World Acceptance Corporation (NASDAQ:WRLD) is dust. Or at least, it’s going to be. The Consumer Financial Protection Bureau is going to kill WRLD as it did payday lending … just with a different process.
The CFPB made no secret that it hates consumer finance. With payday lenders, it just collected data, crunched numbers, decided that consumers were harmed without proving its case, and issued rules that kill the industry. Nice and clean.
World Acceptance was served with a Civil Investigative Demand early in 2014, which is basically an order to provide the CFPB with everything they ask for. Then WRLD disclosed that it was still cooperating with the ongoing investigation earlier this year.
And the CFPB isn’t going away any time soon.
Why World Acceptance Is in the CFPB’s Crosshairs
World Acceptance offers installment loans. Payday loans average $400 and are for two weeks, paid in full with fees on the borrower’s paycheck date. WRLD loans are for more than $1,300 and run an average of 13 months, paid in monthly installments. However, the interest is charged in a totally legal way called the “Rule of 78.”
Let’s say the loan runs 13 months. The consumer pays 13/78ths of the total interest with their first installment payments, then 12/78ths on the next, and so on. Principal is evenly split across the 13 months.
Were this the entire plan, then WRLD would collect about 100% APR on those loans. That’s a tidy sum, but for more than 50 years, World Acceptance has instead encouraged borrowers to refinance the loan after just a couple of payments. As the 10-K states, fully 71.5% of all its revenue is generated by these rollovers.
So each time, the customer pays off about 15% to 20% of their principal, while paying about 32% of the total interest due over what would have been the entire 13 months. By front-loading the interest, they gobble up those huge fees, then do it all over again.
You think the CFPB is going to take kindly to that? Heck, all the bureau has ever done was call payday loans a debt trap. What do you think they’ll call this?
They’ll force World Acceptance to change this model because they can just call it an “abusive practice” and there’s no rebuttal permitted. At best, they’ll only allow refinances after six months (similar to the payday loan rules), which means consumers will default in greater numbers if WRLD keeps making large loans. It will have to make smaller loans, and collect far less revenue.
Oh, and since 20% of World Acceptance’s business is auto-title loans, which the CFPB is trying to limit to 36% APR, that part of the business will be killed.
But we aren’t done yet!
Ever heard of credit insurance? If you lose your job, health or life, the insurance will cover your payments. This makes sense if you need to cover a mortgage or car loan.
However, for payday and installment loans, it is literally useless. That’s because the downside to defaulting on these loans is that the debt gets sold off and you are sent to a collection agency. That’s it. There’s no effect on your credit report, and thus no need for insurance.
Yet, World Acceptance has been printing money by selling credit insurance on their loans, and getting consumers to finance that cost. It collects a whopping 65% commission on the premiums, because the insurance company obviously knows that few people are going to make any claims.
Not only that, but the insurance company pays WRLD to re-insure the claims, so that WRLD picks up the cost of any claim payments … which is what it would do anyway in the case of a default!
WRLD thus sells a useless product, collects commissions from it, collects interest payments on it, and collects the reinsurance fee on it.
Considering the CFPB collected more than $400 million in fines and restitution (mostly the latter) against Discover Financial Services (CFS), Capital One (COF) and American Express (AXP) for deceptive marketing of credit insurance, I wonder what they’ll do to WRLD?
I’ll tell you.
World Acceptance Is Headed Down
I believe the CFPB will put World Acceptance’s business model of refinancings and bogus credit insurance to death, and the company will have to liquidate.
WRLD has $1.11 billion in gross receivables. According to ProPublica, 30% of World Acceptance’s loans are delinquent at any one time. After charging those off, it will be left with $778 million.
In last week’s 8-K, WRLD’s credit facility was cut, with this nasty clause: “Certain material governmental or regulatory injunctions, judgments, rulings or orders will, if not discharged, bonded or otherwise stayed within 60 days, result in an event of default under the Revolving Credit Agreement” This, along with a prohibition on repurchasing stock — which was how WRLD was able to support its price — is why the stock cratered last week.
World Acceptance will have to repay its $575 million in debt, leaving it with $212 million. It has $38 million in cash, but owes $50 million in taxes and A/P’s, so it finishes with roughly $200 million. (Which, by the way, is about $22 per share. WRLD currently trades at $62.)
Now come the fines and restitution.
Figure $5 million in fines, which is what the CFPB nailed two payday lenders with last year.
I think the CFPB will kill WRLD on restitution. It made COF and DFS pay hundreds of millions, so why not WRLD?
With about just $195 million left, I think the CFPB will confiscate it all.
Bottom Line
One last thing: I think management sees the writing on the wall. Kelly Malson, the chief financial officer, retired in September 2013. Then-President and COO Mark Roland stepped down in November of that year. In September 2014, World’s 8-K showed that auditor KPMG walked away. World was about to place $250 million in debt in May of this year, but had to pull the offering a week later.
And just 17 days later, CEO Sandy McClean announced his retirement.
WRLD is toast.
If what you want is to invest in consumer finance, then it’s a no-brainer. Go with the stocks that do it legally, in a heavily regulated sector called “credit cards.” That means Visa (V) and MasterCard (MA).
Leave World Acceptance to the sharks.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he was short on WRLD and also held puts on WRLD. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
