201601-23-201601-25-201601-27-201601-29-201601-31-201602-02-201602-04-201602-06-2016 Since then…02-08-201602-10-201602-12-201602-14-201602-16-201602-18-201602-20-201602-22-201602-24-2016 SPY AEA CSFS QCCO WRLD
  26. 26. 115 95 85 90 100 105 110 12012-28-201512-30-201501-01-201601-03-201601-05-201601-07-201601-09-201601-11-201601-13-201601-15-201601-17-201601-19-201601-21-201601-23-201601-25-201601-27-201601-29-201601-31-201602-02-201602-04-201602-06-201602-08-201602-10-201602-12-2016 Since then… (part 2)02-14-201602-16-201602-18-201602-20-201602-22-201602-24-2016 SPY CSH FCFS DLLR EZPW
  27. 27. Multiples (as of 24 February 2012) AEA CSFS CSH DLLR EZPW FCFS QCCO WRLDEV to 1.14 0.59 1.19 1.69 1.76 2.34 0.51 2.41Revenue ⑥ ⑦ ⑤ ④ ③ ② ⑧ ①EV to 5.75 4.73 6.15 5.58 7.59 10.23 3.76 7.27EBITDA ⑥ ⑦ ④ ② ① ⑧ ③P/E 11.25 16.08 10.93 14.02 11.70 17.51 6.66 10.41(Trail) ⑤ ② ⑥ ③ ④ ① ⑧ ⑦Price to 2.48 1.28 1.50 1.84 2.24 4.09 0.80 2.19Book ② ⑦ ⑥ ⑤ ③ ① ⑧ ④P/E (Y 7.70 7.94 — — — — — —+1)
  28. 28. Contact Us Mike Costello Tom Decosimo CPA•ABV, ASA, CFE, CFF CPA•ABV, ASA Principal Principalmikecostello@decosimo.com tomdecosimo@decosimo.com 423-756-7100 423-756-7100
  29. 29. About Decosimo  Top 100 Regional CPA firm with approximately 300 professionals and staff  Office Locations:   Huntsville, Alabama   Chattanooga, Knoxville, Memphis and Nashville, Tennessee   Cincinnati, Ohio   Atlanta and Dalton, Georgia   Grand Cayman  Independent firm associated with Moore Stephens International Limited   Association comprised of 314 independent CPA firms with 638 office locations across 97 countries   Allows us to provide resources comparable to Big Four firms  CPA of choice for the pioneers in consumer finance with a 40 year history of serving payday cash advance providers, rent-to-own operators, title loan providers, pawn shops and consumer loan providers  Consumer finance services include:   Business advisory including due diligence and business valuation   Tax consulting and compliance   Assurance and accounting www.decosimo.com/consumerfinance
  30. 30. About Decosimo Advisory Services  Decosimo Advisory Services is a practice of the regional accounting firm Decosimo providing business valuation, litigation support, and transaction advisory services to businesses, business owners and their advisors. These services have been an integral part of the Decosimo firm since its founding in 1971.  Our professionals have a diverse array of credentials in a variety of fields:   Accredited in Business Valuation   Accredited Senior Appraiser   Business Valuator Accredited for Litigation   Certified Business Appraiser   Certified Fraud Examiner   Certified Management Accountant   Certified Public Accountant   Fellow of the Healthcare Financial Management Association  With 40 years experience involving over $17 billion in transactions, Decosimo Advisory Services has the strength, capacity and expertise to maximize value for the middle market. www.decosimo.com/advisory
  31. 31. About Decosimo Corporate Finance  With a forty year history in hundreds of transactions, DCF helps business owners grow and maximize value when selling their businesses, accessing capital for growth, or growing through acquisition. DCF is a broker/ dealer, member FINRA/SIPC  Sell-Side Advisory –   DCF’s clients concentrate on maximizing their value by doing what they do best – running their businesses. DCF seeks to maximize their clients’ value by doing what they do best – conducting their disciplined sell-side process. DCF’s process is comprehensive, minimizes disruption to daily operations, and is designed to maintain confidentiality and maximize value.  Buy-Side Advisory –   DCF’s full range of buy-side advisory includes acquisition searches, valuation analysis, due diligence, and merger and acquisition financing. DCF brings its experience of over 40 years and $17 billion of transactions to each assignment.  Capital Sourcing –   Growing businesses require capital, and DCF understands the methods to help business owners obtain an optimal capital structure. DCF utilizes a myriad of capital sources including banks, asset based lenders, equipment lessors, mezzanine lenders, equity funds, Regulation D private offerings, and other private sources.  Fairness Opinions –   Corporate boards, special committees, trustees, shareholders, and other interested parties wishing to confirm the fairness of a particular sale or transaction price require fairness opinions. DCF’s professionals have more than 40 years of transaction and valuation expertise, as well as senior business valuation credentials. www.dcf-llc.com

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