2 Consumer Loan Stocks Overcoming Challenging Industry Environment

Zacks’ consumer lending industry continues to bear the brunt of declining consumer sentiment, driven primarily by inflation, geopolitical issues and recession fears. This will therefore gradually dampen demand for consumer loans and hurt revenue growth. Weakening asset quality as economic growth continues to slow remains a major near-term concern.

Nevertheless, the easing of credit conditions, which has increased the number of customers eligible for consumer credit and the digitalization of operations, will continue to benefit players in the sector. So companies like credit acceptance company CCCC and Encore Capital Group, Inc. ECPGs are worth considering in the short term.

About the industry

Zacks consumer lending industry includes companies that provide mortgages, refinance, home equity lines of credit, credit card loans, auto loans, education/student loans and personal, among others. These help industry players generate net interest income (NII), which forms the largest part of total revenue. The outlook for companies in this industry is highly sensitive to the country’s overall economic situation and consumer sentiment. In addition to offering the products and services mentioned above, many consumer loan providers are involved in other activities such as commercial lending, insurance, loan servicing and asset recovery. These help companies generate royalty income. In addition, it helps companies diversify their sources of income and be less dependent on the vagaries of the economy.

3 themes shaping the future of the consumer lending industry

Slump in consumer sentiment: The ongoing conflict between Russia and Ukraine, supply chain issues and runaway inflation (constantly hovering above 8%) continue to weigh heavily on consumer sentiment. As a result of these factors, the Conference Board’s consumer confidence index fell to a 16-month low of 98.7 in June. Additionally, the Expectations Index – which shows a six-month outlook – fell to 66.4 this month (the lowest level since March 2013) as consumers become more optimistic about the outlook for the economy. economy, labor market and income.

Lynn Franco, senior director of economic indicators at The Conference Board, said, “The gloomy consumer outlook has been driven by growing concerns about inflation, particularly rising gasoline and food prices. Expectations have now fallen well below a reading of 80, suggesting weaker growth in the second half of 2022 as well as a growing risk of recession by the end of the year. As such, consumer spending is expected to weather the headwinds of inflation and rising interest rates in the second half of the year. This will therefore result in a drop in demand for consumer credit. Thus, the growth of the net interest margin (NIM) and the NII for consumer finance companies is likely to be hampered.

Credit quality may deteriorate: Since March 2020, the US administration has provided substantial financial assistance to individuals through various packages to overcome challenges related to the pandemic. However, with the phasing out of stimulus packages and the Federal Reserve signaling continued monetary policy tightening to control inflation, the US economy is highly likely to slide into a recession over the next six to nine month.

Additionally, according to the central bank’s latest summary of economic projections, the US economy will grow 1.7% in 2022 and 2023, down from the previous projection of 2.8% for 2022 and 2.2 % for 2023. ability to repay loans. Thus, consumer loan providers will likely need to build up additional reserves to deal with unexpected defaults and late payments due to the economic downturn. This will therefore lead to a deterioration in the quality of the assets of the players in the sector in the future.

Relaxation of lending standards: With the nation’s major credit reporting agencies removing all tax privileges from consumer credit reports since 2018, many consumers’ credit scores have improved. This has increased the number of consumers for industry participants. In addition, the easing of credit standards is helping consumer loan providers meet the demand for loans.

Zacks’ Industry Ranking Reflects Muted Outlook

The Zacks Consumer Lending Industry is a group of 17 stocks within the broader Zacks Finance sector. The industry currently carries a Zacks industry ranking of #211, which places it in the bottom 16% of over 250 Zacks industries.

The group’s Zacks Industry Rank, which is essentially the average Zacks Rank of all member stocks, indicates short-term underperformance. Our research shows that the top 50% of industries ranked by Zacks outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of Zacks-ranked industries is the result of a disappointing earnings outlook for constituent companies overall. Looking at revisions to aggregate earnings estimates, it appears analysts are gradually losing confidence in the earnings growth potential of this group. Since the end of April 2022, industry earnings estimates for the current year are down 1.3%.

Before outlining a few stocks you might want to add to your portfolio despite the challenges in the industry, let’s take a look at recent stock market performance and the valuation picture.

Industry vs wider market

Zacks’ consumer lending sector has underperformed both the Zacks S&P 500 composite and its own sector over the past year.

Shares in this industry have collectively lost 28% during this period, while the composite sector Zacks S&P 500 and Zacks Finance are down 12% and 13.5%, respectively.

Year-over-year price performance

Current industry assessment

Based on the price to tangible book (P/TBV), which is commonly used to value providers of consumer loans due to large variations in their results from quarter to quarter, the sector is currently trading at 1.03X. The highest level of 1.54X and a median of 1.21X are recorded over the past five years.

This compares to the S&P 500 12-month P/TBV of 13.32X, as seen in the chart below.

Tangible Price-to-Pounds Ratio (TTM)

As financial stocks generally have a lower P/TBV, comparing consumer loan providers with the S&P 500 may not make sense for many investors. But a comparison of the group’s P/TBV ratio with that of its wider sector ensures that the group is trading at a decent discount. The Zacks Finance sector’s 12-month P/TBV of 3.92X for the same period is well above the Zacks Consumer Lending sector’s ratio, as shown in the chart below.

Tangible Price-to-Pounds Ratio (TTM)

2 Consumer Loan Stocks Braving Industry Challenges

Credit accepting company: Based in Southfield, MI, CACC provides financing programs and related products and services to automotive dealerships across the United States, enabling them to sell vehicles to consumers regardless of their credit history. In addition, it is engaged in reinsurance business under maintenance contracts for vehicles sold to consumers by dealers on vehicles financed by the company.

Revenue growth remains a major positive for credit acceptance, with a five-year (2017-2021) CAGR of 13.7%. The growth is mainly attributable to a steady increase in financial charges, which are also the main component of income. Finance charges should continue to improve, with demand for auto loans increasing steadily, driven by solid economic growth. A decent increase in dealership registrations and active dealerships should also help the company’s revenue.

Credit Acceptance believes in returning capital to shareholders through share buybacks instead of paying dividends. In September 2021, it authorized the repurchase of an additional 2 million shares. As of March 31, 2022, the company still had 0.36 million shares to buy back. Despite substantial leverage, its high cash flow business model and low capital expenditures should help support share buybacks.

The company’s earnings are expected to decline 11.1% for 2022. Shares of this Tier 2 (buy) Zacks company have lost 14.4% over the past three months.

You can see the full list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Pricing and Consensus: CACC

Still Capital: Based in San Diego, California, ECPG provides debt collection solutions and other related services for consumers across financial assets worldwide. The company also provides debt servicing and other portfolio management services to credit originators for non-performing loans in Europe.

Encore Capital is primarily focused on portfolio purchase and recovery activities in the United States and Europe. It plans to leverage its leading position in portfolio purchase and collection as well as credit management services to strengthen its market share globally.

Organic growth remains solid for ECPG. Over the last three years (end of 2021), revenues recorded a CAGR of 7.2%. A gradual increase in portfolio purchases will contribute to the company’s revenue growth.

Similar to Credit Acceptance, ECPG believes in returning capital to shareholders through share buybacks. In May 2021, it authorized an additional $250 million for share buybacks. As of March 31, 2022, the company had a remaining authorization of $153.2 million. Despite a huge debt burden, its strong cash flow generating business model should help support share buybacks.

This Zacks Rank No. 2 stock has lost 8.2% over the past three months. ECPG’s revenues are expected to increase by 14.4% for this year.

Pricing and Consensus: ECPG

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