• Elevate Credit provides a superior alternative to payday and other ultra-high interest lending products serving unbanked consumers.
• A combination of factors, including regulatory uncertainty, has led the market to misprice the business dramatically.
• I estimate Elevate is currently worth at least $10 per share and could go as high as $25 in the next few years.

Introduction

Elevate Credit provides an alternative to payday loans and other services marketed to subprime borrowers. These are exceptionally high-risk borrowers, to such an extent that the business is qualitative, not merely quantitatively, different from traditional lenders.

Their core business consists of a line of credit (Elastic) and an installment loan product (RISE). They also have a small but fast-growing credit card business (Today Card). Their portfolio includes 255,099 customers who owe $532 million in principal, with an average effective APR of 91%. In the most recent quarter, they generated $117 million in revenues and gross profits of about $45 million.

In the early days of COVID, Elevate essentially stopped marketing and tightened lending standards. This was partially due to uncertainty about the impact that the pandemic would have on credit quality and partially because stimulus payments reduced demand from their core customers. Because they make short-term loans, this caused their portfolio and revenues to shrink far more rapidly than would those of a long-term lender that took similar steps.

They resumed lending in 2021, but a couple of large-scale legal settlements, namely the Think Finance Settlement and their settlements with Virginia(Gibbs) and Washington D.C., resulted in tens of millions of dollars in charges. At the same time, they shifted to “fair value” accounting making apples-to-apples comparisons for investors more challenging.

As a result, the stock has been pummeled, dropping from a still-cheap high of $4.58 in March 2021 to $1.10 last Friday. With their legal issues behind them and the company returning to growth mode, I believe Elevate trades at a discount of more than 90% from intrinsic value.

Competitive landscape

The payday lending industry is highly fragmented. Large chains, such as Check Into Cash, Cash ‘N Go, and Advance America, have very limited public reporting, which makes finding reliable data on the industry difficult.

Indeed the most recent numbers I was able to find were from a 2010 Stephens report, which estimated that there were a combined 19,700 payday loan stores, generating approximately $7.4 billion in revenues (cited by Pew). In 2021 CNBC claimed that there were 23,000 payday lenders. Though they did not cite a source for this number, it is consistent with my observations that the number of stores has been fairly stable.

Online-only lenders have had advantages and disadvantages relative to brick-and-mortar stores. Disadvantages include a more impersonal borrower experience and the fact that they can’t easily branch out into related services such as pawn shop lending. Advantages include significantly lower fixed overhead and greater control over lending and collection practices (which is extremely important in an industry under heavy regulatory scrutiny.

Critics generally see payday lenders as outrageously expensive competitors to mainstream lenders, but in fact, traditional banks are not competing for the market Elevate et al. serve. There’s a telling anecdote near the beginning of a book by Elevate’s former CEO, Ken Rees:

It was the mid-1990s, and I was working on a consulting engagement at a large bank to improve branch productivity. The goal of the engagement: accomplish more with the same (or fewer) staff.

As I met with different branch employees, a term came across their lips that puzzled me: “lobby trash.” [This is what bankers called the people who] were there to cash checks written to them by the bank’s customers. Unlike others, who deposited their checks in their own checking accounts and waited several days for the checks to clear and for the money to become available, these people needed their money right away. And they were willing to show up at the branch and stand in line to get it.

In recent decades U.S. financial regulators and mainstream lenders have effectively driven tens of millions of people away from the mainstream banking system so that they could focus on more profitable and less labor-intensive clientele. Lisa Servon has done an excellent job of reporting on how poor people have been abandoned by banks.

Big banks have little incentive to pursue low-income customers and many reasons to ignore them, so that is what they have done. Unless that changes (and there’s little reason to think it will anytime soon), banks and other “traditional” financial institutions will not pose a competitive threat in the near future.

Regulatory risk

U.S. Financial regulation consists of a complex web of overlapping state, federal, and local laws. Many states have strict usury laws that apply to everyone except (ironically) banks. You read that right (how these laws work is outlined here).

The trouble is that while banks are often exempt from interest rate limitations, they are subject to a wide range of other regulatory requirements and hurdles. In recent years many companies have begun using what they call “bank partnerships” (critics call them “rent-a-bank” systems). If you take out a Rise or Elastic loan from Elevate, you are most likely borrowing the money from a bank partner. The bank partner and Elevate split the loan income via a complex system of holding companies.

The details of how these arrangements work are complex. I believe that legal risk going forward is limited. Elevate’s practices are conservative relative to others in the industry: They clearly disclose their rates, follow marketing and collection laws, and have invested heavily to ensure compliance with industry regulations.

While I expect additional regulation is coming, I believe it will take the form of legislative changes rather than court rulings that overturn long-accepted practices. Legislative changes may result in Elevate having to modify products or even withdraw from specific states, but not additional large-scale settlements.

A true national ban on payday lending seems unlikely because there is no clear replacement. A rational legislative solution would attempt to disentangle the regulatory web that currently results in so much of the fees from these products going to lawyers and bank intermediaries. Removing the legal/regulatory thicket would

Portfolio Value

Elevate’s modeling assumes extremely high loss ratios. This is a key difference between them and the “subprime” companies that came to grief in the 2008 financial crisis: Subprime mortgage lenders assumed/claimed that bundling high-risk loans would de-risk them. Elevate doesn’t need to make any dubious claims about bundling or derisking its portfolio because high loss rates are already factored into its pricing.

In addition, because they make exclusively short-term loans, they can instantly tighten lending standards at the first sign of portfolio deterioration. As we can see below, their loss rates have generally been quite stable in the 20-25% range. The only recent outlier is 2020 when the loss rates were significantly below target because they were only extending loans to existing customers, who are far lower risk.

One important note is that while loss rates are relatively stable across vintages they are heavily concentrated in months 3-9 of the loan lifecycle. Prior to adopting fair value accounting, this made earnings quite volatile as they incurred huge loan losses in the quarters after rapid portfolio growth and then while seeing disproportionate profits when they slowed lending (as in 2020) as they collected payments from the mature portfolio.

Theoretically, the adoption of fair value of accounting was supposed to remedy this, though the impact is blunted by the fact that they’ll still need to make fair value adjustments if/when results deviate from the model (which is most likely to be in the same 3-9 month window after the loan was issued).

I believe that they’re currently experiencing higher losses than anticipated and will report some negative adjustments in the next quarter, which is why they’ve furloughed some of their workforce (according to Glassdoor). These adjustments are likely immaterial to the long-term value of the business, but management is using them as justification to cut overhead (which has long been higher than necessary).

Income Statement

In 2021, they had $416.6m in revenues less $185.8 million in net provisions for loan losses (a better loss ratio than they target). They also spent $41 million on direct marketing (direct mail, tv, and radio) and $14 million on other costs of sales. That left $175 million in gross profits

Of that, they spent:

• $76 million compensation and benefits
• $38.5 million in net interest expenses
• $32.5 million on professional services
• $21.7 million on occupancy and equipment
• $18.4 million on depreciation and amortization

Unsurprisingly compensation and benefits are the biggest single expense: they have 436 employees, including

• 211 in technology
• 43 in risk management
• 62 in marketing and product development
• 60 in customer support and loan operations, and
• 60 in general and support functions

The senior leadership is overpaid in my estimation but based on Glassdoor, it looks like they pay competitively across the board.

Net interest expenses are higher than one would ordinarily like to see. This isn’t so much because the company is particularly risky or heavily leveraged. Rather, it’s because their business model requires them to work with Federally regulated banks, but for several years the DOJ actively sought to discourage those banks from working with payday lenders through a program called Operation Chokepoint. While Operation Chokepoint ended in 2017, it had a chilling effect that limited the ability of payday lenders to find bank partners, which has pushed rates several points high than they would be otherwise).

Professional services consist of legal, accounting and auditing, recruiting, and outsourced collection fees. I expect that legal fees should decline as the company puts major litigation behind it. Because they don’t break down professional service fees by type, it’s not clear how much of an overall impact that will have, though.

Occupancy and equipment and depreciation and amortization both include significant-tech costs: O&E includes include web hosting, and D&A includes amortization of software development expenses.

Bottom line: The business generates a lot of money, but too much has been eaten up on high overhead. Management had been attempting to “grow into” their overhead, but I think recent furloughs indicate that they’ve resigned themselves to reducing costs to attain sustained profitability at their current size.

Valuation estimate

Elevate’s underlying business is highly profitable, but a range of non-recurring charges and management missteps have caused the market to ignore or discount these profits. With these issues behind them, I estimate the business has a fair value of approximately $10 per share under current management and could be as high as $25 per share if an activist investor got involved.

Disclosure: I am long Elevate Credit.