Why I’m Investing in This High Risk, High Yield Fintech Stock

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I recently initiated a new position in the fintech company OppFi (NYSE: OPFI), a company that went public through a Special Purpose Acquisition Company (SPAC) in late 2020 and began operating on its own in July. The company is trying to revolutionize lending in the subprime credit space, which caters to the riskiest borrowers, typically with a FICO score below 600.

While investing in this space undoubtedly comes with risk and scrutiny from regulators and investors alike, I love OppFi’s mission and strategic plan so far, and believe the action has enormous potential. Here’s why.

Shake up the subprime space

OppFi uses artificial intelligence and automation to give small loans to people who cannot normally get loans from a traditional bank. The company’s main product, the OppLoan, is an installment loan averaging $ 1,500 over an 11-month period, and is used by borrowers to deal with debt-related situations. car, housing, medical, family and education costs.

Borrowers can apply for a loan in five minutes and get a very quick decision on their application. OppFi seeks to serve the 60 million borrowers who do not have traditional access to credit. OppFi defines its customers not as low income, but as those who typically make $ 50,000 a year and have a bank account, but live paycheck to paycheck.

From everything I’ve seen so far, OppFi is committed to providing fair services to a subset of the market that can’t get credit when it needs it. During the company’s second quarter earnings call, CEO Jared Kaplan noted that about 40% of his customers have bank accounts at the country’s three largest banks, but cannot access products. small dollar loan.

OppFi actually assesses a person’s credit standing and will turn the business over to a near-senior lender if that person qualifies. However, Kaplan said less than 2% of customers who come to OppFi end up qualifying.

To be clear, OppFi charges a very high Annual Percentage Return (APY) on OppLoans, in the range of 30% to 160%. However, in the subprime space, this is actually towards the lower end of what other subprime lenders charge. OppFi also appears to preach transparency, as its loans don’t charge late fees, overdrafts, or prepayment penalties. The APY that borrowers see is what they get.

Image source: Oppfi investor presentation.

Now I can understand that OppFi’s APY isn’t exactly cheap, but what people need to understand is that small dollar loans are hard to come by because they always come with many of the same costs. fixed than those required to create a normal loan. Also, given the nature of borrowers at risk, OppFi always cancels 25-40% of its loan balances, which is obviously very high. The company must therefore assess the risk appropriately.

However, there are two reasons that make me confident in OppFi’s mission. First, the company buys most of the loans issued by its partner banks and keeps them on its balance sheet, and takes on the risk instead of just selling all of its loans on the secondary market.

Second, OppFi has a Net Promoter Score of 85 which is phenomenal. The promoter’s net score indicates the likelihood of a customer returning to a business for repeat business and recommending a friend to the business. This 85 is higher than that of companies such as Starbucks, Apple, SoFi, Reached, and almost all other banks. OppFi chief financial officer Shiven Shah said customers are taking an average of 2.5 loans from the company.

Person walking from one bar to another.

Image source: Getty Images.

Strong financial data and valuation

Unlike many promising fintechs, OppFi has been profitable and has actually been profitable since 2015. In the second quarter of this year, OppFi made nearly $ 18 million in profit on adjusted revenue of over $ 78 million. of dollars. The company expects to generate between $ 62 million and $ 66 million in net income for the full year on total revenue of between $ 350 million and $ 360 million. By 2023, revenue is expected to accelerate to $ 875 million, with net income reaching $ 127 million.

While there are fintechs with more revenue, OppFi’s profitability is strong and growing, given the company’s position in its lifecycle. What’s even better is that OppFi doesn’t have a crazy rating like other popular fintechs.

Evaluation comparison.

Image source: Oppfi investor presentation.

As you can see, OppFi generated more revenue and better margins in 2020 than many of its competitors, but has a total enterprise value that is roughly seven times its expected profit for 2021 before interest, taxes. , depreciation and amortization (EBITDA). OppFi is trading at around 12 times projected earnings this year. Even if you prefer OppFi’s competitors, there is a huge disparity in valuation.

Risks

Now, there is a reason for the decline in valuation. While I currently don’t view OppFi as a predatory lender based on the subset of the market it serves and its mission, any lender offering a high APY like this is going to end up in the group of predatory lenders by some. investors, who simply won’t. invest for this very reason. The subprime lending category was also very problematic during the Great Recession, and apart from the pandemic, which was an unprecedented economic situation but appeased by billions of dollars of stimulus, AI models and the credit quality of the industry. ‘OppFi have not been tested in a more traditional downturn or higher interest rate environment.

There are also very real regulatory risks. The Consumer Financial Protection Bureau (CFPB) previously issued a civil inquiry request to OppFi to determine whether the company had violated the military loan law. Recently, however, OppFi revealed that CFPB had alerted it that it was not planning to take any coercive action.

In April, the Washington, DC attorney general sued OppFi for allegedly using deceptive marketing regarding high-cost loans with interest rates above Washington, DC’s usury cap. The allegation is largely based on the fact that OppFi initiated these unlicensed loans, but the company denies the allegations because its partner bank originated the loans.

And then, of course, another big threat is that lawmakers would pass a 36% national interest rate cap on consumer loans, which would obviously be devastating for all subprime lenders. But Kaplan said he believes the likelihood of that happening is very low given the current makeup of Congress and the fact that such legislation could prevent many at-risk borrowers from accessing credit.

An exciting future

OppFi plans to build a strong community that captures an underserved area of ​​the market that it can serve in multiple ways, which could increase profitability by lowering customer acquisition costs. In addition to its signature product OppLoan, OppFi is launching or preparing to launch several exciting products.

One of them is called SalaryTap, which would allow clients to repay their loans by setting up direct payments from their paychecks. Since this type of loan would be viewed more as a securitized product, loan amounts would start at $ 2,000 for a term of 24 months and would carry much lower interest rates of around 30%.

OppFi is also preparing to offer other good products and services to its customers, such as OppU, an educational program that reinforces good credit behaviors and teaches financial literacy, and a special OppFi credit card to customers who repay successfully their OppFi loans. These cards will again go to customers who might not necessarily be able to get a normal credit card and will have spending limits of $ 1,500. These are just a few of the products OppFi has planned for this historically underserved market, but it is considering many other products down the line as well.

While OppFi is an inherently risky business given the borrowers the business serves and the regulatory landscape, it is also a business that has been fair to its customers so far, is still profitable, has a very reasonable valuation. and also has strong growth prospects.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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