Springleaf/OneMain Financial: DOJ Likely to Define ...

[Pages:7]June 9, 2015

Springleaf/OneMain Financial: DOJ Likely to Define Installment Loan Market Narrowly, and Pending CFPB Oversight Creates Additional Uncertainty, but Significant Divestiture Allowance in Merger Agreement May Drive Clearance

Update

Likely antitrust concerns. DOJ is likely to identify significant antitrust concerns in reviewing the merger between Springleaf and OneMain Financial, which would extend the timeline for the deal beyond the parties' initially anticipated closing date of Q3 2015. Springleaf and OneMain both offer the same core product: a consumer installment loan targeted to non-prime borrowers. DOJ will likely exclude from the relevant product market both (a) loans made to consumers with lower credit quality (e.g., payday loans), and (b) those made to consumers with higher credit quality, such as loans originated by banks and credit unions. We anticipate that the DOJ will focus on local geographic markets, and that divestitures will potentially be required in a substantial number of the companies' overlapping local markets.

Divestiture allowance may drive clearance. Springleaf/OneMain's agreed upon divestiture limit (or "Detriment Limit") of $677 million suggests that the parties anticipated a regulatory hurdle from the antitrust regulators prior to announcing the deal. Because the parties have structured their deal to address the possibility of divestiture ? and should therefore be willing to give up a significant portion of their business ? we believe that DOJ's potential concerns will be resolvable through this remedy, and that the merger will eventually be cleared.

Pending CFPB oversight. The CFPB's upcoming rulemaking for supervision of larger participants in installment loan and vehicle title loan markets broadens the regulatory risk surrounding Springleaf and OneMain, as the CFPB will have greater oversight for compliance with Federal consumer financial laws. The rulemaking is most likely too indefinite and long-term to directly impact the antitrust investigation, and is unlikely to constitute a Material Adverse Effect (MAE) ? as per the merger agreement, "changes (including changes of Applicable Law) or conditions generally affecting any industry in which the Company and its Subsidiaries operate" are excluded from the definition of MAEs.

Still, it is important to note that the rule ? as its parameters and scope continue to be revealed by the CFPB ? could possibly alter the parties' financial calculations for pursuing the merger, thereby presenting an additional element of uncertainty for consummation of the deal. Additionally, the level of agency coordination between DOJ and the CFPB is difficult to ascertain, and DOJ could potentially tap into the CFPB's expertise in the installment loan market. Lastly, the pending rule may complicate the divestiture buyer question, as otherwise willing buyers could shy away from acquiring Springleaf/OneMain's business for fear of coming into increasing regulatory oversight ? particularly if acquiring the divested branches would make the divestiture buyer a larger participant in the installment loan market where it was not before.

Timing. Compliance with the CID, which was issued on April 28, will likely be a time-and labor-intensive process, as some of the information may need to be compiled on a state-by-state or local basis. DOJ's investigation could also be considerably protracted, as the HSR timeframe will not apply.

For this article, we spoke to several policy and legal experts, including a staffer on the House Financial Services Committee, a source from the Center for Responsible Lending, a source from the American Antitrust Institute, and a law professor who focuses on the intersection of financial regulation and antitrust.

1

You are a subscriber to The Capitol Forum. Please contact 202-601-2300 for editorial or sales questions.

In Depth: DOJ Investigation

Since the transaction is not subject to the HSR timeframe, investigation and review may be prolonged. Several significant differences result from merger review being outside of the HSR process. First, review outside of HSR may take relatively longer, since HSR time limitations do not apply. Second, the DOJ does not have as much leverage on merging parties with a CID as it does with a second request, in that parties outside of HSR, like Springleaf/OneMain, could technically close the transaction with the investigation ongoing.

Of course, with a second request, the parties are prohibited from closing until the waiting period expires. Here, if the parties were to decide to close the deal despite the open CID, DOJ would have to get a court order to stop the deal. But closing with an open CID during an on-going agency investigation is normally a surefire way to create ill will at DOJ, and accordingly, most parties refrain from doing so. If DOJ opts to drag its feet on making a decision, the parties' best option will be to work with the agency to resolve any potential concerns.

Compliance with the CID may itself be time consuming and onerous, as state and local data may not be readily available. Compliance with investigative demands in merger reviews is inherently a time- and laborintensive process, as the information requested will include a wide range of data about potentially relevant products, markets, and business practices. But in the case of a primarily state regulated industry such as subprime consumer lending, the process could prove to be even more difficult.

Our source from the House Financial Services Committee explained that "for anything that's regulated at the state level, it's always much harder to aggregate data." In comparison, compliance would be relatively easier for an industry regulated at the federal level, according to Bert Foer, founder and former president of the American Antitrust Institute. "For something like the bank industry, there is a lot of market share and product information available through the federal bank regulators. So something like a bank holding company, for instance, could pull this market data and competition-related information together much more quickly," said Foer.

Here, the companies may be required to compile data on a state-by-state basis from state regulators, at least for the 26 states where operations overlap. In fact, the agency may find that it needs even more location-specific information from the two parties (or from others, such as smaller, local competitors) as the investigation proceeds. It may not be easy for DOJ to determine market shares in each of the local markets ? which ultimately goes to how much information and data is required for its analysis.

In Depth: Antitrust Risks Related to Proposed Merger

DOJ is likely to define the relevant product market narrowly around subprime consumer loans, as loans made to those with higher or lower credit risk are unlikely to be considered adequate substitutes. To define the relevant product market, "DOJ will consider the industry through the perspective of the consumer, and ask who else makes these types of loans to these types of people," says Foer. Notably, Springleaf and OneMain target a specific and very similar customer demographic: the "non-prime" customer that is looking to borrow substantially more than a payday loan would allow, but is unlikely to qualify for loans from traditional lenders such as banks.

Type of loan Average loan amount

Springleaf (as of Feb 2015) Secured & unsecured personal loans

$4000 to $5000

OneMain (as of Oct 8, 2014) Secured & unsecured personal loans

$6,189

2

You are a subscriber to The Capitol Forum. Please contact 202-601-2300 for editorial or sales questions.

Average loan term Customer's avg. FICO score Customer's avg. income

3.3 years (max 5 years) 606 (range: 550-650)

$47,000

5.1 years 630 (range: 550-749)

$45,000

Therefore, while it may be true that "the U.S. consumer finance industry has approximately $3.1 trillion of outstanding borrowings," as stated in OneMain's regulatory filings, the type of loans to be included in the relevant product market for analyzing this merger will likely comprise a much smaller pool. According to Foer, "there are obviously some market definition issues in this space, and DOJ could ultimately define a product market which is very narrow. The idea would be that a subprime loan is a different kind of financial product from a loan being made to a better credit risk."

DOJ will scrutinize merger for unilateral effects in overlapping, local markets. Our sources indicate that the relevant geographic market to be applied in analyzing Springleaf/OneMain's merger will most likely resemble the model applied to commercial banks in bank merger analysis ? meaning that geographic markets are likely to be locally defined. According to recent guidance on bank merger analysis, the Federal Reserve considers local banking markets, with a focus on "economic integration of different regions as it pertains to consumer price sensitivity and willingness to switch banks."

With Springleaf and OneMain, DOJ is likely to find that consumers are visiting local branch offices to get their loans originated and serviced. Much like personal banking at commercial banks, consumers are unlikely to travel far outside of their local markets. DOJ will need to determine where the two companies compete with each other, then break down its analysis to the local level, location-by-location.

The companies' nationwide footprints (see maps below) show that there are several areas of serious overlap, especially in many of the Midwestern and southern states, where branches of both companies are particularly concentrated. Additional areas of potential overlap are discernable near the Seattle metropolitan area, and throughout southern and northern California. There are even entire states, like Colorado, where Springleaf and OneMain are the only two companies underwriting this type of subprime consumer loan (according to Denver Post article) ? which is presumably why the Colorado AG's office is also looking into the merger.

Springleaf and OneMain should be concerned, in part, because DOJ will likely use a relatively low HHI screen ? especially if it models its analysis after bank merger analysis. For bank mergers, any merger that results in a postmerger HHI over 1800 and an increase of more than 200 is a potential problem, which translates to concentration levels seen as problematic being relatively low. Even if DOJ includes other local competitors, like local non-bank lenders that make similar loans, the agency could easily still have concerns where Springleaf and OneMain overlap.

Notably, according to the merger agreement, Springleaf has committed to divest assets accounting for up to $677 million in 2014 revenue, if necessary, to obtain antitrust clearance. This number is particularly notable when considering that its 2014 revenue was $2.8 billion: the company has essentially committed to divest up to 25% of their business, which roughly figures out to be anywhere from 100 to 200 branches that they are anticipating they may have to divest.

Since both companies have an online component to their business, DOJ will need to confront the emergence of online lenders and what this means for market definition. Customers can submit loan applications to both Springleaf and OneMain online, though borrowers are required to come into the nearest OneMain branch before the loan will be granted, and are highly encouraged to do so by Springleaf. Due to the companies' online presence

3

You are a subscriber to The Capitol Forum. Please contact 202-601-2300 for editorial or sales questions.

? and because online lending is becoming an increasingly common practice ? DOJ could find itself wrestling with the question of whether online lending is a separate market from brick and mortar lending.

However, we believe that brick and mortar competitors will figure much more prominently in DOJ's antitrust analysis, with online lenders being seen as a relatively less important source of competition. Aside from the fact that the vast majority of Springleaf and OneMain's business is still conducted in person, our research shows that most online would-be competitors offer different types of loan products, which are unlikely to be considered substitutes for Springleaf/OneMain's core loan product.

For instance, peer-to-peer lending companies such as Lending Club and Prosper Marketplace require minimum credit scores that are higher than Springleaf/OneMain's target demographic, while other online lenders tend to focus on lending to small businesses, such as OnDeck, Kabbage, and CAN Capital. Furthermore, brick and mortar lenders likely enjoy several advantages over online lenders, such as less susceptibility to fraud and faster servicing and origination. Still, the parties are likely to make the argument that online lenders should be included as competitors, in the hopes of alleviating DOJ's concerns regarding post-merger anticompetitive effects.

DOJ could anticipate several different post-merger harms, such as price increases, less flexibility of loan terms, or poorer customer service. Importantly, state regulated rate caps on subprime loans provide an element of industry-wide price control ? another feature of subprime lending that the parties are sure to highlight. But while the rate caps determine the maximum interest rate that can be charged on a particular loan amount (and is generally applied for the riskiest borrowers), the two lenders may still be competing on terms for less risky borrowers ? that is, those with relatively better credit scores or those who are able to secure the loan with an automobile, for instance. Post-merger price increases for this segment of customers would also concern DOJ, even if not all customers would ? or could ? face price increases.

The likelihood of such concerns is heightened because Springleaf and OneMain are by far the biggest players in the subprime consumer lending space, which may give rise to a situation where DOJ will treat smaller players as relatively unimportant in determining the behavior of the two industry giants. According to Foer, "if DOJ finds that these two are the primary competitors against each other, and it seems like their business practices are only really affected by what the other one does, then the merger could be seen as eliminating an important competitive dynamic."

Were DOJ to find such evidence, Foer noted that the merger would draw comparisons to the attempted merger between Staples and Office Depot in 1997. "At the time, there were hundreds and hundreds of smaller retailers selling office supplies. But the evidence showed that the big three ? Staples, Office Depot, and OfficeMax ? were pricing themselves against each other," explained Foer. The evidence compelled FTC to find that office superstores constituted their own market, thereby diminishing the role of smaller competitors.

Further, competition on price will not be DOJ's only concern, as this is an industry plagued by consumer protection issues and abusive practices. We spoke to Chris Kukla, Senior Vice President of the Center for Responsible Lending, whose policy work includes consumer lending legislation and regulation. According to Kukla, "most subprime lending companies charge the maximum interest they are allowed to under state law. So for a company to grow, it's more about gobbling market share than it is about raising charges. If you have one dominant player who doesn't have to worry about losing business, our concern is that some of the industry's prevalent, abusive practices will get worse."

4

You are a subscriber to The Capitol Forum. Please contact 202-601-2300 for editorial or sales questions.

For instance, DOJ could anticipate that the combined company will attempt to raise the criteria for making loans, would more aggressively push unnecessary insurance products, or that service could decline as a result of the merger. Such was the case with airline mergers, where the industry-wide adoption of bag fees, post-merger, was seen as significant, even though it was a relatively small ancillary fee. DOJ may require divestiture in geographic markets where there will be significant loss of competition in some other dimension, even if rate caps would limit prices increases. In future reports, we will explore whether the overlap between Springleaf and OneMain appears to exceed the divestiture limit of $677 million ? taking into account the concentration of local and online competitors ? and what divestiture buyers could (or would be willing to) step up to resolve DOJ's concerns. ONEMAIN ? 1141 Branches Across 43 States

SPRINGLEAF ? 828 Branches Across 26 States

5

You are a subscriber to The Capitol Forum. Please contact 202-601-2300 for editorial or sales questions.

Issue Snapshot

Outlook: Significant Divestiture Allowance in Merger Agreement May Drive Clearance

Reasons for Merger Clearance

Overview Although there is substantial geographic overlap between the two companies' branch offices, potential antitrust concerns are likely resolvable through divestiture of branches in overlapping markets. The parties agreed upon divestiture limit of $677 million indicates a conservative approach to dealing with the Antitrust Division, and suggests that the parties are willing to part with significant assets in order to receive clearance.

Reasons for Collapse/Challenge

Overview Concentration levels seen as problematic for financial institutions tend to be relatively low, and DOJ could therefore be concerned by the combined firm's postmerger concentration level even if local competitors are included in the calculation of market shares.

Analysis

Analysis

-In regulatory filings, Springleaf and OneMain depict -DOJ is likely to define a narrow market around

a highly competitive market for consumer lending that subprime consumer installment loans, thereby

includes both small, local competitors and online lenders.

excluding both higher risk lenders (e.g., payday lenders) and lower risk lenders (e.g., commercial

banks and credit unions) from the relevant market

-Antitrust concerns surrounding mergers in the

definition.

financial services sector are generally resolved through divestiture of branches; here, the parties

-DOJ required divestiture could exceed the parties'

appear to anticipate substantial divestiture of their

anticipated limit of $677 million, given the substantial

business, and have likely structured their deal

geographic overlap of branch offices and the narrow

accordingly.

market definition.

6

You are a subscriber to The Capitol Forum. Please contact 202-601-2300 for editorial or sales questions.

-If DOJ carries out a prolonged investigation and review, the parties could potentially walk away from the deal, particularly in light of the relatively modest reverse termination fee of $212.5 million.

Other Factors -The emergence of online lending could widen the field of Springleaf/OneMain's competitors.

-State regulation of interest rates for subprime loans limits the potential for price increases, which could temper some of DOJ's concerns regarding postmerger unilateral effects.

Other Factors CFPB's ongoing rulemaking for supervision of "larger participants" of consumer installment lending could expose Springleaf/OneMain to further scrutiny.

Timeline -Springleaf/OneMain continue to work with DOJ to comply with CID. -Once parties have complied, DOJ will proceed with its antitrust review.

7

You are a subscriber to The Capitol Forum. Please contact 202-601-2300 for editorial or sales questions.

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download