One Main OMF
November 01, 2016 - 10:25am EST by
cfavenger
2016 2017
Price: 27.95 EPS 4.22 5.67
Shares Out. (in M): 135 P/E 6.6 4.9
Market Cap (in $M): 3,785 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0

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  • Financial

Description

OneMain Financial
 
Overview:
OneMain is the leading consumer finance company in the sub to near-prime space
$4B Subprime lending spinoff, delevered and derisked trading at 5-6x 2017e earnings
Asset quality is improving as OneMain shifts to secured lending
Regulatory vacuum as banks cannot service this segment in a capital-efficient manner
Competitors’ practices and multiple investigations by regulators have led to negative
perceptions around the entire installment & payday lending industry. However, OneMain has far
better regulatory compliance than competitors
 
Business:
Springleaf was sold to Fortress in August 2010, then merged with OneMain subsequent to the spinoff out of Citi in March 2015 
Fortress still holds 54.5% of the combined entity
OneMain originates personal loans that are fully amortizing, fixed rate, non-revolving, secured by titled personal property, consumer goods, or other personal belongings
OneMain currently holds a $13bn portfolio of direct, unsecured and hard secured
There is a $780m legacy real estate portfolio in runoff mode
Finally, OneMain cross-sells credit, life insurance, disability insurance, involuntary unemployment insurance and property and casualty insurance together with its loans
 
Investment Thesis:
 OneMain has a distinct competitive advantage in the near prime space against both banks and other payday / title lenders
o Loans have an average yield of 26%, lower than competitors Regional Management (RM) and World Acceptance Corp (WRLD) but clearly above bank lending rates
o Generally payday / title lenders will lend small amounts at 50%+ rates, to FICO borrowers <500 for short terms whereas banks will lend larger amounts of money to borrowers with >660 FICO at 10%-20% rates for longer terms.
o OneMain falls in the middle of these two segments lending at rates between 12%-36%, at FICO scores <700 for $10,000-$50,000 and up to 5 years
o Due to Basel III, banks cannot compete in this space. Under the A-IRB approach, a subprime loan with a 8% probability of default receives a risk-weight of 161%, or roughly $20 in equity for each $100 in subprime loans given current regulatory capital requirements north of 12%
o At the same time, new rules on usury lending by the CFPB are forcing other payday/title lenders to lower their rates and improve lending practices
 
 
 The federal Consumer Financial Protection Bureau (CFPB) unveiled proposed rules in June that take aim at short-term payday loans charging triple-digit annual percentage rates
 These rules would also cover installment loans with larger prepayment periods that charge rates higher than 36%
 With a hard cap on interest rates at 36% and an average yield of receivables of 25%, this puts OneMain in a favorable position from a regulatory standpoint
against competitors WRLD (60% yield on receivables) and RM (47% yield on receivables)
 In addition to this, OneMain hires former regulators from the CFPB to ensure best-in class regulatory compliance
 Over the past 9 months, OneMain has significantly de-risked and de-levered its balance sheet
o Leverage has rapidly come down from >12x in 2014 to around 6x today due to securitization issuance. This de-levering of the balance sheet seems to have gone largely
unrecognized by the market
 OneMain is now an established issuer in the securitization market, issuing at rates that are competitive with its peers
o Cost synergies of $275 should be readily achievable through branch closures post-merger
o OneMain’s focus has drifted towards secured lending, which now makes up more than 1/3rd of new originations, the ultimate target is about 50% secured, 50% unsecured lending
 The difference this makes can be seen in OneMain and Springleaf’s respective performance during the financial crisis
 Whereas OneMain (80% unsecured) had peak NCOs over 12%, Springleaf (50% secured) NCOs only reached around 8%
o As a result of the merger and shift towards secured lending, lower peak NCOs should also be expected at OneMain
 
Valuation
 
 Springleaf paid 9x 2017 expected post-synergy earnings for the acquisition. Today, investors can get the combined entity for 5-6x 2017 earnings
 Even in a recessionary scenario with peak NCOs of 9%, OneMain would make ~$2.8 in EPS. At around $30, we have the ability to buy the company at ~11x trough EPS
 The rough numbers are as follows:
o OneMain has $13bn of loans on its balance sheet, growing at about 10-15% p.a. as OneMain is filling a genuine need for near-prime financing as banks leave the space
o These loans yield 26% and are financed between at a 6% interest cost, leaving a NIM of ~20% or $2.6bn
o Insurance income is relatively stable around $140m
o Operating costs are also fixed around $1.35bn, but will come down by up to $275m due to branch closures
o With provisions at 7%, 10% growth, and giving OneMain some credit for implementing cost reductions, 2017 EPS would be $5.8. In a more recessionary environment with 9% provisions and no loan growth OneMain would still be able to make $2.8 in 2017 EPS
 The most important assumption is loan losses. The most likely outcome for 2017 is in our opinion somewhere in the middle: no hard recession 2017, but slowly rising provisions. With some lending growth and a moderate increase in loan loss provisions OneMain should do quite well
 Progress towards this thesis can be monitored by closely checking 60+ day delinquencies and total delinquent finance receivables in the 10-Q, as well as losses on OneMain’s outstanding securitizations. These have actually been falling as of 2Q16.
 
Risks
 Loan loss provisions greater than 9%
 A renewed shutdown of the securitization and/or debt markets: OneMain is heavily reliant on
both for financing
 Inconsistent/worsening underwriting standards post-merger
 Technical overhang due to Fortress selling shares
 Unforeseen regulatory action
 
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

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