Quarter Ending
	6/97	3/97	12/96	9/96	6/96	3/96	12/95	9/95
EPS	.09	.09	.05	.11	.10	.08	.08	.09

 

Commentary

Nicholas Financial Corp. is a small, local, specialized consumer lender. It specializes in used car loans which it purchases and originates through a network of 13 branches (11 in Florida, 2 in Georgia). Because of the risky nature of used car receivable and its small size, this stock should be viewed as a speculation. Nicholas Financial began as Nicholas Data Services in 1985. The founder, Peter L. Vosotas, had been the Vice President of Sales for Paradyne Corp. prior to its acquisition by AT&T.

Nicholas Data was a software company which designed custom software for various small business applications. Starting in 1990, they switched their emphasis for future growth to the purchase of used vehicle loans from car dealers. Nicholas Financial's proprietary software allows them to closely track both the quantity and quality of quarterly loan pools from each branch office. This allows for very targeted incentive bonuses for its branch managers. Negative variances in loan quality are picked up in early stages before they grow into real problems. Nicholas Financial's growth has been held back over the past two years by the presence of foolish competitors. The "sub-prime" lending market had been a Wall Street favorite and many such companies were brought public. So much money was raised, that there was soon too much money chasing too few good used car loans. Nicholas Financial is frequently outbid for such loans at prices which they do not believe make economic sense. Newly public companies in the sub-prime auto business had to keep their volume of loans growing to make the aggressive earnings growth, which was expected by investors. They mostly securitized their loan production and reported large gains on sale as these were sold in the bond market. Securitization is a valid method for financial companies to get loans off their balance sheets and generate funds for new lending. These loan sale "profits" under securitization are a statistical estimation of future earnings from the servicing of packaged loans. Estimates of future credit losses and prepayments are necessary to compute the "gain on sale." Many public "sub-prime" lenders have gotten in serious trouble when delinquent loans underlying their securitizations produced much worse loan losses than were originally estimated. They then had to go back and recapture as losses many of their earlier "gains." Nicholas Financial is a portfolio lender. The car loans that they originate and purchase are held on their own balance sheet, where they earn a spread over their cost of funds. In fact, net interest income (after provision for loan losses) comprised over 90% of the company's income in the June quarter. Nicholas Financial experiences higher loan losses than a bank due to the lower credit ratings of its borrowers. About 1 in every 5 used car loans that they hold becomes delinquent before maturity. They know this from experience and reserve for this level of loss up front. They also hold back "dealer reserves" by paying less than the face amount of the loans when initially purchased. These reserves absorb loan losses before the company's loss reserves are charged. Total delinquent loans at June 30th were $1.8 million, or 4.6% of gross loans. 80% of this, however, was in the least serious category of 30 to 59 days past due. The company had total reserves of 15% of net receivables. The final step of delinquency remediation is the repossession and sale of the car involved through a dealer auction. About 50% of the loss is recovered in this way.