Overview

Nicholas Financial-Canada is a Canadian holding company incorporated under the laws of British Columbia in 1986. Nicholas Financial-Canada conducts its business activities through two wholly-owned Florida corporations: Nicholas Financial, which purchases and services Contracts, makes direct loans and sells consumer-finance related products; and NDS, which supports and updates certain computer application software. Nicholas Financial accounted for more than 99% of the Company's consolidated revenue for each of the fiscal years ended March 31, 2012, 2011, and 2010. Nicholas Financial-Canada, Nicholas Financial and Nicholas Data Services are collectively referred to herein as the "Company".

The Company's consolidated revenues increased for the fiscal year ended March 31, 2012 to $68.2 million as compared to $62.8 million and $56.5 million for the fiscal years ended March 31, 2011 and 2010, respectively. The Company's consolidated net income increased for the fiscal year ended March 31, 2012 to $22.2 million as compared to $16.8 million and $10.9 million for the fiscal years ended March 31, 2011 and 2010, respectively. The Company's earnings were positively impacted by a decrease in the net charge-off percentage to 4.59% for the fiscal year ended March 31, 2012 as compared to 4.65% for the fiscal year ended March 31, 2011. The Company believes the decrease in the charge-off percentage was primarily attributable to the following factors: a temporary reduction in competition, the increased market value of auctioned cars, the continued application of stricter underwriting guidelines, and the continued allocation of additional resources focused on collections. The Consumer Assistance to Recycle and Save Act of 2009 ("CARS") established a voluntary vehicle trade-in and purchase program pursuant to which owners of vehicles were eligible to receive a credit of either $3,500 or $4,500 in connection with the purchase of a new vehicle from a participating dealer, depending upon how the trade-in and acquired vehicles fit within the program criteria, including the amount of improved fuel efficiency. The program reduced the supply of used cars in the market, resulting in increases in the market value of used cars in subsequent years, especially for older used cars such as those financed by Contracts held by the Company. The Company's underwriting guidelines were changed in 2009 to increase the minimum income required by any applicant before loan approval can even be contemplated. The Company also reduced the maximum advance to any dealer, raised the minimum ENH beacon score, and reduced the maximum amount that can be financed.

During the latter part of fiscal year 2012 the Company began experiencing increased competition which has continued into the first quarter of fiscal 2013. Historically, when competition has increased, the Company has experienced higher losses, decreased contract origination and as a result reduced profits. While it is difficult to predict the level of competition long-term, the Company believes the current competitive environment will be prevalent throughout fiscal 2013.

Portfolio Summary                                         Fiscal Year ended March 31,
                                                 2012                2011                2010
Average finance receivables, net of
unearned interest (1)                        $ 272,979,496       $ 250,962,519       $ 223,547,537

Average indebtedness (2)                     $ 115,688,980       $ 113,833,641       $ 106,985,830

Interest and fee income on finance
receivables (3)                              $  68,122,532       $  62,719,904       $  56,403,536
Interest expense                             $   4,891,854       $   5,599,951       $   5,169,736

Net interest and fee income on finance
receivables                                  $  63,230,678       $  57,119,953       $  51,223,800

Weighted average contractual rate (4)                23.93 %             23.66 %             23.62 %

Average cost of borrowed funds (2)                    4.23 %              4.92 %              4.83 %

Gross portfolio yield (5)                            24.96 %             24.99 %             25.23 %
Interest expense as a percentage of
average finance receivables, net of
unearned interest                                     1.79 %              2.23 %              2.31 %
Provision for credit losses as a
percentage of average finance
receivables, net of unearned interest                 0.00 %              1.84 %              5.06 %

Net portfolio yield (5)                              23.17 %             20.92 %             17.86 %
Marketing, salaries, employee benefits,
depreciation and administrative expenses
as a percentage of average finance
receivables, net of unearned interest (6)             9.85 %             10.15 %             10.35 %

Pre-tax yield as a percentage of average
finance receivables, net of unearned
interest (7)                                         13.32 %             10.77 %              7.51 %


Write-off to liquidation (8)                          5.66 %              6.17 %              9.87 %

Net charge-off percentage (9)                         4.59 %              4.65 %              7.37 %

(2) Average indebtedness represents the average outstanding borrowings under the Company's line of credit facility. Average cost of borrowed funds represents interest expense as a percentage of average indebtedness.

(3) Interest and fee income on finance receivables does not include revenue generated by NDS.

(4) Weighted average contractual rate represents the weighted average annual percentage rate ("APR") of all Contracts purchased and direct loans originated during the period.

(5) Gross portfolio yield represents interest and fee income on finance receivables as a percentage of average finance receivables, net of unearned interest. Net portfolio yield represents interest and fee income on finance receivables minus (a) interest expense and (b) the provision for credit losses as a percentage of average finance receivables, net of unearned interest.

(6) Administrative expenses included in this calculation are net of administrative expenses associated with NDS which approximated $220,000, $216,000, and $213,000 during the fiscal years ended 2012, 2011 and 2010, respectively.

(7) Pre-tax yield represents net portfolio yield minus operating expenses as a percentage of average finance receivables, net of unearned interest.

(8) Write-off to liquidation percentage is defined as net charge-offs divided by liquidation. Liquidation is defined as beginning receivable balance plus current period purchases minus voids and refinances minus ending receivable balance.

(9) Net charge-off percentage represents net charge-offs divided by average finance receivables, net of unearned interest, outstanding during the period.

Critical Accounting Policy

The Company's critical accounting policy relates to the allowance for credit losses. It is based on management's opinion of an amount that is adequate to absorb losses in the existing portfolio. The allowance for credit losses is established through allocations of dealer discounts and a provision for loss based on management's evaluation of the risk inherent in the loan portfolio, the composition of the portfolio, specific impaired loans and current economic conditions. Such evaluation considers, among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, management's estimate of probable credit losses and other factors that warrant recognition in providing for an adequate credit loss allowance.

Because of the nature of the customers under the Company's Contracts and its direct loan program, the Company considers the establishment of adequate reserves for credit losses to be imperative. The Company segregates its Contracts into static pools for purposes of establishing reserves for losses. All Contracts purchased by a branch during a fiscal quarter comprise a static pool. The Company pools Contracts according to branch location because the branches purchase Contracts in different geographic markets. This method of pooling by branch and quarter allows the Company to evaluate the different markets where the branches operate. The pools also allow the Company to evaluate the different levels of customer income, stability and credit history, and the types of vehicles purchased in each market. Each such static pool consists of the Contracts purchased by a branch office during a fiscal quarter.

Contracts are purchased from many different dealers and are all purchased on an individual Contract by Contract basis. Individual Contract pricing is determined by the automobile dealerships and is generally the lesser of the applicable state maximum interest rate, if any, or the maximum interest rate which the customer will accept. In certain markets, competitive forces will drive down Contract rates from the maximum rate to a level where an individual competitor is willing to buy an individual Contract. The Company only buys Contracts on an individual basis and never purchases Contracts in batches, although the Company may consider portfolio acquisitions as part of its growth strategy. See "Item 1. Business - Growth Strategy."

The Company has detailed underwriting guidelines it utilizes to determine which Contracts to purchase. These guidelines are specific and are designed to cause all of the Contracts that the Company purchases to have common risk characteristics. The Company utilizes its District Managers to evaluate their respective branch locations for adherence to these underwriting guidelines. The Company also utilizes an internal audit department to assure adherence to its underwriting guidelines. The Company utilizes the branch model, which allows for Contract purchasing to be done on the branch level. Each Branch Manager may interpret the guidelines differently, and as a result, the common risk characteristics tend to be the same on an individual branch level but not necessarily compared to another branch.

A dealer discount represents the difference between the finance receivable, net of unearned interest, of a Contract, and the amount of money the Company actually pays for the Contract. The discount negotiated by the Company is a function of the credit quality of the customer, the wholesale value of the vehicle, and competition in any given market. The automotive dealer accepts these terms by executing a dealer agreement with the Company. The entire amount of discount is related to credit quality and is considered to be part of the allowance for credit losses. The Company utilizes a static pool approach to track portfolio performance. A static pool retains an amount equal to 100% of the discount as an allowance for credit losses.

Subsequent to the purchase, if the reserve for credit losses is determined to be inadequate for a static pool which is not fully liquidated, then an additional charge to income through the provision is used to reestablish adequate reserves. If a static pool is fully liquidated and has any remaining reserves, the excess discounts are immediately recognized into income and the excess provision is immediately reversed during the period. For static pools not fully liquidated that are determined to have excess discounts, such excess amounts are accreted into income over the remaining life of the static pool. For static pools not fully liquidated that are deemed to have excess reserves, such excess amounts are reversed against provision for credit losses during the period.

In analyzing a static pool, the Company considers the performance of prior static pools originated by the branch office, the performance of prior Contracts purchased from the dealers whose Contracts are included in the current static pool, the credit rating of the customers under the Contracts in the static pool, and current market and economic conditions. Each static pool is analyzed monthly to determine if the loss reserves are adequate, and adjustments are made if they are determined to be necessary.

Fiscal 2012 Compared to Fiscal 2011

Interest and Fee Income on Finance Receivables

Interest income on finance receivables, predominantly finance charge income, increased 9% to $68.1 million in fiscal 2012 from $62.7 million in fiscal 2011. The average finance receivables, net of unearned interest, totaled $273.0 million for the fiscal year ended March 31, 2012, an increase of 9% from $251.0 million for the fiscal year ended March 31, 2011. The primary reason average finance receivables, net of unearned interest, increased was the development of new markets in Missouri, South Carolina, Ohio, and Alabama. The gross finance receivable balance increased 4% to $389.0 million at March 31, 2012 from $373.0 million at March 31, 2011. The primary reason interest income increased was the increase in the outstanding loan portfolio. The gross portfolio yield decreased to 24.96% for the fiscal year ended March 31, 2012 from 24.99% for the fiscal year ended March 31, 2011. The net portfolio yield increased to 23.17% for the fiscal year ended March 31, 2012 from 20.92% for the fiscal year ended March 31, 2011. The gross portfolio yield remained relatively flat primarily due to an unchanged weighted APR earned on finance receivables. The net portfolio yield increased primarily due to the decrease in provisions for credit losses. The Company has experienced favorable variances between projected write-offs and actual write-offs on certain pools which has resulted in an increase in expected future cash flows. Accordingly, the amount of additional provision necessary to maintain an adequate allowance to absorb losses in the existing portfolio was less than the provision in fiscal 2011. As a result, the provision for credit losses was less than write offs during the current periods. More specifically, during the 4th quarter of fiscal 2012 actual losses were considerably lower than expected along with auction prices of repossessed vehicles at historically high levels.

Marketing, Salaries, Employee Benefits, Depreciation, and Administrative Expenses

Marketing, salaries, employee benefits, depreciation, and administrative expenses increased to $27.1 million for the fiscal year ended March 31, 2012 from $25.7 million for the fiscal year ended March 31, 2011. This increase of 5% was primarily attributable to additional staffing at existing branches. The Company opened additional branches and increased average headcount to 293 for the fiscal year ended March 31, 2012 from 276 for the fiscal year ended March 31, 2011. Marketing, salaries, employee benefits, depreciation, and administrative expenses as a percentage of average finance receivables, net of unearned interest, decreased to 9.85% for the fiscal year ended March 31, 2012 from 10.15% for the fiscal year ended March 31, 2011.

Interest Expense

Interest expense decreased to $4.9 million for the fiscal year ended March 31,
2012 as compared to $5.6 million for the fiscal year ended March 31, 2011. The
following table summarizes the Company's average cost of borrowed funds for the
fiscal years ended March 31:



                                                             2012        2011
      Variable interest under the line of credit facility     0.48 %      0.53 %
      Settlements under interest rate swap agreements         0.00 %      0.70 %
      Credit spread under the line of credit facility         3.75 %      3.69 %

      Average cost of borrowed funds                          4.23 %      4.92 %

The primary reason that the Company's average cost of funds decreased for the fiscal year ended March 31, 2012 as compared to the preceding fiscal year was the absence of costs associated with settlements under interest rate swap agreements during, such period, which costs were incurred during fiscal year ended March 31, 2011.

On January 12, 2010, the Company executed a new line of credit facility, or Line. Under the new Line, the Company's credit facility pricing changed from 162.5 basis points above 30-day LIBOR to 300 basis points above 30-day LIBOR, with a 1% floor on LIBOR. The average cost of borrowings in future periods will continue to be impacted by such pricing increases. Effective September 1, 2011, the size of the Line was increased to $150.0 million from $140.0 million and the maturity date was extended to November 30, 2013. For a further discussion regarding the Company's line of credit, see "- Liquidity and Capital Resources" below and note 5 ("Line of Credit") to our audited consolidated financial statements included elsewhere in this Report.

The weighted average notional amount of interest rate swaps was $23.3 million at a weighted average fixed rate of 3.80% during the fiscal year ended March 31, 2011. For a further discussion regarding the effect of our interest rate swap agreements, see note 6 ("Interest Rate Swap Agreements") to our audited consolidated financial statements included elsewhere in this Report.

Analysis of Credit Losses

As of March 31, 2012, the Company had 1,249 active static pools. The average pool upon inception consisted of 65 Contracts with aggregate finance receivables, net of unearned interest, of approximately $640,000.

The following table sets forth a reconciliation of the changes in the allowance for credit losses on Contracts for the fiscal years ended March 31:

                                                2012               2011

         Balance at beginning of year       $  35,895,449      $  30,408,578
         Discounts acquired on new volume      12,415,896         12,919,492
         Current year provision                  (176,745 )        4,484,284
         Losses absorbed                      (14,971,422 )      (14,036,888 )
         Recoveries                             2,405,750          2,255,683
         Discounts accreted                       (73,244 )         (135,700 )

         Balance at end of year             $  35,495,684      $  35,895,449

The following table sets forth a reconciliation of the changes in the allowance for credit losses on direct loans for the fiscal years ended March 31:

                                               2012            2011

              Balance at beginning of year   $ 378,418      $  382,869
              Current year provision           182,062         125,937
              Losses absorbed                  (93,041 )      (173,970 )
              Recoveries                        24,745          43,582

              Balance at end of year         $ 492,184      $  378,418

The average dealer discount associated with new volume for the fiscal years ended March 31, 2012 and 2011 was 8.47% and 8.78%, respectively.

The provision for credit losses decreased to $5,000 for the fiscal year ended March 31, 2012 from $4.6 million for the fiscal year ended March 31, 2011, largely due to the fact that net charge offs during fiscal 2012 were less than the expected charge-offs previously contemplated in the allowance for loan losses. Accordingly, the amount of additional provision necessary to maintain an adequate allowance to absorb losses in the existing portfolio was less than the provision for prior periods.

The Company's losses as a percentage of liquidation decreased to 5.66% for the fiscal year ended March 31, 2012 as compared to 6.17% for the fiscal year ended March 31, 2011. The Company experienced improvements in the quality of its Contracts in fiscal 2012 as compared to fiscal 2011 due to an increase in auction prices, and an increased focus on collections. Increased auction proceeds from repossessed vehicles reduced the amount of the write-off which, in turn, lowered the write-off to liquidation percentage. During the fiscal years ended March 31, 2012, 2011, and 2010, auction proceeds from the sale of repossessed vehicles averaged approximately 57%, 52%, and 45%, respectively, of the related principal balance.

Recoveries as a percentage of charge-offs were approximately 16.80% and 17.90% for the fiscal years ended March 31, 2012 and 2011, respectively. Historically, recoveries as a percentage of charge-offs have fluctuated from period to period, and the Company does not attribute this decrease to any particular change in operational strategy or economic event.

The delinquency percentage for Contracts more than thirty days past due as of March 31, 2012 increased to 3.01% from 2.21% as of March 31, 2011. The delinquency percentage for direct loans more than thirty days past due as of March 31, 2012 decreased to 1.09% from 1.13% as of March 31, 2011. The delinquency percentage increases reflect portfolio weakness that generally manifests itself in increased future losses. The Company utilizes a static pool approach to analyzing portfolio performance and looks at specific static pool performance and recent trends as leading indicators of the future performance of its portfolio.

The Company considers the following factors to assist in determining the appropriate loss reserve levels: unemployment rates; competition; the number of bankruptcy filings; the results of internal branch audits; consumer sentiment; consumer spending; economic growth (i.e., changes in GDP); the condition of the housing sector; and other leading economic indicators. The Company continues to evaluate reserve levels on a pool-by-pool basis during each reporting period. While unemployment rates have stabilized, somewhat, they remain elevated, which will make it difficult for additional improvement in loss rates. The longer term outlook for portfolio performance will depend on overall economic conditions, the unemployment rate, the rationale or irrational behavior of the Company's competitors, and the Company's ability to monitor, manage and implement its underwriting philosophy in additional geographic areas as it strives to continue its expansion.

Income Taxes

The provision for income taxes increased to approximately $13.9 million in fiscal year 2012 from approximately $10.5 million in fiscal year 2011 primarily as a result of higher pretax income. The Company's effective tax rate decreased to 38.53% in fiscal 2012 from 38.54% in fiscal 2011. The primary reason for this increase was an increase in the amount of taxable income subject to higher graduated federal income tax rates.

Fiscal 2011 Compared to Fiscal 2010

Interest and Fee Income on Finance Receivables

Interest income on finance receivables, predominantly finance charge income, increased 11% to $62.7 million in fiscal 2011 from $56.4 million in fiscal 2010. The average finance receivables, net of unearned interest, totaled $251.0 million for the fiscal year ended March 31, 2011, an increase of 12% from $223.5 million for the fiscal year ended March 31, 2010. The primary reason average finance receivables, net of unearned interest increased was the increase in the receivable base of several existing branches and the development of new markets in Georgia, Indiana, Illinois and Missouri. The gross finance receivable balance increased 15% to $373.0 million at March 31, 2011 from $325.4 million at March 31, 2010. The primary reason interest income increased was the increase in the outstanding loan portfolio. The gross portfolio yield decreased to 24.99% for the fiscal year ended March 31, 2011 from 25.23% for the fiscal year ended March 31, 2010. The net portfolio yield increased to 20.92% for the fiscal year ended March 31, 2011 from 17.86% for the fiscal year ended March 31, 2010. The gross portfolio yield decreased due to a lower weighted APR on contracts purchased during fiscal year 2011. The net portfolio yield increased primarily due to the fiscal year over fiscal year decrease in provisions for credit losses.

Marketing, Salaries, Employee Benefits, Depreciation, and Administrative Expenses

Marketing, salaries, employee benefits, depreciation, and administrative expenses increased to $25.7 million for the fiscal year ended March 31, 2011 from $23.3 million for the fiscal year ended March 31, 2010. This increase of 10% was primarily attributable to additional staffing at existing branches. Marketing, salaries, employee benefits, depreciation, and administrative expenses as a percentage of average finance receivables, net of unearned interest, decreased to 10.15% for the fiscal year ended March 31, 2011 from 10.35% for the fiscal year ended March 31, 2010.

Interest Expense

Interest expense increased to $5.6 million for the fiscal year ended March 31,
2011 as compared to $5.2 million for the fiscal year ended March 31, 2010. The
following table summarizes the Company's average cost of borrowed funds for the
fiscal years ended March 31:



                                                             2011        2010
      Variable interest under the line of credit facility     0.53 %      0.41 %
      Settlements under interest rate swap agreements         0.70 %      2.32 %
      Credit spread under the line of credit facility         3.69 %      2.10 %

      Average cost of borrowed funds                          4.92 %      4.83 %

The primary reason that the Company's average cost of funds increased was an increase in pricing under its line of credit facility, mainly offset by the effects of the Company's interest rate swap agreements.

On January 12, 2010, the Company executed a new Line. Under the new Line, the Company's credit facility pricing changed from 162.5 basis points above 30-day LIBOR to 300 basis points above 30-day LIBOR, with a 1% floor on LIBOR. The average cost of borrowings in future periods will continue to be impacted by such pricing increases. For a further discussion regarding the Company's line of credit, see "- Liquidity and Capital Resources" below and note 5 ("Line of Credit") to our audited consolidated financial statements included elsewhere in this Report.

The weighted average notional amount of interest rate swaps was $23.3 million at a weighted average fixed rate of 3.80% during the fiscal year ended March 31, 2011 as compared to $67.8 million at 3.95% for the fiscal year ended March 31, 2010. For a further discussion regarding the effect of our interest rate swap agreements, see note 6 ("Interest Rate Swap Agreements") to our audited consolidated financial statements included elsewhere in this Report.

Analysis of Credit Losses

As of March 31, 2011, the Company had 1,147 active static pools. The average pool upon inception consisted of 63 Contracts with aggregate finance receivables, net of unearned interest, of approximately $610,000.

The following table sets forth a reconciliation of the changes in the allowance for credit losses on Contracts for the fiscal years ended March 31:

                                                2011               2010

         Balance at beginning of year       $  30,408,578      $  24,926,076
         Discounts acquired on new volume      12,919,492         11,087,231
. . .