I’ve written over 10 pages in the past two weeks and discarded them all. Sometimes, things just don’t click, and I find it better to start over than to finish a concept that doesn’t hit the mark. However, there’s a fine line between that and paralysis. Today is the day to get some words on the page to break the cycle.
While rain is nothing new in Seattle, it can take many by surprise in other places. Not checking the weather and being unprepared with an umbrella can ruin an otherwise survivable day. The same approach tends to apply in capital markets. When fear grips pricing, homework must have already been done. Learning about businesses when liquidity is falling apart is a challenging endeavor, similar to shopping for an umbrella at the beginning of a strong rainstorm.
Knowing one’s psychology is also crucial to understanding whether to duck into a restaurant and have a meal to wait it out or brave the storm to reach the next destination. In his book, Steve Schwartzman outlined this point:
The best time to buy is when there’s blood in the streets. That’s when you get bargains. But it’s also when you have to be most careful. You don’t want to catch a falling knife. You want to wait until it hits the floor and bounces back up a bit.
What It Takes: Chapter 16 (Why There Are No Old Brave People In Finance)
Others take a different approach and “catch the proverbial knife” by buying on the way down.
As financials took a beating over the past few days, unlike in the past when I was unprepared, this time I had a name in mind that I wanted to own but was waiting for the right price. OneMain Holdings is a market-leading sub-prime consumer lender with a 20% share of the installment lending market. It’s a sandwich of AIG and Citigroup’s legacy subprime consumer lending businesses, shepherded by Fortress in the prior decade. In essence, it is similar to a bank in that it borrows money and lends it out. However, its borrowings come from long-term fixed-rate bonds and medium-term fixed-rate securitized debt, not deposits.
In some sense, it is constructed inversely to the regional banks feeling pain this week by having longer duration liabilities than assets when one considers the unsecured bond liabilities and non-recourse match funding on the securitized funding side (there is nuance, but keeping it simple).
It runs a highly efficient operation, with low operating costs, charge-off rates, and high cash generation. It currently trades for a market cap of $4.3B with total adjusted capital of $3.2B. It generally underwrites to a 20-30% return on total adjusted capital or $0.8-1.2B annually. It returns about $500M to shareholders via dividend and returns incremental earnings to shareholders via repurchase (~$280M last year but likely much lower this year). More importantly, as a banking business, the company prioritizes discipline and consistency over growth. Here’s what the CEO had to say:
We try to stay disciplined and stick with our discipline. I’ve talked before about we actually don’t manage the growth. Growth is an output. We have our credit box. It’s very specific and granular. We want to put customers in loans, they can afford and pay us back. That’s good business for our customers. It’s a good business for us.
Barclays Financial Conference, September 2022
Bigger picture, the major questions I ask myself about this business are whether consumer credit will grow or shrink over the next 5 years and whether unemployment will rise to deeply recessionary levels (say 8-10%)? Both questions I am unqualified to answer, but willing to bear the downside risks given diversified portfolio construction.
As Schwartzman outlined what works for his psychology, deep concentration in home-run like ideas doesn’t match my personality. I tend to find greater confidence and comfort in a diversified portfolio with a material yield to anchor on. To each their own. I bought a small amount of shares, specifically roughly 1/15th the largest concentration I would take in a new single stock (which is roughly 3%). But as the portfolio is designed for yield, not market timing, with each month that passes with the pricing being acceptable, I’ll be able to grab a bit more.