The Consumer Financial Protection Bureau is in very real danger of being dismantled by President-elect Donald Trump and Congress within the first 100 days of his presidency. As it is, a federal court found its structure unconstitutional. The CFPB is challenging the ruling, but if it stands, director Richard Cordray is likely to be bounced, at a minimum.
But before either he or his bureau is executed, you can bet he will add one last crowning achievement to his legacy: the wholesale destruction of an installment lender.
Getting to Know World Acceptance Corp. (WRLD)
World Acceptance Corp. (NASDAQ:WRLD) has been under investigation by the CFPB since March 2014, and on Aug. 7, 2015, it received a “NORA Letter” that indicates the CFPB intends to take legal action against the company.
Based on my extensive knowledge of World Acceptance Corp., I believe there are two main areas the CFPB is going to address, and they are cornerstones of WRLD and how it operates.
World Acceptance Corp. is an installment lender. Its average loan is $1,190 for 13 months with an average interest rate of 100% APR. However, it uses an obscure rule to calculate interest, called the “Rule of 78.” It charges 12/78ths of the interest due in the first month, 11/78ths the second month, and so on.
I believe the CFPB hates that 69.4% of World Acceptance Corp. loans are generated through refinancings of previous loans, for the same reason it hates the “debt treadmill” of payday loans. Because of the interest rate structure, WRLD is incentivized to refinance these loans early, because it collects more than 40% of total interest due in just the first three months of a loan.
Get a consumer to refinance early, roll them into a new loan, then start collecting heavily front-loaded interest on the refinanced loan.
Just as the CFPB issued rules designed to kill payday lending, which includes severe restrictions on rollovers, I believe the CFPB will issue similar rules designed to prevent World Acceptance Corp. from engaging in refinancing of any loans unless WRLD adheres to similar impossible-to-meet standards.
The other revenue scheme for World Acceptance Corp. has been to entice consumers into purchasing credit insurance for their loans, which is also financed. I direct you to Citron Research’s excellent analysis of the insurance product. The CFPB hates credit insurance, and the Citron report is accurate — the CFPB hit Capital One Financial Corp. (NYSE:COF) and Discover Financial Services (NYSE:DFS) with nine-figure fines for add-on products like credit insurance.
These two areas make up all of WRLD stock revenues, and I believe the CFPB will attack both of them in the very near future.
What Does This Mean for WRLD?
What might punitive action look like? I think it will be bad enough to force WRLD stock into liquidation.
I think the CFPB will kill the refinancing model that is the cornerstone of the company’s entire business. With that gone, insurance revenue goes away, too.
Yes, I really do think Cordray will do this. World Acceptance has received tremendous amounts of bad press, and what greater political swan song could the CFPB have than wiping out a bad player?
Here’s the liquidation scenario:
The balance sheet shows net loan receivables of $714 million. Throw out all the other assets as being effectively worthless. Subtract $360.6 million in senior notes payable, and $28.9 million in accounts payable (and ignore the $10 million in income taxes since there’s a deferred tax asset of $41.9 million). That leaves a net of $324.6 million.
Kiss the cash balance of $16.25 million goodbye. That will get lost to a fine, as the CFPB has traditionally hit payday and title lenders with fines of $10 to $15 million.
The best-case scenario, based on 8.8 million shares outstanding, is liquidation value of WRLD stock of $36.88. Tuesday’s closing price was $66.33.
However, if the CFPB decides to hit World Acceptance with an even larger fine, then that value falls by a dollar per share for every $8.8 million in additional fine levied.
If you think I’m wrong, then ask yourself why management and auditors have been jumping ship and why financing couldn’t be closed.
CFO Kelly Malson scooted out in September 2013. COO/President Mark Roland bailed in November 2013. September 2014 saw KMPG (the auditor) blow town. In May 2015, WRLD was unable to complete a bond offering. That convinced CEO A. Alexander (Sandy) McClean to suddenly announce his retirement.
In full disclosure, I’m short WRLD stock and holding puts. But that’s because I think it’s a no-brainer.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he is short WRLD and holds puts. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.