Cash Converters (ASX:CCV), Australia’s largest subprime lender and second-hand property retailer, has explained the inherent lag in the revenue the firm recognizes on the loans it underwrites, to help investors appreciate the difference between its half-year results.
The company generates more than 50% of its earnings before interest, taxes, depreciation and amortization (EBITDA) through its personal finance business segment, which generates income from small unsecured loans (up to ‘to $2,000) and medium (up to $5,000).
The combined average duration of these products is less than 10 months, so a large proportion of clients repay their loan within a calendar year.
It’s a very different cycle than a bank would experience with its mortgage portfolio, which has loan terms of up to 30 years.
Although the lead time for a Cash Converters loan is relatively short, there is still a time lag between advancing principal and recognizing profit, with the company appropriately factoring in expected credit losses on potential loan losses to advance.
The demand cycle
Peaks and troughs in demand within Cash Converters’ personal finance business are primarily seasonal.
Tracking business activity (such as loan volumes and velocity) over a calendar year would reflect an inverted bell curve, with activity peaking in the final weeks of the calendar year and then declining in June/ July, before growing again.
The reverse is true for the income generated by this loan activity, with the company fully recognizing the benefit of this income over the quarter and the following six-month period from the period of loan origination.
This relationship between “activity” and “earnings” contributes to Cash Converters’ second half fiscal year profits from the provision of personal financial services being greater than in the first half (when the lending activity is at its highest).
The first half of the financial year covers the months of July to December, when the company typically sees a monthly increase in demand for loans until Christmas.
The busiest time for loans is December, where Cash Converters said the number of applications submitted can exceed 50,000 during the month.
It’s a trend that has remained consistent even during the COVID-19 pandemic and is allowing the company to benefit in the following half year.
Cash Converters managing director Sam Budiselik said dealing with short-term, high-volume personal finance presents its own challenges due to the complexity of complying with responsible lending laws and the high volume of inquiries received.
“Our finance business is a high-volume operation and the feedback loop between principal advance and loan performance is relatively short, so our ability to adapt to market changes must be quick.
“Coupled with the investigation mechanisms we have across the business, we have a real-time understanding of customer performance,” he added.
“We can only respond responsibly to demand by leveraging our technology and we have invested heavily in data analytics and machine learning to provide a comprehensive profile of each candidate from a risk risk perspective. credit.”
“It is this capability that gives us a competitive advantage in our markets, as our speed, customer experience and compliance record are industry leading,” said Budiselik.
Going from a small to medium loan amount
The company’s decision to gradually transition from small to medium size loans has lengthened the company’s revenue profile as these loans mature in 24 months.
“As pandemic restrictions lifted in the run up to Christmas 2021, we saw an increase in demand which allowed us to have one of our peak months for releases in December,” said Mr Budiselik.
“The changes we’ve made to our customer-facing assets and back-end analytics mean we’re well positioned to capitalize on this pent-up consumer demand, now and in the future.”
He added that the company’s ability to capture pockets of demand as they emerge is important, particularly given the indefinite review of the reopening of the Western Australia border on February 5 as eastern states are exceeding their relative peak infection rates.