LPRO - Open Lending: Ride Through The Short-Term Pain To Reap The Upside Gains

Summary

• The commercial potential is enormous.
• LPRO offers a compelling solution to stakeholders which creates a win-win-win situation.
• LPRO has a low-risk, asset-light business model.

Summary

I recommend going long Open Lending Corporation (LPRO). LPRO has developed proprietary technology that enables auto loan providers to determine the creditworthiness of a borrower and reduce credit risk through its unique insurance solution, allowing them to compete with alternative finance businesses. The company's Lenders' Protection Program [LPP] is a loan insurance program that protects lenders against defaults by subprime borrowers, and combines a proprietary risk-based pricing algorithm with default insurance from third-party insurers to help auto lenders quickly analyze data and provide insured, all-inclusive interest rates to borrowers. The underlying technology and data that supports the LPP creates a win-win-win situation for auto lenders, borrowers, and Open Lending itself. The company is well-positioned to tap into the massive, underserved near-prime and non-prime vehicle lending market, which is estimated to be worth $18.1 billion.

Company overview

For automotive lenders, Open Lending specializes in loan analytics, risk-based pricing, modeling, and automated decision technology. Customers in the United States are served by Open Lending.

Market opportunity is huge

Traditionally, car finance institutions have routed large numbers of subprime and non-prime borrowers to independent subprime lending firms. The proprietary technology developed by Open Lending enables auto loan providers to determine a borrower's creditworthiness and reduce credit risk with Open Lending's one-of-a-kind insurance solution, allowing them to compete with alternative finance businesses. This means that Open Lending's auto lenders can keep their clientele and not have to hand them over to a new company.

When it comes to near-prime and non-prime borrowers, the car industry is still in need of answers. Open Lending is only scratching the surface of the massive, underserved near-prime and non-prime vehicle lending industry, which is estimated to be worth $18.1 billion .

LPRO offers a compelling solution to stakeholders

Open Lending presents an attractive value proposition to a wide range of automotive lenders, such as original equipment manufacturers, credit unions, banks, and others, by allowing them to safely and economically lend to a greater range of credit scores and loan-to-value ratios. As a result of the LPP efforts, these lenders are able to raise the number of loan applications they get from near-prime and non-prime customers and boost their credit appetite with minimally increased risk. The LPP is a loan insurance program that protects lenders against defaults by near-subprime and subprime borrowers. It combines an in-house pricing algorithm with default insurance from highly rated third-party insurers to help auto lenders swiftly analyze data to determine the credit risk of prospective borrowers and provide them with an insured, all-inclusive interest rate. As a result of LPP's default insurance, auto finance companies are able to extend credit to these borrowers with minimal added risk.

Underlying technology that supports LPP creates a win-win-win situation

A primary component of the LPP is the in-house data it has amassed over the past twenty or more years, which is used to inform risk assessment and management. All data pertaining to a loan's origination and insurance is recorded, and LPRO receives information about the loan's performance over the course of its life. Open Lending's term of experts are able to regularly improve and refine their predictive model using live data and new information because of the high granularity of the company's origination and performance data.

I think this is a big competitive advantage as Open Lending's database is more granular and holistic than that of auto lenders. As a result, auto lenders using Open Lending are able to extend more credit to consumers with less-than-perfect credit. For instance:

1. Open Lending's LPP expands the age range for which used cars can be financed by auto loan providers from four to seven years to nine years. As a result, dealers may reach a wider demographic of potential buyers, which in turn could boost sales.
2. Many auto loan providers have a mileage cap of 100,000 miles on the vehicles they will finance. Thanks to LPP underwriting criteria, lenders are able to approve loans with a limit mileage of 150,000 or fewer.
3. Auto dealers make a lot of money off of "aftermarket" products like car warranties and extended service plans, as well as "Guaranteed Asset Protection" insurance, which pays any remaining loan balance in the event of a total loss and any insurance payouts. Typically, there is a cap on the total cost of any accessories that can be included in a car loan. Open Lending has established relationships with numerous car finance companies, and as a result, has increased the cap, thereby increasing dealer profitability.

All of these creates a win-win-win situation between LPP, the dealer, and the lender.

Asset light model with little capital risk

Given that LPRO does not maintain any loan balances, any increase in charge-offs will not affect the company's balance sheet. The balance sheet risk associated with underwriting loans is instead retained by Open Lending's customers. Rather, Open Lending generates revenue through client and insurance partner fees. In addition, Open Lending can increase rates in times of loss to make up for revenue shortfalls. For instance, Open Lending raised rates during COVID-19 by adjusting their pricing model to account for increasing vehicle prices. My guess is that the LPRO model will be tweaked as necessary during trying times and as progress is made.

Competition

It seems to me that LPRO has little to worry about in terms of competition for enrolling and keeping auto lenders. Near-prime and subprime loans are typically offered by a subset of auto finance companies and are characterized by lower loan advance rates, shorter loan terms, restrictions on borrowing for vehicles from more recent model years, and lower mileage caps.

On the other hand, the near-prime and non-prime lending markets are extremely competitive and fragmented. LPRO competes with a plethora of consumer lending options, including but not limited to banks, credit unions, and online marketplaces like LendingClub Corporation (LC) and Square (SQ). The ability of LRPO's competitors to hold loans on their balance sheets is, in my opinion, LRPO's greatest comparative shortcoming.

Valuation

According to my model, investors can expect a 41% return.

My model assumption is based on LPRO management's FY22 revenue guidance and my belief that the company will reaccelerate its growth after the weak FY23 due to a bad global economy. I hold the same view as consensus that in the near-term, things could get very ugly due to the bad economy. However, as LPRO reaccelerates its growth and returns to its historical margin profile, I believe LPRO should be able to at least sustain its current 11x forward earnings multiple (which is effectively pricing this asset as a melting ice-cube business).

Risks

Downcycle

LPRO's program fees and profit sharing revenue could be negatively impacted by a prolonged economic downturn due to a decrease in auto loan origination volumes and/or an increase in loss estimates.

Declining downcycle

The average size of vehicle loans underwritten has a significant impact on LPRO's income. Reduced average loan sizes could slow LPRO's expansion if vehicle prices fall and/or auto lenders tighten lending.

Concentration of customers

LPRO relies heavily on a select group of large vehicle lenders and insurance providers. If these connections are hampered in any way, LPRO's expansion plans may be jeopardized.

Conclusion

Auto loan companies may now compete with alternative finance companies thanks to LPRO's exclusive technology, which helps them assess a borrower's creditworthiness and mitigate risk through an innovative insurance product. The LPP is an insurance program that helps auto lenders swiftly assess data and offer insured, all-inclusive interest rates to borrowers while protecting them from defaults by subprime borrowers. The near-prime and non-prime vehicle loan market is huge and underserved, with an estimated value of $18.1 billion, and I believe LPRO is positioned to capitalize on this opportunity.

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