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April 9, 2009
Via EDGAR
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H. Christopher Owings
Assistant Director
Securities and Exchange Commission
100 F Street, NE
Washington, D.C. 20549-0404
Re: Response to Comments Received from the Staff of the Commission with
respect to Amendment No. 1 to Registration Statement on Form S-3
Filed on March 4, 2009
File No. 333-157390
Form 10-K ("10-K") for Fiscal Year Ended January 31, 2009, filed
on March 26, 2009;
File No. 0-50421
Client-Matter No. 067780-10416205
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Dear Mr. Owings:
This letter sets forth the responses of Conn's, Inc. (the "Company") to the
comments of the staff of the Division of Corporation Finance (the "Staff") of
the Securities and Exchange Commission (the "Commission") received by letter
dated April 1, 2009 (the "Comment Letter") with respect to Amendment No. 1 to
Registration Statement on Form S-3 (File No. 333-157390) filed on March 4, 2009
and the Form 10-K filed on March 26, 2009.
For the convenience of the Staff, we have set forth below, in boldface
type, the number and text of each comment in the Comment Letter followed by the
Company's responses thereto.
Form 10-K for Fiscal Year Ended January 31, 2009
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Item 8. Financial Statements and Supplementary Data, page 58
- ------------------------------------------------------------
Note 1. Summary of Significant Accounting Policies, page 66
- -----------------------------------------------------------
Receivables Not Sold, page 69
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1. Please explain to us in detail your methodology for calculating the
provision for bad debts associated with the receivables not sold to
your qualified special purpose entity and the GAAP guidance you relied
upon in developing your methodology. Please separately address the
methodology used for your primary and secondary portfolios and the
installment and revolving loans included in the portfolios. Refer to
SAB Topic 6:L and EITF D-80. Please include a discussion of the
factors that are relevant to an understanding of your methodologies
and estimates used to determine probable losses, including the
following:
o How you consider your security interests and credit insurance
sold to customers;
o How you identify and evaluate the risks inherent in your primary
and secondary portfolios of installment and revolving loans
including whether "same as cash" or deferred interest program
loans have different risk characteristics;
o How you segment and/or group loans in the portfolios in terms of
risk and past due status; The methods used to identify loans to
analyze individually, including how the amounts of impairments
are determined and measured;
o Your consideration of industry, geographical, economic and
political factors in determining loss rates;
o The period of time considered in using historical loss
experience; and
o How you consider the level and trend in delinquencies,
charge-offs and recoveries, volume and terms of loans, changes in
underwriting standards or other lending policies.
In addition, please provide a summary of your customer accounts
receivable aging and reserve analysis for the two years presented with
your response. Also, tell us whether you revised your underwriting
standards or other lending policies and/or modified payment terms on
accounts during the past two years and, if so, the impact on your
aging and reserve analysis for each year.
The Company's combined credit portfolio consists of a large number of
smaller-balance homogeneous consumer receivables. At January 31, 2009, the
combined portfolio consisted of 537,957 accounts, with an average balance of
$1,401, including receivables transferred to the QSPE and those not transferred
to the QSPE. Only products and services offered by the Company are financed by
the Company's credit programs. Based on the Company's underwriting criteria and
evaluation of related collection risks, the receivables are classified
(segmented) as either Primary or Secondary Portfolio accounts. Credit
underwriting personnel are independent of the sales personnel and determine
portfolio designation for each customer based primarily on customer credit risk,
after reviewing the customer's credit score, detail credit bureau and payment
history with the Company, if any. The following are typical conditions that may
result in an account being classified in the Secondary Portfolio, if it is
approved:
- The customer's credit score at the time of review of the application
is below 540, and/or
- The customer is a young adult (between 18 and 24 years old) without a
co-signor, and/or
- The customer has "thin" credit file, meaning that they have little or
no credit history reported in their credit bureau report, and/or
- There are questions about the information in the credit bureau or
credit application that require additional verification.
Primary Portfolio accounts represented approximately 78.3% of the combined
portfolio at January 31, 2009, with Secondary Portfolio accounts representing
the remainder. Installment contracts, which represented 95% of the combined
portfolio balance at January 31, 2009, have scheduled monthly payment amounts
and typically have 36-month terms. Revolving charge receivables accounted for
only 5% of the combined portfolio at January 31, 2009, and only customers that
qualify to be designated as Primary Portfolio accounts are eligible to apply for
revolving charge accounts. Additionally, within the Primary Portfolio
classification, customers may qualify for same-as-cash or deferred interest
programs. The Company believes that accounts generated under these programs
generally perform better than the other accounts in the portfolio for customers
of similar credit risk. While the loss rate experienced on these accounts is
generally lower, the portion of the Primary Portfolio represented by these
accounts has not changed significantly over time, and the loss experience is
incorporated in the loss reserve calculation for the Primary Portfolio. These
accounts represented 16.4% of the combined portfolio at January 31, 2009. All
installment and revolving receivables require monthly payments and are secured
by the products financed by the credit account.
In determining the provision for bad debts for receivables not sold to
the Company's QSPE, the Company considered the requirements of FASB Statement of
Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies, and
SFAS No. 114, Accounting by Creditors for Impairment of a Loan. Paragraph 6a of
SFAS No. 114 excludes from the application of its provisions "large groups of
smaller-balance homogeneous loans that are collectively evaluated for
impairment. Those loans may include but are not limited to credit card,
residential mortgage and consumer installment loans." As such, the Company
applies the provisions of SFAS No. 5, since, as stated in EITF D-80, "it is
probable that a group of similar loans includes some losses even though the loss
could not be identified to a specific loan." Additionally, the Company believes
that its approach complies with SAB Topic 6:L and EITF D-80.
The Company uses a formula-based approach to calculating its provision for
bad debts. A separate calculation is prepared each quarter for each of the
groups of Primary and Secondary Portfolio accounts based on the trailing
12-month actual charge-off experience, net of recoveries, as a percentage of the
applicable average portfolio balance over the same time period. The Company uses
its 12-month charge-off experience, given the relatively short weighted average
life of the portfolio, to ensure that the loss rates derived incorporate the
most recent charge-off trends and consider a full calendar year business cycle.
The loss rates derived from this calculation are then multiplied with the ending
balance of the applicable portfolios at each quarter end to determine the
appropriate reserve. Because the charge-off experience of the Primary and
Secondary Portfolio groups is generally consistent across the various markets in
which the Company operates and the relative finance contract volume contributed
by each market has been relatively consistent from year to year, the Company
does not further segment the Primary and Secondary Portfolio loss reserve
calculations by market.
To the extent a customer has a claim under a credit insurance policy, the
insurance payment made on the account by the third-party insurance company
typically reduces the account balance before any amount is charged-off,
otherwise it is included in recoveries. Since all finance contracts are secured
by the products financed under the contracts, the Company has the ability to
negotiate voluntary repossession of the financed products. The value of
repossessed product and post-charge-off cash collections are included in
recoveries when determining the Company's charge-off experience.
As the Company only began retaining significantly more receivables on its
balance sheet during the fiscal year ended January 31, 2009, it used the loss
rate experience of the combined portfolio to estimate the loss rate for
receivables not sold, as it expects the receivable performance to be consistent
with the performance of the receivables sold to the QSPE. Beginning in August
2008, the Company began retaining virtually all new receivables generated on its
balance sheet and then implemented a random allocation method in October 2008 to
avoid adverse selection risks in both the receivable portfolio held by the QSPE
and the receivable portfolio not sold to the QSPE.
As appropriate, the Company adjusts the loss rate estimate if trends in
portfolio performance, including delinquency and losses, changes in underwriting
standards or external economic or regional factors suggest that the trailing
12-month loss rate may not be indicative of future loss expectations. For
example, in the year ended January 31, 2006, the Company increased the reserve
as a result of the new bankruptcy law that went into effect in October 2005. The
majority of the Company's operations are located in Texas, with the remaining
locations located nearby in southwest Louisiana and Oklahoma. As the Company and
its customers have not experienced the same economic and consumer credit
challenges as many other regions of the country, no adjustment to the reserve
was made at January 31, 2009, as a result of the economic environment.
Additionally, since the weighted average life of the portfolio is so short
(approximately 1.2 years for Primary Portfolio accounts and 1.7 years for
Secondary Portfolio accounts) the loss rate calculation incorporates portfolio
performance trends very quickly.
While the Company makes minor changes in its underwriting guidelines from
time-to-time, it has not made any significant changes to its underwriting
standards or other lending policies, and has not changed contractual payment
terms at origination over the past two fiscal years. Recently the Company raised
the minimum credit score it would accept and raised down payment requirements,
which it expects to lead to improved receivable quality. Typically, the primary
effect of any changes in underwriting guidelines is a change in the relative
volume of receivables underwritten for the Primary and Secondary Portfolios.
Since the calculation for the allowance for bad debts already separately
considers each of the portfolios, no adjustment to the reserve calculation has
been necessary due to the changes made in underwriting guidelines.
Since January 31, 2009, the combined portfolio performance has continued to
improve and at this time the Company expects to report, at its next reporting
date, an improved net charge-off rate and reduced delinquency percentage, with
no significant change in the re-age percentage.
The following tables show the reserve analysis and delinquency summary for
the two years presented in the Company's Form 10-K:
Reserve Analysis - for Receivables not Transferred to the QSPE
Reserve Analysis as of January 31, 2009
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(dollars in thousands) Total
Primary Secondary Legacy (1) Other Reserves
------- --------- ---------- ----- --------
Trailing 12-Month Charge-offs, net of Recoveries - Combined 14,505 7,171 789
Average Portfolio Balance - Combined 543,559 153,010 7,614
Loss Rate - Combined 2.7% 4.7% 10.4%
Receivable Balance at January 31, 2009 - Not Sold 81,926 19,648 6,224
Calculated Reserve at January 31, 2009 2,186 921 645 161 3,913
Reserve Analysis as of January 31, 2008
---------------------------------------
Trailing 12-Month Charge-offs, net of Recoveries - Combined 926
Average Portfolio Balance - Combined 9,468
Loss Rate - Combined 9.8%
Receivable Balance at January 31, 2008 - Not Sold 9,005
Calculated Reserve at January 31, 2008 881 - 881
(1) Prior to August 2008, when the Company began retaining new receivables on
balance sheet, the Company had a small portfolio of receivables that were
in run-off. The reserve for these receivables is calculated independently
of the other receivables.
Customer Accounts Receivable Aging
(dollars in thousands)
Year ended January 31,
-----------------------
2009 2008
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Days Past Due:
Current 95,143 4,738
1-30 8,176 1,654
31-60 1,552 613
61-90 1,004 482
91-120 780 327
121-150 440 236
151-180 188 219
181-209 93 140
210+ 422 596
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Total 107,798 9,005
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Note 3. Interest in Securitized Receivables, page 74
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2. Please tell us in detail how you derived the market place participant
assumptions used to measure the fair value of your interest in
securitized assets at each balance sheet date. Please include a
discussion of available market information such as quoted prices,
reports issued by analysts and ratings agencies, current level of
interest rates and directional movements in relevant indexes, as well
as information about the performance of the underlying credit card
receivables, such as delinquency rates and loss experience considered
in developing the assumptions. Also address the extent to which
assumptions, such as those related to net interest spread, credit
risks, delinquency rates and loss experience, and risk reduction
arrangements such as credit insurance and security interests reflect
your own assumptions of what market participants would use in pricing
your interests in securitized assets.
The Company estimates the fair value of its Interests in securitized assets
using a discounted cash flow model with most of the inputs used being
unobservable inputs. The primary unobservable inputs, which are derived
principally from the Company's historical experience, with input from its
investment bankers and financial advisors, include the estimated portfolio
yield, net credit loss rate, discount rate, payment rate and delinquency rate
and reflect the Company's judgments about the assumptions market participants
would use in determining fair value. In determining the cost of borrowings, the
Company uses current actual borrowing rates, and adjusts them, as appropriate,
using interest rate futures data from market sources to project interest rates
over time. The following is a discussion of each of the key assumptions and the
available market information used to develop the assumptions.
- Interest Rates/Funding Cost - the valuation model uses the Company's
current borrowing rates adjusted based on changes in quoted interest
rate futures to estimate the underlying interest rate for future
periods for the variable rate borrowings of the QSPE.
- Discount Rate - the discount rate used in valuation is based on the
one-year Treasury risk-free interest rate, plus the risk premium that
the Company expects a market participant would use. In order to
estimate the risk premium a market participant would require on the
Company's interests in securitized assets, the Company talks to its
bankers' structured finance teams at the end of each quarter for their
perspective and references to applicable market data. In addition to
the information provided in those discussions, the following are the
data sources they have referred us to:
o Publicly available market information regarding pricing and
spreads on asset-backed securitization transactions.
o The filings of other companies valuing residual assets from
receivables securitizations.
o The indicative risk premiums for bonds issued under the Company's
securitization program, developed by investment bankers' trading
desks. Because there is no trading activity in the Company's
bonds, the indicative risk premiums are based on estimates by the
trading desk after looking at trading data on other transactions.
- Projected Expense - the valuation uses the contractual reimbursement
rate, plus the actual rate for other fees collected, which have varied
very little over time, plus a premium that the Company expects a
market participant would require to maintain the portfolio performance
at the same standard being achieved currently. The premium was based
on the Company's review of the servicing fees required in other
securitization transactions.
- Expected Losses - the expected loss rate assumption is based in part
on the Company's historical loss experience, plus a premium that the
Company expects a market participant would require. The premium is set
based on the range of the net loss rates experienced by the Company
over time, in light of the performance of other consumer credit
portfolios and reports issued by the agency rating the QSPE's bonds.
The Company's historical experience, and thus this assumption
incorporate the effects on losses of the benefits of the credit
insurance policies sold to its customers and the benefits of the
secured interest held in the products sold.
- Portfolio Yield - the portfolio yield assumption is based on the
Company's historical experience. Since all contracts are generated
based on a fixed rate of interest, generally based on state statutory
maximum rates, and the Company rarely varies the rate charged, it
expects a market participant would utilize the historical experience.
- Payment Rate - the payment rate assumption is based on the Company's
historical experience. Since all contracts are generated based on
standard terms, which rarely vary, and the weighted average life of
the portfolio has varied very little over time, the Company expects a
market participant would utilize the historical experience.
- Delinquency Rate - the delinquency rate assumption is based on the
Company's historical experience and is adjusted according to the
Company's estimation of the expectations of a market participant, in
light of recent trends in the portfolios and other consumer credit.
3. We note your disclosure in various Form 8-K current reports filed
throughout the year that you periodically re-age your credit
portfolio. Please describe the policies and methods used to re-age the
accounts in your credit portfolio to us in detail and the basis or
rationale for re-aging the accounts. Also, please tell us, and
quantify to the extent practicable, how your re-aging policy affects
the aging of your credit accounts and the determination of
delinquencies, charge-offs and recoveries, and historical loss rates,
as well as the impact on the assumptions used to estimate the fair
value of your interest in securities assets and probable losses on
customer receivables not sold to your qualified special purpose entity
for each year presented.
Unlike many finance companies, the Company's finance programs are integral
to its retail sales efforts. Accordingly, given the Company's focus on customer
service and building long-term relationships with its customers, in
administering its finance programs the Company strives to coach its customers
into a habit of making consistent payments on amounts owed to the Company. As
part of this effort, at times, when a customer experiences hardships (loss of
job, extraordinary medical payments, etc.) the Company will work with the
customer to help them arrange a payment plan that will result in ultimate
collection of the receivable and allowing the customer to maintain a long-term
relationship with the Company. One of the ways the Company works with its
customers to achieve these goals is through its re-aging process. As a result of
the re-aging process, the customer's account can be brought into a current
status. The following are the core re-aging policies and methods used by the
Company:
- Standard Extension - the customer pays the interest due on the account
for the number of months past due and the contractual term on the
contract is increased accordingly.
- Hardship Extension - this program is available to customers that are
120+ days past due. If, over a two month period, the customer makes
two full monthly payments and pays two months of interest, an account
that is up to 210 days past due can be brought current. The
contractual term on the contract is increased accordingly.
- Revolving Account Re-age - if a revolving account customer that is
past due makes two consecutive full monthly payments, the account can
be brought current.
- Due Date Changes - typically applies to customers that are working
with a consumer credit counseling service and similar circumstances,
which may not require a payment by the customer. The contractual term
on the contract is increased, as applicable, based on the past due
status of the account.
In addition to the requirements of the re-aging methods discussed above, the
following are standard criteria that typically must be met before an account can
be re-aged:
- A customer may be offered a re-age program only once every six months.
- Collections personnel must contact the customer and verify contact
information and source of income to verify the customer's ability to
make payments.
- Any exceptions to the above requirements must be approved by an
authorized credit collection manager.
- Over the past 24 months, the Company has re-aged each month, on
average, approximately 2.8% of active, outstanding balances, with
Standard and Hardship Extensions representing approximately 2.7%.
The Company ages accounts based on the contractual due date and an account
is considered delinquent if a payment is not received by the scheduled due date.
Typically, if an account meets the requirements discussed above and is approved
to be re-aged, the account is considered to be current. By offering these
programs, many customers have been able to re-establish regular monthly payment
schedules and pay-off their credit accounts, avoiding charge-off and the related
negative credit bureau reporting ramifications. Ultimately, customers that are
not able to maintain a regular monthly payment schedule after being re-aged will
likely be charged-off or go through the voluntary repossession process. The
re-age programs have been utilized consistently by the Company for many years
and have not varied significantly over time. As a result, the Company has been
able to maintain consistent delinquency, charge-off and re-age performance year
after year. Since the re-aging of accounts has been a long-term, consistent
practice of the Company and the delinquency trends, charge-off trends and
payment rate trends inherently incorporate the effects of the re-aging process,
typically no additional adjustment is necessary when completing the Company's
estimate of fair value of its interests in securitized assets or the estimated
loss reserve for customer receivables not sold to the QSPE. The act of re-aging
an account does not have a direct impact on the loss reserve or loss rate
assumption since the charge-off policy (120 or more days past due and
seven-months with no payment) criteria would not be met if a valid, full-payment
payment is made, whether the account is re-aged or not. Additionally, since the
loss rate and loss reserve are calculated on the total receivable balances (see
Question #1), the aging of the receivable has no direct impact on the loss rate
or loss reserve calculations. Adjustment of the fair value assumptions or loss
reserves estimates is considered when circumstances, portfolio performance or
market trends, indicate a market participant may change their expectations about
portfolio performance, as evidenced by the increase in the loss rate assumption
used in the fair value calculation, beginning with the October 31, 2008
calculation.
4. Please tell us how your delinquency rates, charge-offs and recoveries,
aging policies and underwriting standards or other lending policies
compare with other market place participates [sic] and the causes and
other factors to which you attribute any significant differences. If
meaningful, please tell us the differences between your proprietary
standardized credit scoring model and pre-determined aging charge-off
criteria described on page 13 and those of other market place
participants.
Given the Company's financing program focus on retail consumer credit, the
following response is based on a comparison to consumer credit card lenders,
which the Company believes are the most comparable market participants available
for this review.
The following summarizes the Company's comparison of data available from
the Prime Credit Card ABS Index (from Fitch Ratings):
Conn's Index
------ -----
Data range is for the past four years
Delinquency Rate (60+ days)
as of January 31st each year 6.6% to 7.6% 2% to 4% (approx.)
Charge-off Rate - Net of Recoveries 2.5% to 3.3% N/A
Charge-off Rate - Gross 3.1% to 3.7% 3% to 7% (approx.)
While the Company does not have direct knowledge of the aging policies used
by the companies in the index to determine delinquency statistics, it is aware
that there are two common aging practices used - Contractual Aging and Recency
Aging. The Company uses the Contractual Aging practice, which determines past
due status based on the contractual due date, which is the number of days since
the next contractual due date. Whereas, Recency Aging is based on the date the
customer last made a payment. The Company believes the Contractual Aging
practice provides a more accurate reflection of its customers' performance
relative to their contractual obligation.
With respect to underwriting and lending policies, the Company believes its
proprietary scoring model gives it an advantage in managing credit risk. The
Company understands that the majority of market participants in the credit card
industry makes underwriting decisions based primarily on customer credit risk
and typically lend on an unsecured basis with no down payments. However, the
Company's underwriting process considers:
- customer credit risk (87% of transactions include a review of the
customer's bureau report by a trained underwriter),
- product risk (the Company monitors charge-off performance by product
category), and
- down payment (the weighted average down payment received was between
8% and 10% over the past two fiscal years, with the average down
payment on the Secondary Portfolio averaging over 20%).
- Additionally, the vast majority of the Company's sales are of products
that are durable home necessities that the customer will have in their
home for years to come. Combined with the Company's secured interest
in the product, the Company has significant leverage in the collection
process that does not typically exist in credit card receivable
collections as many purchases on a credit card are for consumables
(food, gas, clothing, etc.) and are rarely, if ever, secured.
The Company's pre-determined aging charging off criteria requires an
account to be charged-off when it is 120 days or more past due and a payment has
not been made on the account in seven months. The Company understands that
credit card lenders' charge-off criteria generally are based solely on past due
status. As discussed in Question #3, the Company's focus is on customer service
and building long-term relationships with its customers. In administering its
finance programs, the Company strives to coach its customers into a habit of
making consistent payments on amounts owed to the Company. As compared to credit
card companies whose primary focus is typically solely on its collection
efforts, because of the high level of integration of the Company's finance
programs with its retail sales efforts, the Company attempts to build a
long-term retail sales and finance relationship with the customer.
The Company believes that the unique nature of its underwriting and lending
practices, as compared to credit card lenders, and its desire to build a
long-term retail sales and finance relationship with the customer has allowed it
to maintain consistent credit portfolio performance over a long period of time.
******
Should any member of the Staff have any questions or additional comments
regarding the responses to the Comment Letter set forth above, please do not
hesitate to call the undersigned at (214) 855-7177.
Sincerely,
/s/ D. Forrest Brumbaugh
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D. Forrest Brumbaugh
DFB:pl
Enclosures
cc: William Thompson, Accounting Branch Chief, Securities and Exchange
Commission
Tony Watson, Accountant, Securities and Exchange Commission
Scott Anderegg, Staff Attorney, Securities and Exchange Commission
Ellie Bavaria, Special Counsel, Securities and Exchange Commission
Thomas J. Frank, Sr., Conn's, Inc.
Sydney K. Boone, Conn's, Inc.
Michael J. Poppe, Conn's, Inc.