When it comes to finance companies, Springleaf (LEAF) tiptoed into a space largely abandoned for decades — the personal line of credit.
Not to be confused with payday and installment loans, which average $400, mature in two weeks and cost anywhere from $15 to $30 per every hundred borrowed, Springleaf’s model loans are non-revolving, with a fixed rate and term of two to five years.
Installment loans typically range from $800 to $2500 for a period of several months, at a 100% to 200% annual percentage rate.
Springleaf’s return to personal credit is proven very profitable. As of the six months ended June 30, LEAF has about 950,000 such loans, representing $3.8 billion of net finance receivables. Half of that is secured by collateral consisting of “titled personal property,” while 35% of it is secured by consumer household goods. The remaining 15% is unsecured.
Many of these personal lines of credit vanished when the companies offering them were absorbed by the big four banks, which created the imbalance in supply and demand that Springleaf now fills. LEAF has originated $12.9 billion in personal loans since 2010, and is back up to 828 branches.
The Method Behind Springleaf’s Success
The reason Springleaf is successful, however, is because it isn’t just the subprime consumer that Springleaf serves. According to the LEAF March investor presentation, 38% of LEAF loans go to those with FICO scores of 750 or higher. Another 16% are above 700. The average patron is 47 years old, 56% own a home, have average household income of $47,000 and 95% have a checking account.
With more than half its loans to FICO scorers of 700 and higher and half secured by autos, the company has a great mix that keeps default low.
The result is a stable net charge-off ratio for LEAF, which was 5.07% in the most recent quarter, with 60-day-plus delinquencies stable at 3.75%. The consequence of this underwriting for LEAF is a risk-adjusted yield on the entire portfolio ranging between 20.5% to 21.5%. That the company is able to get its own funds at 5.35% on average shows it has a great spread to take advantage of.
That spread led to $378 million in net pretax earnings for fiscal year 2014, up 20% from FY13. After taxes, core earnings (not including the mortgage runoff) was $238 million, also up 20% YOY.
Through the first half of FY15, the numbers just kept improving for LEAF stock. Pretax core earnings were $208 million, up from $174 million during the same period a year ago, or a 20% increase. This came on an increase in origination volume to $2.06 billion from $1.67 billion, or 26%.
Risk-adjusted yield was 21.92%. Pretax income was up 27%. Auto loans now account for 15% of the portfolio, and originations rose 33% quarter to quarter. The company expects net charge-offs of 5% to 5.5% for the year.
The best part of the model is that, because Springleaf’s loans are below 36% APR, which is this magic arbitrary level that the Consumer Financial Protection Bureau finds acceptable, it is insulated from likely regulatory obstacles. Everyone else is getting nailed.
The only newcomer in this space is Enova International (ENVA), which is migrating away from payday and installment into this space. The good news is that there is plenty of room for everyone.
What we see now is the stock trades at 20 times its core pretax earnings, based on a 2015 run-rate of about $400 million. That’s right on target with the 20% growth rate. But when you consider the additional income from the mortgage runoff, it is arguably slightly undervalued.
What makes it a long-term hold is that it is servicing a huge market that is under-served, with a high barrier to entry and earning great spreads with little regulatory risk.
I think it’s a buy.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
