Financial Federal Corporation Q3 2008 (Qtr End 04/30/08) Earnings Call Transcript

Jun. 5.08 | About: First Trust (FIF)

Financial Federal Corporation

Q3 2008 Earnings Call

June 5, 2008 11:00 am ET

Executives

Paul Sinsheimer – CEO

Steve Groth - CFO

David Hamm – Controller

Analysts

John Hecht – JMP Securities

Carl Drake – Suntrust Robinson Humphrey

Robert Napoli – Piper Jaffray

Justin Maurer – Lord Abbett

Operator

Good day, ladies and gentlemen, and welcome the Third Quarter 2008 Financial Federal Corporation Earnings Conference Call. My name is Sesquana and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference.

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 report on Forms 10-K and 10-Q filed by the Company with the Securities and Exchange Commission that identify such risks and uncertainties. The Company is not obligated to update or revise forward-looking statements for subsequent events or circumstances.

I would now like to turn the presentation over to your host for today’s call, Mr. Paul Sinsheimer, Chief Executive Officer.

Paul Sinsheimer

Thank you and good morning. Thank you for attending our earnings conference call for the Third Quarter Ending April 2008. I’m joined Steve Growth, our CFO, and David Hamm, our Controller.

I will briefly discuss our third quarter results and give an overview of business trends; we’ll then ask Steve discuss liquidity. Finally, we will take questions from participants.

Net income for the quarter was $12.7 million with diluted earnings per share of $0.51, unchanged from last quarter. Finance receivables declined to $2.01 billion from $2.07 billion during the quarter. Origination for the quarter were $232 million compared to $225 million last quarter. The yield for the quarter was 9.21%, down from 9.23% last quarter. Cost of debt was 4.44%, down from 5% last quarter. The net interest margin increased to 5.79% from 5.34% last quarter. Expenses were unchanged from last quarter at $6.9 million.

This performance resulted in a 13% return on equity and a 3.9 debt to equity ratio. For the first nine months of our fiscal year, net income grew 2% from last year to $37.9 million, and diluted earnings per share increased 9% to $1.52 from $1.40. Credit quality statistics remain above average. Net charge-offs were $1 million for the quarter compared $700,000 last quarter. The provision for credit losses was $1.5 million in the quarter compared to $800,000 last quarter. Non accrual, delinquencies, and repossessed equipment have all shown higher levels compared to last year, but remain better than the Company’s historical average.

At this point, I’d like to turn it over to Steve.

Steve Groth

Thanks Paul. Very quickly, on liquidity, I’m happy to report the majority of our funding is long-term, which allows us to avoid the problems others have faced during this credit crisis. We successfully renewed our conduit facility in April for $325 million and termed out two non-renewing banks for $200 million in that deal. This provides us with over $300 million of liquidity and the flexibility to fund with the least costly borrowings. Paul.

Paul Sinsheimer

Once again, we had another outstanding quarter with superior results. Discipline has always been the centerpiece of how we manage our business. While credit quality statistics have returned to more historical norms, we continue to report lower debt losses than other finance companies. We continue to focus on our core industries rather than diversifying for the sake growth and have avoided the pitfalls others have faced.

There were less new business opportunities this past quarter and competition remains aggressive as lenders began to compromise underwriting criteria. Conditions in the transportation sector are especially soft as the slowing economy and soaring fuel prices have forced some out of business. Construction sector has also been impacted, although collateral values remain firm.

As always, our future performance depends in large part on where the economy goes from here. With that, I will take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of John Hecht –JMP Securities.

John Hecht – JMP Securities

I wonder if you can give us some color on originations, Paul, by segment maybe where you’re seeing any activity, and any color on the end market activity in that regard as well.

Paul Sinsheimer

Construction is a little soft, but where the volume has fallen off meaningfully is in the transportation sector. There are many reasons for that. I believe most of them are front page type reasons: Very high fuel prices, a diminished level of freight available to be moved has caused a number of truckers to go out of business; and when there’s less amount of freight and higher costs to move it, new business opportunities in that arena become slim and none.

How long that’s going to be with us is anyone’s guess. I would tell you that intuition is that we are very close to a bottom if not at the bottom as we sit here today. Trucks do have to be replaced. If the economy shows any signs of improvement, there will be a new demand for the new trucks and there will be new business opportunities. But I’ll repeat, that is a little bit intuitive on my part because it’s very difficult as we sit here today. Waste is consistently the same. There’s not a lot of movement one way or the other.

John Hecht – JMP Securities

Shifting to that discussion on your non-performing assets, I know they remain historically low, but is there any, is it consistent that you’re seeing slowdown in transportation [inaudible] and that would be also more pressure on the delinquency side, or is there different trends emerging there?

Paul Sinsheimer

No, they’re very similar. I would tell you, I’ll make an educated guess here. I would tell you that 70% of the non-accruals we had last quarter came from the transportation sector and the transportation sector represents a little less than 40% of our total portfolio so that we’re getting twice the negative results from transportation than we are from the other industries. So it’s pretty consistent, John.

John Hecht – JMP Securities

In terms of the fluidness of the equipment market, are you able to clear the collateral pretty quickly and maintain reasonable recovery rates?

Paul Sinsheimer

You know that is a fascinating positive set of circumstances and a very negative picture. Componentry costs to be build a new truck is forcing the price of newer trucks higher. They’re not selling many, but they’re at least forcing the trucks higher, which a rising tide lifts all the boats in the harbor. So what we’re able to see right now is a solid values in the return trucks, and we’re doing pretty darn good.

John Hecht – JMP Securities

Then last question is: Assuming no changes in the rates out there right now, what would you expect to happen to your margins? I guess that’s in the context that you had not a full quarter of the benefits of the LIBOR reduction.

Paul Sinsheimer

That’s a great question and the simple answer is I don’t know. I can tell you what I expect. Today it’s very competitive for new business and at rates that I personally believe are pretty low for the risk inherent in what’s being offered. I can only summarize that banks and others have taken their money that they were formally lending for home equity loans and home mortgages and they’ve redirected it to our asset class. As a result, there’s some downward pressure on interest rates. How long that’s going to continue, I don’t know; but I’ll only remind that you these are the same people that got the banks in trouble before probably are heading down the road again.

John Hecht – JMP Securities

So there may be a period of time where the competitiveness overweighs the kind of implicit credit risk out there, but that will flush itself out over the next few quarters, in your opinion?

Paul Sinsheimer

I would hope so. I mean once again, we have an asset class not only with trucks, albeit weaker than construction that betrays 30 years of history in the business. This is a business that has losses in it, but the last several years seemed indicate otherwise. What happens when industries exhibit low loss characteristics, people in an institutional level want to believe it’s become a commodity like event. My experience tells me otherwise, but that can certainly be challenged in the short run.

John Hecht – JMP Securities

All right, I’ll get back in the queue. Thanks very much for giving me the detail.

Operator

Your next question comes from the line of Carl Drake - Suntrust Robinson Humphrey.

Carl Drake – Suntrust Robinson Humphrey

Question, Paul and Steve, is the portfolio yield was flat in the face of declining rates and I was wondering if it might’ve been aided by, it looked prepayments were as high as we’ve seen, and I was wondering if that might have, maybe you can comment on both of those. Was there any contribution to yield from prepayment income maybe higher than normal, and what’s causing this high level prepayment? Is that a less activity utilization?

Paul Sinsheimer

Once again, Carl, there’s a number of questions embedded in there. Our yield every quarter is infected by prepayment premiums. They were a little bit higher than they normally have been, but not higher than one would expect in a declining interest rate environment. Once again, this is a tender subject because we don’t really have the ability to predict it, to quantify it. I can only tell you that it was more than we would have routinely expected with absolutely no direction given here to what it may be next quarter or the following quarter.

Carl Drake – Suntrust Robinson Humphrey

Sure. So the prepayment income is, I mean prepayments in general are jus picking up from the declining rate environment?

Paul Sinsheimer

Yes.

Carl Drake – Suntrust Robinson Humphrey

Next question. There was a reserve build this quarter that was a little bit higher than we’d seen and credit was still, as you said, above average and just moderated slightly. What was the thinking on the reserve? I was surprised to see a reserve build this quarter. What should we take away from that?

Paul Sinsheimer

Well, I think that’s a, at least from my perspective…

Carl Drake – Suntrust Robinson Humphrey

Sign of conservatism?

Paul Sinsheimer

It’s sort of consistent with who we told you we are over the years. We tend to air on the conservative side in times like this. The economy’s very fluid. Picking a future direction even three months out is a lot more difficult today than it has been recently and we’ve always taken sides with those you like conservatively. Someone with a benefit of hindsight a couple years from now might think that we over reserve, but we don’t like to disappoint on the liberal side.

Carl Drake – Suntrust Robinson Humphrey

That’s helpful. Then last question on the renewals in the quarter, could you provide some specifics on the, whether there was a spread increase on the new facilities that were renewed?

Steve Groth

What ultimately happened was, and we put this, I mentioned it quickly in my comments, two of the banks did not renew and there’s a component in our deal that allows for that to be termed out based on the collections of the cash flow over the next three years. Then there is an increase in pricing on that term out. For the renewal on the facility, we saw a increase based on market conditions for the 325 million.

Carl Drake – Suntrust Robinson Humphrey

But it was something like 100 basis points type of increase in the…

Steve Groth

No, it was less than 100. It was less than 100 basis points, yeah.

Carl Drake – Suntrust Robinson Humphrey

Then nothing too significant on the term out in terms of an increase in rate there.

Steve Groth

That’s correct. That had already been built into the old deal so that was significant, but that was around 100 basis points.

Carl Drake – Suntrust Robinson Humphrey

Thank you very much.

Paul Sinsheimer

Let me be clear here to make sure that story regarding the conduit is clear. Two banks that were in for $100 million each decided to term out, the other two banks that were in there each went up $50 million so that ultimately over a period of time, today the conduit went from 4.25 to 5.25. But depending on what we do with it in the future, it could get reduced to as low as 3.25. But putting all of that aside in today’s environment, we are north of $300 million of liquidity.

Operator

Your next question comes from the line of Bob Napoli – Piper Jaffray.

Robert Napoli – Piper Jaffray

Nice job, not unexpected on the quarter. A couple of questions: Maybe, Steve, a little bit more on liquidity and line renewals that you have over the next 12 maybe 18 months.

Steve Groth

We’re fortunate, Bob, to always spend effort and time on this to continue to push out the different facilities that we have. So regardless of growth and or non-growth in the portfolio, on the death side, we only have about $67 million coming through for the balance of the year. That’s a bank revolver and a term note and at this point we’re not sure whether the bank revolver would be renewed or not. So there is not much in the hopper in terms of amortization. Going through ’09, and that’s not including the natural amortization of the $200 million on the securitization which terms out over three years. But we’re in very good shape in terms of liquidity today given our prospects and there is other debt out there that’s available for us should we choose to put it into the portfolio.

Robert Napoli – Piper Jaffray

A couple questions related to that maybe. I mean obviously your leverage is really, really low and that’s, I mean that’s great in this kind of environment, but I mean it’s also something that’s probably lower than you’d like to see it. But your fund, your asset quality over the years has been so good and it’s for so long. I would think that… Have you thought about an ILC structure? I mean bank deposits, I would think the regulators would love your business to be and the asset base that you have and the credit quality you’ve had probably would be a slam dunk approval. I just wonder if that’s something that you thought about or have any interest in.

Steve Groth

Bob, Paul has threatened to send me out to Nevada and Utah several times to live out there. But we’ve looked at it countless times and you actually stated what our fear is that the regulators would love to get at us. It’s highly regulated. It would change our reporting considerably and in many respects, you can look at the fact that it’s fast money. It can go away quickly. But it also in many cases doesn’t represent much of a savings cost against our low spread to LIBOR on our bank lines. But we do look at it all the time.

Robert Napoli – Piper Jaffray

Right. I just wondered I mean with the possibility of spreads to LIBOR for you guys going up.

Steve Groth

That’s a fair point. If the credit concerns continue, that might be more economical funding.

Robert Napoli – Piper Jaffray

Then giving that your funding is locked in and you’re in great shape on the liquidity side and your leverage is so low, would there be unusual financial services companies that would be repurchasing its own shares in this kind of environment. But it seems like you guys are that unusual financial institutional that may be... Instead of letting that leverage drift down into the mid threes that you ought to be repurchasing some shares or raising your dividend or something like that too?

Paul Sinsheimer

I will say this to you, Bob: It’s an interesting topic. It is one that is actively discussed on a regular basis. As you know, and I’m sure all of us that are on this call know, it’s a balancing act that’s very subjective in nature. I can only tell you that capital is king today and we treasure our capital, but we also view what you’ve discussed which is balancing the leverage of the Company with the economic circumstances; and we tend to be on the conservative side of that decision. I think it’s the conservative side of that decision that allows us to still be on the phone with you today.

Robert Napoli – Piper Jaffray

I’ll leave it that. Let me ask a question about the outlook for credit. I mean your delinquencies came in better than expected, non-accruals were in line, charge-offs were a little better than what he had modeled. I mean do you feel like that we should continue to see… Do you feel comfortable that we’re going to see a gradually controlled increase in credit trends?

Paul Sinsheimer

That’s a fair choice of words, but let me remind you that when you have very low statistics such as what we have reported over the last several quarters, it doesn’t take much in the way of one obligor that owes you $3 or $4 million. It really conforms to your non-accrual policy that’s really not a major, where we’re not facing a major economic loss. It’s a [inaudible] statistics. I used to on these calls kid everybody about going from one basis point to three basis points of net losses and caution you guys against saying that we tripled. It is the same thing with these non-accrual statistics. You can have one guy in there that’s $3 or $4 million that will distort the numbers. But putting all of that noise aside, I’m comfortable with your description of it being… I think it’s going to get worse. I don’t think it is going to be uncontrollably worse. I think that things will get worse before they get better, and our statistics will continue to trend negatively but nothing we’re concerned about.

Robert Napoli – Piper Jaffray

Then just a long-term strategic question: First of all, I guess, Paul, I mean you’ve been running this Company awhile. How long do you want to do this and run the Company? In that context, where would you see the Company five years from now as far as growth and goals and market segments served and alike?

Paul Sinsheimer

I don’t know how to take your question, Bob. I will tell you that I enjoy coming to work every day as much today as I did yesterday and several years ago. I absolutely love what I’m doing. But putting that aside, there is a management succession plan. There’s some very, very capable people that are running this business day-to-day of which I am not. These people are no different… In my opinion, they are no different than who I was when I started this business in 1989, meaning that they were hired like I was in the mailroom and they started out in collections and went to credit, went to marketing and to operations and then into management and they have big responsibilities and they have successfully moved along in their career to the point where I have no problem maintaining a large portion of my net worth in this Company. I sleep extremely well at night knowing that these guys are running the business.

Where we going to be in five years? My god, if I could answer that question, I’d probably already be retied and on the beach and telling [George Soris] what to do.

Robert Napoli – Piper Jaffray

What do you think is a growth rate that this type of a company should have over the long run?

Paul Sinsheimer

15% should be doable. If we don’t believe… We’re all owners here, Bob. We all have a large portion of our net worth here; and if we ever come to the conclusion we can’t do this, nobody’s hanging around to get another year on a pension. We’re shareholders and we think like shareholders. But we really today believe that we have profitably postured the Company, not only organizationally but financially that our best opportunities are in front of us. Intuitively, I think they’re sooner rather than later; and we will continue to think and act like owners. The only I can say in that regard is that our shareholders are our partners and we’re looking out for our own economic interest as well as theirs.

Robert Napoli – Piper Jaffray

That 15% growth, would you view that as a asset growth or net income growth?

Paul Sinsheimer

My goodness gracious, I would certainly hope they would go together. I mean I can tell you, I have no desire to have 40% asset growth and 80% reduction in net income.

Robert Napoli – Piper Jaffray

I’ve seen grow assets 15%, you can probably grow earnings a little bit more than that.

Paul Sinsheimer

Yeah, I mean there’s some leveragability not only in the balance sheet, but there’s leveragability in the organization. A lot of our growth as it has been from the day I got asked this type of question in 1990, the future growth of the Company is totally dependent, from my perspective, on the ability of management to grow its own ranks in a manner that is consistent with what our historical performance has been. This is a management business. It’s a financial business, but it is a simple business that can be done very, very well if the proper people are in place to do it. It’s also a business that if it’s run by people who are not very good can be a disaster.

Robert Napoli – Piper Jaffray

Great. Thank you very much.

Operator

(Operator Instructions) Your next question comes from the line of Justin Maurer – Lord Abbett.

Justin Maurer – Lord Abbett

Just a follow-up on the funding side with the term out and just thinking about the futures of the Fed maybe leaning the other way possible as we get to back half of this year, how do you guys think about kind of fixed to floating at this point?

Steve Groth

Well right now we stand at 53% fixed and 47% floating, which is a little bit more on the fixed side than we have been over the last couple of years. But again, we hesitate to really go much more on the fixed side because we like keeping it short. We borrow overnight and those daily rates, you can kind of do the math, overnight LIBOR continues to be 30 basis points less than the traditional 90-day that a lot of people are referenced on. Again, we have a mix in that liability side that floats. We set overnight 30 days, 90 days, the six months in some of the swaps so…

Justin Maurer – Lord Abbett

The term out, those are floating still on the $200 million term outs?

Steve Groth

That’s correct.

Justin Maurer – Lord Abbett

Secondly, I know the discussion about the competitive environment still remains and guys may be shifting dollars around, but just given your comments about certainly the trucking business and maybe the construction to a lesser extent, do you feel like you guys are still kind on the main gaining market share despite the fact that it remains competitive?

Paul Sinsheimer

I think we’re in the ballpark there, Justin. It’s moving around quite a bit right now. We took this stance 2002/2003, if my memory is correct, where we just weren’t going to compete at interest rates at 5%. It’s fascinating, the banks will lend to a contractor of certainly not investment grade credit for five years at 5%, but they won’t lend money to GE at 5.5% for the same term. I believe that’s averment. I think the market is dislocated in the present tense. The cost for term debt in the financial services space is prohibitively high with the Fed funding the banks liquidity at 2%. Why does a bank go out and raise capital at 8% and then leverage at 5%, I mean lend at 5% when at the same time, and I’m quoting the New York Times now so to the extent my numbers and memory are inaccurate I will apologize upfront, you can buy a Home Depot seven-year debt yielding at 6.5% to 6.75%. But my daughter can go out and buy a brand new Toyota for $30,000 and get it financed for 5%. Assuming the bank isn’t going to look to me to pay my daughter’s car off, I would certainly think the Home Depot would be a better bet.

Justin Maurer – Lord Abbett

That beach stay may be a little bit shorter that you’re hoping for.

Paul Sinsheimer

Yeah, I mean I think it’s just temporary, but I can assure that if our lenders continue to lend money at this rate, they will pay for it dearly.

Justin Maurer – Lord Abbett

I guess the reason I’m asking is because even for you guys to write $230 million worth of business, I know it’s been open and subject to criticism by some because it’s meaningful down year-over-year. It’s still a decent piece of business, certainly not as much as you guys would like, I’m sure. But just given the economic conditions and your end markets, it still seems to me to be a pretty good level.

Paul Sinsheimer

I think it’s an outstanding level and I will repeat and often use a word in these calls, we are very disciplined in our underwriting, but we are also normal human beings in that today it’s more difficult to have a positive outlook about a prospect as opposed to having a less positive outlook. So while you maintain your disciplines and your underwriting, when the future is murky and as uncertain as it is, you’re less likely to take chances that are you in a different environment. So I think the $200 million/$230 million, I’m not embarrassed about it in the slightest.

Justin Maurer – Lord Abbett

Then lastly on, of course, the credit discussion, you mentioned that 70% of the non-performers is in the 40% of the business. It certainly doesn’t sound like though from prior discussions that you expect that to go the way of the light manufacturing business you guys were involved with the last cycle. To your point, is that because just the way the equipment is replaced as to why you think that’s not going to suffer a similar fate?

Paul Sinsheimer

What I believe happened in the manufacturing sector was a permanent loss of capacity that left the domestic U.S. marketplace. I don’t believe there’s a permanent loss of trucking capacity in this country by any stretch of the imagination.

Justin Maurer – Lord Abbett

What’s the secondary market like for that stuff vis-à-vis the equipment?

Paul Sinsheimer

It has remained unusually firm and we’re currently of the opinion that it is the higher prices on replacement assets that are driving up or firming up the used collateral values.

Justin Maurer – Lord Abbett

Thanks a lot guys. Keep it up.

Operator

At this time, there are no further questions. I would now like to turn the call back over to Mr. Paul Sinsheimer for closing remarks.

Paul Sinsheimer

Thank you all once again. We’ll see you in about another 90 days. Have a good day.

Operator

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

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