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Financial Federal Corporation (NYSE:FIF)

F1Q09 (Qtr End 10/31/08) Earnings Call Transcript

December 4, 2008, 11:00 am ET

Executives

Paul Sinsheimer – Chairman, President and CEO

Steve Groth – SVP and CFO

Analysts

John Hecht – JMP Securities

Roland Underhill [ph]

Brian Hogan – Piper Jaffray

Scott Valentin – FBR

Brendan Sheehy – KBW

Sabina Bhatia – Basso Capital

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2009 Financial Federal Corporation conference call. My name is Emanuel and I will be your operator for today. At this time, all participants are in a listen only mode. We will conduct a question and answer session towards the end of this conference. (Operator instructions)

This call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and are subject to risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. Readers are referred to the most recent reports on forms 10-K and 10-Q filed by the company with the Securities and Exchange Commission that identifies such risks and uncertainties. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Paul Sinsheimer, President and CEO. Please proceed, sir.

Paul Sinsheimer

Thank you, and good morning. Thank you for attending our earnings conference call for the first quarter ending October 31, 2008.

Please bear with me folks out there, I have a little bit of a cold, and if you don’t understand me, please make notes and I will try to clarify. Today I am joined by Steve Groth, our CFO and David Hamm, our controller. I will briefly discuss our first quarter results and business strengths, I’ll then ask Steve to discuss liquidity, and finally we will take questions from participants.

Net income for the first quarter was $11.7 million, 4% lower than last quarter. Diluted earnings per share were $0.47 also 4% lower than last quarter. Originations for the quarter were $225 million compared to $208 million in the prior quarter. Financial receivables declined by 30%. The yield for the quarter was 8.89%, up from 8.82% last quarter, and the cost of debt was 426 up from 415. The net interest margin increased to 5.71% from 5.67% in the last quarter. Expenses increased to $7.2 million from $7 million.

Our expense ratio was 1.48% and the efficiency ratio was 26% compared to last quarter’s ratio of 1.42% and 25%. This performance resulted in 11% return on equity and a 3.3 to 1 debt to equity ratio. Net charge-offs were $1.4 million in the quarter compared to $1.2 million last quarter. The provision was $1.4 million for the first quarter compared to $1.3 million last quarter. Non-accruals were 1.63 versus 1.73 last quarter. Delinquencies were 1.9 versus 1.18 and repossessions were up a little bit to 0.81% from 0.68%.

At this point, Steve?

Steve Groth

Just a quick comment, at quarter end, we had over $390 million of liquidity as we’re collecting more of our receivables than we are funding in new business originations. As a result and based on the first quarter’s pace continuing, we estimate we wouldn’t need to access capital markets for almost a year and a half. Finally, we renewed a $30 million two year unsecured bank facility for another two years in September, and we can take more questions when we get there. Paul?

Paul Sinsheimer

Okay. I believe our first quarter’s performance was outstanding given the enormous problems in the capital markets as well as the overall economy. The return on equity of 11% with a 3.3 to 1 leverage and losses of only 29 basis points are remarkable achievements when many in the banking and financial services community are reporting historic losses and are seeking government assistance. Receivables outstanding fell by $55 million as the volume of new business opportunities slowed in the face of a weakening economy, but asset quality statistics remained at acceptable levels.

If the economy slows further, our balance sheet should continue to shrink and asset quality should become weaken. I believe there are many opportunities that will arrive out of these difficult times. We’ve already seen bank competitors exit our marketplace. GE Capital, a significant competitor also sharply curtailed its lending activity in the industries in which we serve. Less competition usually improves pricing, and we may also have opportunities to acquire portfolios at a discount.

The process to open a bank charter has also become easier, and we’re exploring the benefits of gaining access to deposits as an additional funding source. There are also reports that the government will implement a significant infrastructure spending bill to stimulate the economy. This could benefit us through an increased demand for construction equipment financing. We also recently purchased $10 million of our convertible debt in the open market for $9.2 million resulting in an $800,000 gain. We are poised and confident and prepared for the opportunities and challenges that lie ahead. And with that I will begin to take some questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question will come from the line of John Hecht with JMP Securities. Please proceed.

John Hecht – JMP Securities

Good morning, guys. Thanks very much for taking my questions. Real quick question is the $800,000 gain, is that going to be taken next quarter in your P&L?

Paul Sinsheimer

Yes.

John Hecht – JMP Securities

Okay. Second is, you guys had a yield pickup during the quarter according to our model and I’m wondering is that, some of that related to the prepayment fees or is that the new book of business you’re putting on at sufficiently higher margins that is driving that up or is it a combination thereof?

Paul Sinsheimer

Is this John Hecht?

John Hecht – JMP Securities

Yes.

Paul Sinsheimer

Okay. John, I just wanted to make sure I got your name here. The answer is all of the above. As we state virtually every quarter, our yields are a moving target affected in part by prepayment premiums, the collection of late charges in addition to collections from litigation matters. It’s very, very difficult for us to pin point them. But all I can tell you is that the rates that are being charged on new business now are meaningfully higher than they were six months ago. Perhaps, the reason for that is just the reality adjustments to the forces that are currently in the marketplace as the cost of all borrowings appear to be going up, except those who borrow from the federal discount window. Those seem to be going down. It’s also probably a reflection of fewer competitors and in particular now that GE has at least gone to the sidelines, we don’t know whether it is extended or short term, but the short term effects have been a better pricing environment.

John Hecht – JMP Securities

Can you give us – I mean is this 50 basis points pick up, 25, can you give us any sense of that?

Paul Sinsheimer

It is just higher. At this point, I would be quite reticent to pinpoint it, but rates are moving higher.

John Hecht – JMP Securities

Okay. The other question I have is you did – you guys had continued to show very positive in relation to the economy credit performance. It wasn’t on a dollar basis, didn’t see much change and didn’t see much change this quarter in non accruals or repossessions on a dollar basis, are you seeing any change in terms of where that mix is coming from, give us a sense for what’s happening at the segment level that you lend to, or any trends you see in that matter?

Paul Sinsheimer

As to trends, John, they are pretty much intact with where they had been in the last several quarters. By that I mean that transportation continues to be disproportionately higher than the rest. If you had asked me this question last quarter, I would have told you I expect that to start to reverse itself and I would have been wrong this quarter. And therefore I will state I expect that trend to flatten out now but don’t hold my feet to the fire, that’s a guess. So as to segments, it’s still disproportionately transportation assets.

But I will and I want to talk at least in theory here to you, John, and please I am going to repeat that in theory several times. But in our business, a substantial portion of our real losses occur in transactions that are less than 12 months old, for what I would believe are obvious reasons. As we march down the road with fewer originations, there are fewer transactions that remain in that first 12 month bucket, and so at least in theory, that as the portfolio shrinks and the remainder of the portfolio continues to amortize, I can’t tell you that delinquency in the past two statistics will change, the losses should start to diminish with a gigantic provision, and that provision is provided assets don’t materially go down in value, which would be a little counterintuitive, but in general as the portfolio matures and continues to pay and the amount of new business replacing this starts to go down, one could at least in theory expect losses to recede. By the way, I don’t expect that to occur, but in theory it should.

John Hecht – JMP Securities

So stabilization with a maturing portfolio. And then the latter comment you had there in terms of recovery rates, what are you – you don’t have a lot of that business, you are seeing a tremendous amount of pressure on the credits on book, what would your expectations be in terms of residual values or recovery rates at this point in the cycle?

Paul Sinsheimer

It is hard to be positive about much in this cycle. I can tell you that the prices for the assets that we finance and subsequently foreclose on are reflective of the supply and demand as virtually all assets are. If the economy continues to tank, it would be hard for me to give you a set of circumstances where asset values would remain firm considering what everybody at least from what I read in the newspaper believe we are facing a worldwide slowdown. So it is tough to be positive as to future equipment values for that matter alone. I can go to the flip side of that and say if our new government, our new President enact a major infrastructure spending bill, I would be willing to take back most of what I just said because the demand would be rekindled and the value of those assets could actually go up. And once again from what I’ve read in the paper, the concept of having a significant stimulus bill for the infrastructure is a lot closer to being real today than it was 30 days ago.

John Hecht – JMP Securities

Yes, okay. I really appreciate the color. Thanks very much.

Paul Sinsheimer

Thank you, John.

Operator

All right. And our next question will come from the line of Roland Underhill [ph]. Please proceed.

Roland Underhill

Steve, could you comment on the credit volume or lack of volume situation, number one question? The second thing is, is there anything you guys have in your plans to – is there any way you can mitigate the legal costs as delinquencies now here in this cycle compared to how you handled things last time?

Steve Groth

Okay. I am going to leave the second question to Paul. In terms of the first question, we’ve seen it kind of move back and forth in terms of the credit markets being open. The same paper that Paul read, I read, and very article is telling you how tight it is out there, difficult to provide liquidity to everyone. And we are facing that as well. That’s not to say that we don’t have opportunities, it’s just at inopportune prices. So…

Roland Underhill

So, on a macro level, not much has changed?

Steve Groth

That’s correct.

Roland Underhill

Okay.

Paul Sinsheimer

Good morning, Rolland. On the second question, it is legal costs, I am always open to new ideas. But I will tell you that as has been our policy from the day we started the company is we do as much of our legal work in house as possible. And that effort is not only controlled from a legal strategy point of view but also equally from a cost point of view. I believe our legal costs while they go up in these type of environments, are significantly reduced number than you would see any place else.

Roland Underhill

Sounds fair.

Paul Sinsheimer

Thank you, Roland.

Operator

And our next question will come from the line of Brian Hogan with Piper Jaffray. Please proceed.

Brian Hogan – Piper Jaffray

Good morning guys, nice quarter.

Paul Sinsheimer

Thanks.

Brian Hogan – Piper Jaffray

Just a question on the funding, I believe you said in your comments you won’t have access to capital markets or anything for another year and a half, did I hear that right?

Steve Groth

Yes, I mean, that’s given the fact that if we continue on the scale of our originations today and assuming the collections that we’ve seen historically, our assets would come down a little bit and we would need to approach the market. Even if everything termed out, nothing was renewed for about a year and half.

Brian Hogan – Piper Jaffray

Okay. And then on that, what’s coming due say through the end of the calendar 2009?

Steve Groth

We have the $175 million convert which comes due at the end of April, and we are looking at obviously opportunistic repurchasing, possible modification of that facility. It’s still five months away, so a lot can happen. We have liquidity and we are planning on the redemption. And other than that, we’ve $40 million of bank lines, which at this point I am fairly optimistic I can renew, but that’s really for calendar 2009. Yes, and then you have the normal term out of the securitization that was termed out last year that pays off over time as the assets amortize.

Brian Hogan – Piper Jaffray

If you had access – I mean some of these new like the bank lines and rolling them over, what would the interest rates be on that, I mean obviously I would expect it would be higher, but can you give the magnitude of that?

Steve Groth

I can’t really. You know you are looking at a lot of different areas. Caterpillar went out and borrowed money at 8%, and they are a solid A. Goldman is 200 over treasuries with a AAA. You are talking about what I would borrow from that, right?

Brian Hogan – Piper Jaffray

Right.

Steve Groth

Okay. So I am talking about private placements, I am talking about securitizations, banks, I really don’t know. It could be a couple of 100 over, everybody is reticent right now to issue new lines of credit, renewals are treated a little differently.

Brian Hogan – Piper Jaffray

Sure. And kind of the same regards, you have a share buyback program out there, and then obviously balancing liquidity and share repurchases is a huge monumental task, can you give your thoughts around share buybacks?

Paul Sinsheimer

We will give you the same thought we always give you, Brian. We review it quarterly. The Board looks at it every quarter, management looks at it every quarter, and we make a decision based upon the facts that we see at that moment and react accordingly.

Brian Hogan – Piper Jaffray

You didn’t buy anything back in the first quarter, did you?

Paul Sinsheimer

No.

Brian Hogan – Piper Jaffray

All right, thanks guys.

Paul Sinsheimer

Thank you, Brian.

Operator

And our next question will come from the line of Scott Valentin with FBR. Please proceed.

Scott Valentin – FBR

Good morning. Thanks for taking my question. You mentioned potential portfolio acquisitions, can you may be would it be in terms of size or content, I guess I assume it would be similar to your current portfolio? Would you look to maybe diversify a little bit?

Paul Sinsheimer

I never say never, Scott, but it would be highly unlikely unless there are some unusual circumstances for us to get out of our sweet spot. So sitting here today, I would be quiet hesitant to suggest we would do that. I don’t want to say never, we would stick to what we know how to do.

Scott Valentin – FBR

Okay. In terms of size, any limits that you would – I mean you prefer smaller or…

Paul Sinsheimer

You know we prefer opportunities and opportunities come in all shapes and sizes. We have quite a bit of liquidity at our disposal. Risk and reward underwriting, all the usual the suspects would dictate our level of interest, but we’re open.

Scott Valentin – FBR

And then on the bank holding company structure, potential to pursue that, how far are you in the process, are you kind of in the initial stages talking to counsel and trying to get an idea of what is to be done or has it gone beyond that?

Paul Sinsheimer

We are in the early stages and don’t really have anything meaningful to report. And when we do, we will report it, but events are very fluid. You know just with this accelerated program that was announced last week, things are changing, and as a result plans that you might have had two weeks ago can change dramatically because the playing field has changed. But we’re moving in that direction and when we have something concrete to report, we will.

Scott Valentin – FBR

Okay. And own final question, on the construction portion of the – construction segment of the portfolio, I remember there was concern about residential construction exposure, I think you have commented it’s relatively small, what percentage of this segment, is it half or quarter or a third is would you say tied to municipal type of construction, kind of road projects, infrastructure type projects?

Paul Sinsheimer

I don’t have that answer, but I would say it would be a real portion. When you say tied to municipal road, local construction, I would say it is a very meaningful number, but would be hesitant to actually put a number to it.

Scott Valentin – FBR

Okay, thank you very much.

Paul Sinsheimer

Thank you, Scott.

Operator

(Operator instructions) And our next question will come from the line of Brendan Sheehy with KBW. Please proceed.

Brendan Sheehy – KBW

Hey guys, good morning. Thank you for taking my question. I decided to jump off, so I apologize if this is repetitive. Steve, if you could just I guess provide a little more color on how you expect to or how you get the cash to pay down the convertible debt that is coming due and as well as if you could tap the bank lines to pay this down? Thanks.

Steve Groth

Yes, we stated in the opening that at quarter end we had $398 million of committed unused facilities. So those are fully committed, a great majority of them are multiyear in terms of tenor, and we can draw them down for whatever purpose. So given the lack of growth and visibility right now, we’re sitting with the capital today to repay that converted if and when it comes due in April. And it is four and half months away and we have time to consider a lot of alternatives. And I continue to look and explore for new funding sources which Paul mentioned, deposit taking as well as all the other diversified sources that we have, and we’re continuing to talk to insurance companies, banks, conduit players for the securitization and it’s open dialog. So we have the liquidity in place right now to pay that down. Hello?

Operator

Okay. And our next question will come from the line of Sabina Bhatia with

Basso Capital. Please proceed.

Sabina Bhatia – Basso Capital

Hi guys. Most of my questions have been answered. Just to follow up on one of the comments that you made when someone asked about your converts, you mentioned that you might continue to look for opportunities to buy back at these discounted levels in the open market, but you also mentioned a possible modification of was it, were you referring to the converts, or were you referring to the bank line, what were you referring to?

Steve Groth

I was referring to the convertible securities. There is a number of modifications that are going on out in the marketplace, and to look at this time in four plus months on a potential put, we believe all opportunities have the flexibility open.

Sabina Bhatia – Basso Capital

Okay, great. Thanks a lot.

Operator

And our next question is a follow up from Scott Valentin with FBR. Please proceed.

Scott Valentin – FBR

Just a quick question, in terms of any covenants associated with any of the lines, I assume you are not in any type of breaches of covenants?

Steve Groth

We are clearly within the limits of any of the financial covenants. And as I said, investment grade BBB+, the covenants on the debt are few. And as we stated, there is a leverage test, a net worth test and a earnings test. Nothing is at risk, Scott, of tripping any comments.

Scott Valentin – FBR

Okay, thanks.

Operator

And at this time, I show no more questions in queue. I would like to turn the call back over to management for closing remarks.

Paul Sinsheimer

Once again, thank you everyone for attending the call and we look forward to speaking to you in approximately 90 days. Have a good holiday season.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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