Thinking Big About Small Companies

NICK Part 9: Future Growth Opportunities, the CFPB

September 10th, 2015 | Posted by Torin in NICK

NICK has a couple of growth opportunities it can try to exploit in the coming years.

Most broadly, the subprime market itself is growing faster than GDP. Primarily this is due to the cyclical rebound in auto purchases, auto prices, and increased use of debt (across the credit spectrum) to make those purchases.


To the extent that this growth trend continues, NICK will have an opportunity to participate. However, given that NICK is currently posting growth rates below the subprime figures in the table above, it would seem that the effect of aggressive competition is currently stronger than the effect of industry-wide volume growth.

More promisingly, Nicholas recently began expanding into the state of Texas. It is difficult to find data for subprime loan issuance by state, but based on new car sales as reported here (see page 5), the Texas auto market is the second-largest in the country (behind California), and is 20-30% larger than Florida. Currently NICK generates one third of its business from Florida customers, and zilch from Texas customers.

That will change, as NICK has recently begun expanding into Texas. The company has been contemplating a move to Texas for some time, and recently it had the perfect opportunity to do so when the family of one of its high-performing branch managers relocated to Texas. Nicholas decided to open a new branch in Texas and let this person manage that branch, which will serve as a beachhead. I believe more openings are soon to follow.

I don’t know the exact size of the Texas opportunity, but obviously it is significant. NICK currently has more than 20 branches (out of 66 total) in its home state of Florida, which as I said is a smaller market than Texas. Meanwhile, NICK has opened about three branches per year on average. NICK may never achieve the market penetration in Texas that it has in Florida, but if it can even come close, then Texas alone should be able to drive NICK’s growth for many years to come.


Where to begin?

The Consumer Financial Protection Bureau, or CFPB, was created in 2010 as part of the Dodd-Frank act. The CFPB was to be responsible for regulating lending and other financial practices by banks, brokerages, payday lenders, debt collectors, credit unions, and other financial companies.

Auto dealers were originally included under the CFPB’s purview, but auto dealer trade groups pushed for—and won—a bill amendment exempting auto dealers from CFPB regulation. However, the CFPB does not seem to like this exemption, and has been attempting to regulate the dealers via the lenders.

(Usually, increasing regulation is good for an industry’s larger players, because they are the companies that can best afford increasing compliance costs, whereas the smaller participants may not be able to. However, only the 34 largest auto lenders can be regulated by the CFPB. NICK falls into this group—so it now answers to the CFPB. So in this particular case, the smaller participants actually benefit from increasing regulation, since they do not have to bear the costs, while their larger competitors do.)

One of the CFPB’s foremost regulatory goals is fairness in lending. In particular, a common practice in the auto industry is for a lender to approve a loan at a given APR (known as the “buy rate”), and then permit the dealer to charge the customer a higher rate, with the lender and dealer sharing the excess interest income. This practice is known in the industry as “rate participation”.

The CFPB has found that minority customers tend to be charged interest rates that are further above the buy rate than are the rates charged to white customers. The CFPB views this as discriminatory lending, and wants to stop the practice. However, since the CFPB cannot directly regulate the auto dealers—who are the actual actors selecting the final interest rates on loans—it has chosen to regulate them indirectly by penalizing the lenders.

The waters get muddy at this point, because lenders are legally prohibited from collecting information about race from potential borrowers. The lenders argue that they cannot be making discriminatory loans because they are not even in possession of knowledge of the borrower’s race. However, under the disparate impact legal doctrine, which the CFPB has embraced, intention and knowledge—or lacks thereof—are irrelevant. If the interest rates are found to be discriminatory, the lender is culpable. Period.

Nicholas Financial does not offer “rate participation” programs to its dealers. However Nicholas’ portfolio of loans, if studied by regulators, is still likely to classify as discriminatory under the letter of the law. I believe this would be true for almost every dealer in the United States.

So the CFPB has begun fining lenders, including Ally, Honda, Toyota, and Nissan. The fines have been large on dollar basis but not a per-customer basis. In general, the total fine and redress have equaled a few hundred dollars per affected customer. Determining the percentage of borrowers affected is the harder part. In the above cases, the numbers of affected customers are just a fraction of the overall borrowers in the portfolio. So it’s hard to say exactly what level fine NICK could be looking at, but my personal estimate would be a few hundred thousand dollars on the low end to a very few million on the high end.

However, CFPB regulations do not end with interest rates. The Bureau has also fined lenders for other malfeasance. The CFPB fined a dealer chain called Drivetime Financial $8M as a civil penalty for unlawful collection and credit reporting practices. This fine appears to have equaled approximately $23 per affected customer. In a similar action against Discover, the CFPB levied a $19-per-customer fine ($2.5M fine for 130,000 affected customers). In a separate action against an auto lender called First Investors, the CFPB levied a $23-per-person fine ($2.75M for 119,000 affected accounts) for sending bad credit reports.

So we can estimate the going rate for these kinds of violations to be around $20 per affected customer. Based on my own research I think it is unlikely NICK has engaged in any of these practices, however I am an outsider with no special knowledge and you MUST undertake your own diligence on this matter.

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Concluding my last research series, on Glentel, I wrote:

I hope it is clear by now that Glentel is trading extremely cheaply … As for why this market inefficiency exists, there is no shortage of reasons: … a float below $100M; the company does not host earnings conference calls; the company does not participate in investor conferences or offer an investor slideshow on its website; the sell-side coverage of the company is very poor; the investment case is complex relative to the small size of the company; etc.

Virtually everything I wrote about Glentel also applies to NICK. In addition, I think NICK is suffering from the beating all financial stocks have taken over the past month. I also think may still be some NICK sellers who wanted to divest their entire positions in the tender, but were not able to, and so now are selling the remainder in the open market. Finally, I don’t think NICK’s new, dramatically-lower share count is well-reflected by various financial data sources.

Those are my thoughts on Nicholas Financial. As always, conduct your own research, do your own due diligence, and make your own investment decisions. Thank you for reading.

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