Consumer Credit Financials: The Case for Asset Class Differentiation

One of the most fascinating financials special situations I regret not investing in was that of Amigo Loans.

Amigo Loans was a guarantor loan provider in the UK. Its core product was a high-interest, unsecured loan lent to a sub-prime or lower-credit-quality customer but guaranteed by a higher credit guarantor.

The company was founded in 2005 and listed on the London Stock Exchange in 2018 at 275p, equivalent to a valuation of £1.3bn. At its peak, the firm was worth £1.5bn.

Over the next 4-5 years, the company experienced a series of painful crises, which ultimately led to its dissolution. If you visit the Amigo Loans website today, you will find that the company is in wind-down, with no new lending.

If you try to buy the shares today, you'll pay 0.26p, equivalent to a £1.5m market cap.

Exhibit 1: Amigo Loans Share Price History

Source: LSEG/Refinitiv

For more background on how we got here, see the March 2023 Financial Times piece, “Subprime lender Amigo Loans Halts all lending as it winds down business”, here.

Another sub-prime consumer credit casualty: So what?

For me, one of the most fascinating aspects of the Amigo situation was that whilst the equity lost 99% of its value, the bonds for the same company were ultimately repaid in full at par.

Hence, Amigo’s 2024 senior secured note, paying 7.625%, having initially dipped to the 50s as the company's challenges began to emerge, gradually drifted back up to par to be repaid in full.

Exhibit 2: Amigo Loans 2024 SSN, repaid at par

Source: LSEG/Refinitiv

For the seasoned credit analyst, such an outcome is not all too surprising. Equity and fixed income are entirely different asset classes, right?

For me on the other hand, having spent most of my career up to that point looking at financials equities, that a company’s bond could pay back in full even as its equity lost 99% of its value was the stuff of legend, or at least some rare financial wizardry...

The rationale – distinguishing between equity and credit

If you look at most companies, it's generally true to say that good performance for equity holders also entails a good result for credit holders. The same is also typically true the other way around: a fundamental company performance that is good for creditors is generally good for owners.

Financial services companies do not neatly fit into this framework of debt-to-equity continuity. In other words, what’s good for the equity and shareholders is often neutral or negative for lenders.

In Amigo's case, the crux of the differentiation lay in the specific economics of a consumer credit institution in (managed) run-off as compared to the economics as a going concern.

One of the problems with high-interest consumer credit businesses is the cost of customer acquisition. By definition, most people are trying to get out of high-cost debt. Like a personal trainer or dating app (Hinge calls itself "the dating app designed to be deleted"[1]), the job of the consumer finance company is to help you address a short-term need but ultimately to provide a bridge to lower-cost pastures (or that summer body, or the love of your life, etcetera, etcetera).

Helping a client, therefore, means, in a sense, helping said client to no longer require your services.

The problem with this type of business model is it means such businesses spend a lot of money acquiring new customers. For unsecured consumer lenders, one can add to this dynamic that loans are often amortising, meaning revenue is constantly shrinking unless outpaced by additional lending to new or existing customers.

In the case of Amigo, closing the business meant that, whilst this was terrible for equity holders, for creditors, as long as the cash flows of the firm’s underlying assets, the amortising loans, could repay the debt and interest costs, said creditors would get paid back in full.

Indeed, with no new customer acquisition costs or marketing spend, an orderly wind-down was ironically better for creditors than growing the business.

What does this mean for us today?

At Fighting Financials, one of our strengths lies in our ability to analyse financials investment opportunistically throughout the capital structure. As the Amigo Loans case study demonstrates, applying different analytical frameworks to securities within the same capital structure can provide the basis for highly differentiated investment risk-return structures.

Today, we’ve published on and added our fourth investment idea to the pilot Fighting Financials portfolio (we aim to publish eight ideas by our official June launch). The idea is in a senior credit security and offers investors a double-digit yield for a modest loan-to-value. We think the opportunity exists in part because – as in the case of Amigo – investors are conflating the equity analysis of the company with the credit analysis.

Clients wishing to explore this recommendation in greater depth can click here. Institutional clients can also contact the FFL team directly to schedule a call or meeting on the name.

For prospective clients interested in gaining access to our full investment research service, please click here or reach out at info@fightingfinancials.com for an initial confidential discussion.

Until then,

Your FFL Team

---

[1] See https://hinge.co/