A Good Trade-in

A Good Trade-in

By Francis X. Gilpin

Associate Editor

There was Peter L. Vosotas, getting ready for an elaborate medical test in Gainesville, when a friendly nurse asked a simple question that he always dreads:

"What do you do for a living?"

The audience listening to Vosotas tell this story at the Aug. 10 annual meeting of Nicholas Financial Inc. was sympathetic. After all, they believe enough in Vosotas that they've invested in his company, which deals in high-interest loans to car buyers who are shunned by banks and credit unions.

Still, the Nicholas Financial stockholders tittered a bit. They shared his sense of foreboding that Vosotas had run into another former customer whose car was repossessed by the company.

"So I'm lying upside down in this machine," continued Vosotas, recalling his sudden feeling of vulnerability. The nurse wasn't satisfied just to know his line of work. She wanted the name of his company that buys installment loans from automobile dealers.

Vosotas practically winced when he complied. Then he was astonished by her response.

"God bless you," said the nurse, a satisfied Nicholas Financial customer.

The point of the story wasn't so much to save a feel-good tale for a feel-good occasion. Instead, Vosotas used the nurse's experience to reveal one of the secrets to why Nicholas Financial has prospered at the brutal business of sub-prime auto finance while others have failed.

Nicholas Financial has doubled net income in the last three years, to $8 million. Its operating margins continue to expand and now hover around 25%. Revenues last year nearly hit $33 million, up 28%.

Henry J. Coffey Jr., a specialty-finance analyst at Ferris, Baker Watts Inc., raised his earnings estimates last month for Nicholas Financial for both fiscal 2006 and 2007. The Baltimore investment bank, which has a neutral rating on the stock due to valuation, has co-managed a Nicholas Financial securities offering in the past year.

About that secret: Vosotas says Nicholas Financial staffers are required to interview every single potential borrower before a loan is approved.

Not just for the loans they originate, which made up 13.6% of the new contracts that the company booked last year. Customers who get their loans through car dealers also must be interviewed by Nicholas Financial employees stationed in 36 branch offices across 10 states in the Southeast and Midwest.

"We'll fire your ass, if you don't," Vosotas says in an interview after the annual meeting.

While other indirect lenders rely almost exclusively on credit scoring at corporate headquarters, Nicholas Financial is more apt to take a gamble on down-on-their-luck borrowers, based on personal interviews.

That's how the Gainesville nurse got a loan to buy the used car that she drove to the medical center where she prepared Vosotas for his test.

The nurse was a single parent with children, according to Vosotas. But she had a permanent address and a steady job. "Her husband had left her, high and dry," says Vosotas. "The circumstances had to be verbalized because they're not on the credit report."

Soft software sales

Vosotas didn't intend to be a financier of risky car loans.

The native New Englander had risen to vice president for international marketing at Paradyne Corp. by the early 1980s, when he began to plan his exit. Vosotas had had enough, after stints at Ford Motor Co., Polaroid Corp., as well as the Largo telecommunications equipment maker.

"The travel, the wear and tear, just the BS of being in a big corporation convinced me I wanted to do my own thing," says Vosotas, who has an electrical engineering degree from the University of New Hampshire.

"Here I am, 63 years old, I haven't worked for somebody or been told what to do - that being the key sentence, maybe - since 1983. What a privilege that is to have [nobody] other than my wife telling me what to do."

In retrospect, the freedom was worth the uncertainty of entrepreneurship, says Vosotas, whose 16% stake in Nicholas Financial is worth about $17 million today.

But there was plenty of uncertainty.

Vosotas bought a small software company, which he renamed Nicholas Data Services Inc., after his late father, who died when Vosotas was 4. "The software company, which was just a little widget, proceeded to lose about $300,000 in the first year, and everything I had went with it," says Vosotas.

Strapped for cash, Vosotas decided on a private placement. He sold shares in Nicholas Data Services for 32 cents apiece, with a promise to take the company public.

That happened in 1987. "The second year of broke Peter, schlepping around," says Vosotas. "I finally closed an offering on the Vancouver Stock Exchange, which finances dreams."

The Vancouver Stock Exchange of the 1980s has been described in less romantic terms. The wild western Canadian exchange was full of scam artists manipulating trading in the small issues it listed.

Nevertheless, Vosotas came away with $500,000 in net proceeds from American stock buyers whom he had lined up himself. "I had a few bucks, but not enough," he says.

In 1988, the desperate met the destitute.

A recent college graduate from Connecticut named Ralph T. Finkenbrink was meeting a friend for lunch in Clearwater. The unemployed Finkenbrink had blown through $3,000 that he had brought with him to Florida.

As Finkenbrink stepped off an elevator, he walked into the middle of a shouting match. The controller of Nicholas Data Services was getting fired right there on the spot.

Finkenbrink, whose bachelor's degree was in accounting, hurried past the commotion and asked his luncheon companion about the guy doing most of the shouting. "Oh, that's Peter," Finkenbrink's friend told him. "He's kind of a jerk."

Seizing an employment opportunity, Finkenbrink remarked: "Well, jerk or not, I need a job."

Finkenbrink, now 44, is chief financial officer and senior vice president of Nicholas Financial.

Vosotas says he managed to hang onto the $500,000 from the public offering and ran Nicholas Data Services with the proceeds of software sales. Even with Finkenbrink, however, the venture lacked growth potential.

"I was miserable, absolutely miserable," says Vosotas. "Most of my business thinking was totally flawed."

Nicholas Data Services often had to arrange financing before pest control companies or building contractors could take delivery on the $25,000 or $30,000 software packages that Vosotas was peddling. That got him to thinking.

"I said to myself, 'Wait a minute here. I'm doing all the work. I've got the goods. I've got the equipment, the people, the overhead, the risk,'" says Vosotas. "And here I go to GE Capital. They write me a check and then they collect checks from my customer and then they hold me responsible.

"So I'm virtually co-signing the note. Perhaps I should look into this."

One afternoon around the same time in 1990, Vosotas and Finkenbrink were relaxing at a local golf club when they joined a conversation with two other duffers about auto finance.

Vosotas ended up buying a $700,000 portfolio of sub-prime auto loans. Nicholas Financial was born. One of the duffers stuck around for three years to show Vosotas and Finkenbrink the ropes.

"We never looked back," says Vosotas, who is chairman, president and chief executive.

Nice spread

A quick look at his company's latest audited financial statements suggests why.

For the fiscal year that ended March 31, the company paid an average interest rate of 5.7% to acquire funds to make or buy car loans. Nicholas Financial turned around and charged car buyers an average rate of 24.1%.

Vosotas is grateful for the fat double-digit percentage point spread, which has been widening over the past four years. But he cautions that a few of his branch managers sometimes have to write off most of their quarterly spread, due to bad debt.

Daphne Hubbard, who heads up Nicholas Financial's 3-year-old Sarasota branch, is not among them. Hubbard was honored at the annual meeting as one of the company's top six branch managers.

Hubbard says she owes her success to two exceptional assistants she hired and the trio's ability to tolerate all sorts of personalities at auto dealerships. "You have to deal with the people who consider themselves the almighty," says Hubbard, "and you have to relate to the people in the trenches."

Vosotas has enormous respect for his successful branch managers, who are treated to an ocean cruise at company expense when they meet annual sales quotas. But he says good branch managers are so hard to find that he is concerned that a shortage could stunt future growth.

"We're looking for somebody who can go toe to toe with what you call a finance and insurance manager of a dealership," Vosotas says. "Now these guys are trained killers. They know how to sell cars, finance cars, pressure people into buying products they don't need."

Vosotas is amazed at how many Florida new car buyers are sold salt-resistant undercoating when that extra is only necessary in the Snow Belt, where rock salt dumped by road plows corrodes motor vehicle exteriors.

Branch managers must know cars and take advantage of their proximity to borrowers to make sure loan payments stay current.

"It's not like somebody in Alaska or Bangalore making a collection call," says Vosotas. "When we make a collection call, we know the street they're living on because we may even live on that street. We're going to get, on average, 24% interest and be putting this high-risk customer on our books, risking our shareholders' money. We damn well want to know where they live."

Nevertheless, fiscal 2005 net charge-offs at Nicholas Financial were 4.4% of average finance receivables, a ratio that would throw bankers into a panic and provoke swift attention from their regulators.

Yet Vosotas says his finance company is more cautious than other sub-prime auto lenders when it comes to buying consumer contracts. "That's why most of our competitors go broke," he says.

At the annual meeting, Vosotas told shareholders that he doesn't play games. "In this business, we can fool you quite easily," he says. "We can, literally, put hundreds of loans on the books, and it's going to take six months to a year for these loans to start stinking up."

Nicholas Financial usually comes out smelling like a rose.

Tens of millions of dollars in retained earnings have been piling up on the company's balance sheet. But Nicholas Financial no longer pays a dividend of any kind, despite the eagerness of Vosotas for more trading in the stock.

Vosotas says retained earnings are plowed back into new loans, thus reducing the company's cost of money and increasing returns. "None of that money exists, other than on paper," he says. "If you saw any cash on the balance sheet, we shouldn't have any."

Dividends were an imprudent drain on the corporate treasury, says Vosotas, the company's biggest shareholder. "I knew it was a poor use of money," he says.

Vosotas and other big holders got most of the dividend payout, not the small investor. The CEO prefers to have that cash available for loans. In fact, Vosotas, whose 2005 salary was $186,000, says he loans his annual bonus - $464,285 last year - back to the company to bolster finance receivables.

Thanks to American consumers, who keep amassing personal debt, Nicholas Financial is almost guaranteed an endless supply of loan applicants with shaky credit histories. Surprisingly, Vosotas doesn't celebrate the trend.

Aside from costly gasoline discouraging low-income borrowers from buying cars at all, Vosotas worries most about household debt.

"We're going to become a third-rate or Third World country if we keep this up," he says. "The same institutions that are trying to quench bankruptcy are sending out a bazillion offers to sign up for credit cards at no interest, with small print that says it will balloon to 90% in the next month."

Sounding oddly like a consumer advocate, Vosotas sits up in an office chair near the end of the interview. "It's not right," he says.

NICHOLAS FINANCIAL AT A GLANCE

Results for fiscal years ending March 31 '04-'05

FY 2002 FY 2003 FY 2004 FY 2005 % Chg.

Revenue:

Interest income on finance receivables $19,852,758 $22,048,535 $25,236,638 $32,582,965 29

Sales $365,367 $328,340 $263,847 $248,928 -5.6

$20,218,125 $22,376,875 $25,500,485 $32,831,893 28

Expenses:

Cost of sales $78,615 $83,904 $66,193 $64,556 -2.4

Marketing $565,626 $654,569 $865,930 $878,194 1.4

Salaries and employee benefits $0 $0 $7,028,267 $8,976,912 27.7

Administrative $7,302,275 $8,460,662 $2,889,884 $3,550,523 22.8

Provision for credit losses $1,912,918 $2,213,859 $2,198,501 $2,396,985 9

Depreciation $189,733 $190,257 $210,125 $221,753 5.5

Interest expense $3,898,400 $3,936,042 $3,851,924 $3,630,267 -5.7

$13,947,567 $15,539,293 $17,110,824 $19,719,190 15.2

Operating income before taxes $6,270,558 $6,837,582 $8,389,661 $13,112,703 56.3

Income tax expense $2,338,419 $2,556,188 $3,176,983 $5,033,008 58.4

Net income $3,932,139 $4,281,394 $5,212,678 $8,079,695 55

Source: U.S. Securities and Exchange Commission