Bad News for World Acceptance Corp.: The State-by-State Loophole Business is Now Going Out of Business

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In May, Citron research introduced readers to the curious case of World Acceptance Corp.  (NASADAQ:WRLD) a sub-prime lender doing business in approximately 900 locations mostly located in the South.  Citron has been quiet as of late because 1.  markets have turned indiscriminately positive 2. We were waiting to assess the prospects for regulation of sub-prime lenders.

Neither a bank nor a payday lender, World has built its entire business on loopholes — and therefore its operating region is limited to just 11 states where its been able to curry the favor of state legislatures to open the loopholes in state usury laws so it can make sub-sub-sub-prime loans at super-high rates.  Any form of federal law, which has never existed, would supercede the many loopholes enabling WRLD to operate in their niche states.

We’re sure World’s shareholders have been sitting on the edge of their seats as lobbying organizations such as World’s own NILA (www.nilaonline.org) , along with an army of banking industry lobbyists, are toiling night and day in DC seeking ways to torpedo the proposed Consumer Financial Protection Agency (CFPA).  And with good reason:  uniform Federal regulation by the CFPA would threaten World’s entire business model.  Refer to last week’s statement from the CFPA’s architect, Elizabeth Warren, the chair of the Congressional Oversight Panel overseeing the US banking bailout. http://www.newdeal20.org/?p=4454

“But there is an even bigger change in the wind: regulating the non-banks. Democrats and Republicans alike agree that the proliferation of unregulated, non-bank lenders contributed significantly to the financial crisis by feeding millions of dangerous financial products into the economic system. Non-bank institutions were active participants in the race to the bottom among lenders.

From sub-prime mortgage loans to small dollar loans, they showed how to wring high fees and staggering interest rates out of consumer lending. Their fine-print contracts, and new tricks and traps, transformed the market.”

A Turn of Events

Before today, the question was “Will there or won’t there be a CFPA? ”

Enter the Fed.  As of today, the only remaining question is not whether World will come under uniform Federal regulation, but only the inevitable:  how soon, and by whom?

http://www.washingtonpost.com/wp-dyn/content/article/2009/09/15/AR2009091503311.html?hpid=sec-business

Lenders that are neither banks nor owned by holding companies remain beyond the reach of federal oversight. The Obama administration has proposed a single oversight framework for all lenders as part of its financial reform package.

Everyone now realizes the need for uniform Federal regulation of consumer lending, and it has become inevitable.  The Fed, which has resisted the new CFPA initiative because of the potential overlap of its jurisdiction, doesn’t need new legislation to fire up its own operations — it’s given notice that it’s the new sheriff in town, effective today.  That step aligns all the parties — Congress, the Obama Administration and the Fed — in their intent : to protect the sub-prime consumer from predatory lending practices.

Citron notes that while a federal interest rate cap would put World completely out of business, it doesn’t expect this outcome in the near term.  And it won’t take a fixed interest rate cap to seriously impair World’s business.  A more likely outcome is prohibition of the most abusive practices of “flipping” and “packing” — which is more than enough to devastate World’s cash flow and viability.

So the question for World becomes:  who’s jurisdiction do you want, the Fed or the CFPA?  Either way, expect a set of regulations that eliminate the egregious differences between how states treat “cycle-of-debt” lending practices.  Citron believes that with its narrow business model (its entire business is one product:  a portfolio of low-dollar, paper-based, high-interest, frequently flipped consumer installment loans) it is now the single most vulnerable financial company in America to regulation which could derail its entire business, regardless of whether a CFPA is ever voted into law as a standalone agency…..but that is not where the story ends.

Something in the Books Smells Real Funky

As consumer credit has hit a 26 year low WRLD’s receivables book might lie in the graveyard with other non-collateralized sub-prime lenders.  Interest rates for World’s customers, who typically are not credit-worthy enough to qualify for conventional bank loans or might not even have a bank account, start at over 80% APR. However, by actively marketing the nefarious practice of “flipping”, (eg re-writing existing loans every time the customer is at risk of missing a payment), and “packing” (selling “credit insurance” of dubious value bundled as an extra fee with the loan) World jacks its effective yield — the take on its portfolio of loans outstanding — to over 100%, as reported in filings.

World claims it has sailed through the hurricane of the current financial crisis without even getting wet.  Its loan losses, a figure the company can pretty much set to whatever it wants in the short term, have barely moved from pre-crisis levels. On the last conference call, analyst after analyst inquired how this could be. Management’s answer was essentially that “Our customers are unique. They are more affected by the price of gas than credit distress, because essentially our customer is always economically distressed.”

It is the opinion of Citron Research that World’s story is reaching the breaking point. As detailed in the linked story below, credit quality is still in serious decline, and the states most impacted are World’s breadbasket. In fact World’s operations are so concentrated in this region, that four of the five most distressed states represent 45% of their US locations.

http://moneyfeatures.blogs.money.cnn.com/2009/07/15/consumer-credit-crisis-no-sign-of-decline/

Unemployment, which sits at record levels, is hitting financially marginal consumers hardest.  While the rate of job losses has begun to slow, unemployment is still rising, and job creation – the real relief — has not even begun to surface. With unemployment closely correlated to credit distress, somehow investors are asked to believe World’s bottom-tier credit customers are immune to unemployment and underemployment, as well as gas prices that have doubled off their lows.

On their last conference call, World was asked repeatedly by analysts how in the face of these adverse conditions, it justifies lowered loan loss reserves. When asked about the increase in loans, and obviously reluctant to discuss its reliance on loan -flipping, management cited less competition from HFC and CitiFinance.

Citron has observed a pattern that small companies under scrutiny of short-sellers find “creative” and “unique” ways to make their numbers….temporarily.  In the case of World, we’re getting into the realm of the ridiculous.

We know that HFC exited the bottom-end consumer finance business in March of 2009 after confessing to a book of mounting losses, and CitiFinance put its book of bottom-end consumer finance business in its “bad bank”.  Yet World asks investors to believe its nearly $500 million book of uncollateralized and unsecured loans, at rates double to triple Citi’s or HFC’s, remains fully collectable.

Remember, World isn’t a bank – it won’t be receiving any government financial support – and investors won’t be receiving any warning notices from regulators about its financial vulnerabilities either.

It is the opinion of Citron Research that by serially flipping and re-writing loans 45 days delinquent, (a “service” which World discloses it “actively markets to its customers”) the company masks the true low quality of its receivables. Further, by its own admission, it also rewrote over $40 million in loans from its own “delinquent” status (beyond 45 days overdue).

Even states that aren’t actively rewriting laws to curb the abusive practices of WRLD and other installment lenders are actively establishing alternatives to extend credit to WRLD’s type of customer. (Note that World has more than twice as many locations in Texas than any other state.)

http://cityhallblog.dallasnews.com/archives/2009/08/bank-on-dallas-plan-would-targ.html

World Acceptance’s Dirty Little Secret.   We expect nothing less….

On the conference call, management stated, “if you look at individual branches, you see a wide disparity between the best and the worst”. Now Citron offers an explanation.  WRLD operates in the gray area of “non-payday” lending to the US military.  Just two years ago, the 2007 Military Authorization Act made it illegal to issue payday loans, car title loans, and tax refund anticipation loans with rates exceeding 36% to members of the US military or their families.

http://www.usmilitary.com/1502/military-financial-protection/

It is obvious that WRLD has sidestepped the spirit of the law by marketing and transacting installment loans at 80% + APR to military personnel (terms over 91 days get around the law) .

Here’s the face of World’s military lending in Killeen Texas:

http://maps.google.com/maps?f=q&source=s_q&hl=en&geocode=&q=World+Finance,&sll=31.128502,-97.735587&sspn=0.033393,0.035577&ie=UTF8&radius=1.05&rq=1&ll=31.121109,-97.727551&spn=0.015063,0.035577&z=15&layer=c&cbll=31.121097,-97.727553&panoid=-o-r4QTqd3R2N9defPavLg&cbp=11,102.66,,1,-6.38

Here is another one — one of their offices in Fort Campbell, Tenn.

http://maps.google.com/maps?f=q&source=s_q&hl=en&geocode=&q=World+Finance,&sll=36.602161,-87.425508&sspn=0.050645,0.076561&ie=UTF8&radius=2.13&rq=1&layer=c&cbll=36.601904,-87.423191&panoid=2PcUodzGhf6R9DxkLpkEug&ll=36.601886,-87.423191&spn=0.025288,0.097075&z=14&cbp=11,224.75,,1,5

Consider the little town of Killeen Texas, home to Fort Hood, one of the largest Army bases in the US. WRLD has four offices located either within or bordering that small town.  Citron has confirmed the terms of these loans to our soldiers in Killeen.  If a soldier borrows only $675, he/she ends up paying an APR of over 100% and that is only on the unlikely chance that the borrower pays the loan off at maturity … rates will be higher if the loan is flipped, like nearly all of WRLD’s loans are (an average of 3 times each).

According to article 70 of the Warner Act, the military law applies to both service members and their dependents. It stipulates that the APR of a covered extension of credit cannot exceed 36% APR, and it mandates disclosures and terms mirroring the Truth in Lending Act. It also includes a provision against any state or federal preemption, unless those laws provide even greater protections.

Other provisions include the following prohibitions: (All of which WRLD participates in)

  • Lenders may not roll over, renew, refinance or consolidate credit unless the new transaction results in more favorable terms to the borrower.
  • Borrowers cannot be required or allowed to waive the right to legal recourse.
  • In the case of dispute, lenders cannot require the borrower to submit to arbitration or impose onerous legal notice provisions.

http://www.frbatlanta.org/invoke.cfm?objectid=193EF0A5-5056-9F12-12C85D0D96F1D4DF&method=display_body

World finds military lending profitable because they can easily get their collection hooks into a soldier’s pay – by putting the loan on “allotment” (the military’s direct deposit system), or calling the soldier’s chain of command — a commonly used collection tactic.

It is Citron’s opinion that WRLD has intentionally grown its business of usury-rate lending to members of the US military. As soon as this loophole is closed, so go those “best offices”.  

Conclusion

Citron still believes that WRLD has got one foot on a banana peel and the other in the corporate graveyard, in which are buried every other sub-prime lender that thought they were one step ahead of the market.  We believe that management is facing too many potential landmines, including a new regulatory scheme intent on leveling the consumer debt field across all states.  If just one of those landmines blows, the true liabilities of its inflated portfolio of unsecured, uncollateralized receivables will be exposed.

World’s business window is narrowing in both time and geography.  While it waits for Federal regulation, it can’t meaningfully expand its eleven-state operations to any new states if it loses one or two.  It offers only one type of transaction — a paper-based installment loan — and has no presence in any form of electronic commerce, no debit cards, no ATM’s, etc.  As a source of growth, its Mexico initiative is obviously failing to generate profits or growth.  Citron believes its military lending business is at heightened risk of being shut down at any time, regardless of the Fed or CFPA.

As economic distress falls disproportionately on those at the bottom of the economic pyramid, Citron Research believes an increasing percentage of the loans on World’s books are in fact delinquent and noncollectable, masked by a corporate policy of serially flipping them whenever the borrower can’t pay.  Adding the inevitable federal regulation to close state-by-state loopholes, Citron concludes World’s options are dimming, and its entire business model is at severe risk.