New subprime-loan giant created from spare parts of AIG and Citi

Wall Street is celebrating the creation of a new subprime-lending leader from the spare parts of two financial giants at the center of the global financial crisis.

Springleaf Holdings Inc. (LEAF), a former subprime lending division of American International Group Inc. (AIG), has agreed to buy Citigroup Inc.’s (C) OneMain Financial, for $4.25 billion in cash.

The deal – which has been anticipated for a while but was cut at a far lower price than analysts expected – sent Springleaf shares soaring by as much 30% this morning to more than $52.

Springleaf was apparently able to get OneMain at an attractive price because it was the most logical strategic buyer and Citi was a highly motivated seller, having publicly placed OneMain on the block as part of a broader effort by the financial conglomerate to trim down. The company edged out a few private equity firms to emerge as the presumptive buyer for OneMain in recent weeks, according to Reuters.

David Schawel, a portfolio manager at Square 1 Bank in Raleigh, N.C., who has been bullish on the prospects for this union, says, “Springleaf was the only one who had the synergies [and] funding to make economics work. Plus Citi had to sell it.”

After quickly running the numbers on the acquisition, Sterne Agee analyst Henry Coffey estimated that Springleaf’s profits look to approximately double for 2015, from $2.43 to well more than $5 per share.

The resulting company will now be, by far, the biggest lender to consumers with lower credit scores in the country. It will have nearly 2,000 branches in 43 states, through which it provides personal and auto loans at high interest rates to customers with little access to other forms of credit.

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A recent investor presentation by Springleaf showed that the average interest rate on its outstanding loans has been around 26% to 27%. Losses for bad loans have been trending below 5%, leaving an effective yield earned by Springleaf near 22%. Springleaf personal loans average $4,000 to $5,000 in size and 40 months in term. Typical uses are for debt consolidation, home or car repair or medical bills.

Strong demand for subprime loans

There is certainly plenty of irony in these companies coming together six years after a credit meltdown rooted in subprime lending – the same meltdown that resulted in the near failure of their former parent companies, AIG and Citi, which combined required more than $100 billion of U.S. government bailout money to survive.

Of course, the most damaging excess in the early 2000s credit bubble was subprime mortgages, specifically, rather than car and personal loans, and these companies were not key players in that area.

Still, the enthusiasm among investors for this combination shows the continued demand for loans among income-strapped borrowers with thin or impaired credit. The Wall Street Journal noted last month that loans to such borrowers reached the highest levels since 2007 last year, led by the highly active auto-loan market.

Data from Experian and the Federal Reserve Bank of New York show that “non-prime” U.S. consumer debt totaled $1.29 trillion, not including mortgage or home-equity debt. That’s about 45% of total consumer borrowing outstanding.

With working-class incomes stagnant for years and the Great Recession damaging millions of Americans’ financial condition, some 44% of households have less than three months’ expenses worth of savings and 55% live paycheck to paycheck.

Meantime, the number of national subprime lenders has shrunk dramatically, leaving the Springleaf-OneMain combination as a dominant player. The company says it expects to close only about 200 branches where overlap exists. Once-prominent subprime players that no longer operate include Beneficial, Household International and Providian.

OneMain dates back to 1912, eventually becoming Commercial Credit, the Baltimore-based lender that Sandy Weill used as the initial vehicle to assemble what became Citigroup through the ‘80s and ‘90s. Over the years, in the consumer-finance area, the company absorbed such competitors as Associates First and Washington Mutual Finance.

Under CEO Michael Corbat, Citi has been shedding businesses deemed outside its core mission of global consumer, commercial and investment banking and credit cards. OneMain also prepared plans for an initial public offering.

Springleaf also has roots stretching back to the early 20^th century, ultimately becoming the consumer-lending arm of American General insurance, which was bought by AIG in 2001.

Investors led by private-equity firm Fortress Investment Group (FIG) bought an 80% interest in Springleaf in 2010, and Fortress continues to control it. Since its IPO in October 2013, Springleaf shares are up more than 150%.

Clearly, lending to the desperate remains a pretty good business in Wall Street’s eyes.