“Americans know that they have a responsibility to live within their means and pay what they owe. But they also have a right to not get ripped off by the sudden rate hikes, unfair penalties, and hidden fees …” President Barack Obama (May 10, 2009)
While President Obama was referring specifically to usurious credit card practices, those are tame and civil compared to how World Acceptance does business. Citron believes in the New America, it is only time before either legislatures, the courts, or its own debt/receivables collapse the “shady” business of World Acceptance. This report clarifies the pivotal difference that makes World’s business model much more vulnerable than the payday lending industry.
In this report, Citron will first expose an accounting artifice used by World Acceptance and then will address the judicial risk the company and its shareholders bear. Citron still believes that the headwinds this company faces are too great, and will eventually force exposure of the farce that its book of receivables and business model really is.
Financials at WRLD are worse than they appear
Citron wishes to draw particular attention to World’s reliance upon the arcane “Rule of 78’s” in its revenue stream. To our knowledge, it is the only publicly traded company whose main revenue stream is derived directly from the rule of 78s. Simply put, the rule of 78’s allows the lender to frontload the bulk of the interest in the beginning of the loan payment schedule. And for customers of WRLD and investors who want to understand the income statement, it is a lesson in subterfuge, because WRLD’s loans so rarely go to maturity. http://www.bankrate.com/brm/news/auto/20010827a.asp
This method is well known to be grossly unfair to borrowers, however — so much so that it is illegal in at least 16 states, and illegal for longer term loans in many others.
Note these effects of the Rule of 78’s, both of which are central to WRLD’s business:
Note how the Rule of 78s works hand in glove to extort money from borrowers caught in serial loan flipping schemes exemplified by WRLD. These consumers are always paying the first and second month payments of a new amortization schedule – which have the highest front-loaded interest – compared to amortization schedules calculated actuarially. The company thereby continues to collect a higher effective interest rate than it discloses to its borrowers.
But much of this money is not real; it just accumulates as a near half-billion receivable of dubious collectability on its books.
WRLD’s $460.4 million net loan book is the least collectible, lowest quality asset of any public company we know. It is our opinion that the book is worth not even 10 cents on the dollar if put into runoff, while new legislative initiatives and judicial challenges bring that risk much closer to reality.
When a borrower fails to make scheduled loan payments to a normal bank, the bank is required by regulations to categorize the loan as impaired. With World, it just gets flipped to a new loan with a higher principal. According to the company’s own disclosures, the average loan has been flipped 4 to 5 times. Presumptively, the main reason for flipping a loan is the borrower couldn’t pay it off.
Consider as an example a recent lawsuit in Texas by Mrs. Subrina Parker. This case was brought after fell behind on her payments and was harassed by WRLD employees. She was paying $50 a month on a $250 loan, on terms which the suit alleges violate the Texas Finance Code. After WRLD called her co- workers, supervisor, and children, the she filed suit. The suit eventually went to arbitration; it is the company’s main defense tactic.
A landmark ruling just issued by the New Mexico Supreme Court this month, however, held that World’s arbitration clause, which is a part of every single one of its loan documents, is unenforceable due to being “unconscionable” (so one-sidedly unfair that it isn’t a legal agreement). This opens the door to a borrower’s suit challenging World’s business practices being granted class action status in the courts.
When the first of these cases is in fact granted class action status, very important consequences begin to fall on World. For one, every current and recent borrower in the state receives official notice that a legal challenge is in progress, which will itself impair their collections. Second, class action status provides substantial economic incentive which levels the legal playing field. A loss in such a case could impair World’s operations in at least the state where it is located, and potentially expose it to a large adverse judgment.
In addition to the suits mentioned above, a newly filed Illinois suit (Dean vs World Finance) alleges that all of World’s loans violate the Federal Truth in Lending law as well as Illinois consumer lending laws. Because of the recent New Mexico ruling, there is greatly increased risk that this suit will be litigated as a Federal class action case.
“From time to time the Company is involved in routine litigation relating to claims arising out of its operations in the normal course of business. The Company believes that it is not presently a party to any such pending legal proceedings that would have a material adverse effect on its financial condition.”
In light of the claims in the abovementioned lawsuits, Citron believes this language is so inadequate it is a joke, except as an invitation to a future shareholder class action suit against management.
Imagine you had a maxed out credit card with Capital One. You notify them that you cannot not pay your minimum – and the next thing you know, they increase your limit, give you a cash advance on your new credit to make your minimum payment, and charge you a fat fee to extend your credit, taking up most of the new higher credit line. Is this even remotely sustainable business practice in the current economic climate? Is this a book of receivables that you want to own?
They’re not exceptions, they’re representative examples. Citron is confident that real court tests of these practices will be ominous for World as the get shut out of the loophole of arbitration.
World Acceptance vs. Payday Lenders – Apples and Oranges
After reading part I, some of Citron’s readers confused WRLD with a payday lender. The business models are starkly different. When you compare financials, you will understand that World Acceptance makes any payday lender look like Goldman Sachs. For this we take as an example the largest publicly traded payday lender : Advance America, and also EZ Corp, the largest pawnbroker.
(largest publicly traded payday lender)
EZ Corp (largest publicly traded pawn shop operator
(largest publicly traded installment lender)
Offices / locations
Revenues last quarter
Over $450 million
Citron believes that a half-billion dollar book of unsecured loans, flipped multiple times, has a huge undisclosed risk of collection. This asset just doesn’t pass the reasonable man test. While a payday loan is essentially secured by a known upcoming payroll check expected within the next two weeks, WRLD’s loans are for terms stretching months, and are secured by nothing
Right out of the Guilty Playbook
Just yesterday, WRLD filed an 8-K, announcing their plan to increase a current $10 million stock buyback plan (which is currently unexecuted) to $15 million stock buyback — all of this with only $6.2 million in the bank. (Maybe they can get an installment loan…). Why a stock buyback now? Is it because Citron has exposed the company for what it is and this is a way to respond? The stock is still currently trading above its 50 day moving average. What is the urgency to burn its scant cash to buy its own stock? This reminds us of the last two companies over the past two years who have tried the same tactic in response to skeptical questions raised by Citron.
Bidz.com – Citron Report- Company announced stock buyback- SEC Investigation, Stock 80% lower
World Acceptance- Citron Report- Stock Buyback – …… ???????
As a business model, WRLD has been the master of loopholes. Loan flipping, tacked-on renewal fees, single-premium “credit insurance” plus Rule of 78-calculated interest, all exist only because of loopholes in states’ various usury laws, and specifically the 11 states that haven’t closed them. The financial effect of this crazy business is unsustainable revenues flowing to current income, while the toxic impairments are swept into the loan portfolio, where the company can shield the hidden risk to investors ….. for a while.
In Part 3, Citron will explore how likely government reform of consumer lending could soon restrict or totally halt the company from indulging in these predatory lending practices. If WRLD’s operations in even a single state are shut down, it will be forced to put that state’s portfolio into runoff, exposing its uncollectability. That is why Citron believes the potential risk of drastically interrupted operations has to be priced into WRLD’s stock.