Source: OneMain.com
OneMain (OMF -1.80%) is a US non-bank consumer finance company. It has over 18 hundred branches and around 2.2 million borrowers who collectively owe around $13.5 billion. Policies and procedures are managed centrally, although the local branch managers do have some discretionary authority. These are high interest loans. The interest rate (Annual Percentage Rate, or APR) averages 27% for the personal loans – and 20% for the auto loans. OneMain also makes money selling insurance (like credit life or credit disability) to its customers. OneMain today is the result of a merger which closed November 1, 2015 of Springleaf and what was then the personal loan part of Citigroup which was then operating under the OneMain name. These loans are installment loans. The borrower gets a check, and signs an agreement to make 36 to 60 monthly payments, to pay off the loan. Sometimes the loan is made at a third-party business, like a used car dealer, or a furniture store. If a borrower makes half a dozen or so payments in a row, the branch staff contact him and suggest that he or she can stop by and pick up a check to top his loan off again (minus another origination fee). If the borrower has some temporary financial setback (maybe losing a few days of pay due to an illness) the branch staff can change the payment date, or lend more money to capitalize a month or two of interest (plus a fee).
These loans behave a lot like sub-prime revolving credit card debt. After the initial loan, the balance goes down slowly for a few months, spikes upward again, and that process is repeated for a long time. A loan can be profitable from the interest and fees, even if is eventually written off.
Amazing profit – as a percentage of assets
These loans are more profitable than almost any other type of loans that financial institutions make. On a typical dollar of loans, the company receives 28 cents per year for interest, fees, and insurance premiums. Deduct 7 cents for charge offs, and 10 cents for operating costs, that leaves an operating profit (which they call unlevered Return On Receivables) of around 11% of assets. About half of that goes to bond holders as interest, and the other half is pre-tax profit. A pre-tax profit of 5% of assets is almost unheard of in the banking industry.
Integration pains from the merger are over
The management team from the legacy Springleaf side of the business decided to buy OneMain because they saw a huge opportunity to increase profits by introducing some of Springleaf’s business practices into the huge legacy OneMain branch network. Specifically, management plans to:
- Increase the proportion of loans which are secured by collateral. This could mean a loan someone takes out to buy a car, but it often means a personal loan, where the borrower gives the company title to a car as collateral. It is often not worth their while to repossess the car (they would usually prefer that the guy use the car to get to work, and maybe someday send in some money), but the borrowers are significantly less likely to miss a payment, knowing that the bill collector who will call to ask about it will have the title to his car on his desk during the call. During the year since the merger, the proportion of the loans being issued from legacy OneMain branches with collateral has increased from 13% to 36%.
- Increase loans made through merchant referrals and car dealer direct loans.
- Reducing costs by closing some redundant branches, and spreading the costs of the centralized functions over a much larger business.
The problem has been that this strategy has been expensive in the short term, and the merger has caused big swings in their accounting results. Some of the legacy OneMain staff has been working on integrating the branch operations into the legacy Springleaf centralized operations. That has distracted them from their regular work, resulting in both higher levels of delinquencies and less aggressive origination of new loans. These are short term issues. Management recognizes the issues and is planning to send more support and more training as they continue the branch integration. The first 100 branches to be integrated (October) caused a huge distraction. The next 500 (in January) were much smoother, because of what management learned from the first 100, and they finished the branches in early February.
The company is performing very well
OMF will have much more stable earnings going forward. The big loss in the quarter ending 12/31/2015 was when the merger closed, management immediately lowered the value of the loans. The management essentially decided to increase the expected losses on the loans, as an accounting change. Expected losses are an expense, and that large one-time expense accounts for their bad quarter. The following quarter (the first quarter of 2016) OMF had a large gain because 127 branches with around $600 million of loans were sold (which the US government required to avoid anti-trust issues). Since then, the company has turned in 3 solid quarters of about 20 cents per quarter of earnings per share.
Management has much higher non-GAAP numbers. I generally don’t like to use non-GAAP metrics, because any company can make up some metric that looks good. In this case, the differences are related to accounting for the merger. The existing loans were purchased for more than face value, so the company has a non-cash charge for the premium. To explain with a simple example. If you buy a $100 loan for $103, and the loan is paid off sometime later, your profit is the interest (and fees, etc) which you collect, minus the $3 (since you paid $103 but the borrower only pays back $100 Management’s justification is that for evaluating the efficiency of the company, whether OMF bought the loan for $103 or originated it makes no difference.
