The Justice Dept. May Have Met Its Match in the Payday Lending Industry

The payday industry may be one of the least loved industries, which warrants government oversight. However, a movement afoot under the Obama administration threatens to upend the industry, but this time the effort is not only unfair, but may also be illegal.

Jun 18, 2014 at 2:20PM

Payday lenders haven't been able to shake the unrelenting glut of regulations and laws aimed at curtailing many of their business practices. However, a Justice Department-backed initiative called Operation Choke Point goes too far, and it has elicited a first of its kind lawsuit from the industry's players.

Among the key players in the space that I will point out in this article are First Cash Financial Services (NASDAQ:FCFS) and EZCORP (NASDAQ:EZPW). I chose these because of the assortment of payday lenders, they've been the most put upon, and even singled out, for their practices.

Concerns about the industry have mainly stemmed from the exorbitant amount of interest and fees payday lenders charge borrowers for loans. The Operation Choke Point initiative, however, should not be a reason to avoid the space, as the measure is riddled with provisions that I believe will be found to run afoul of the law. If the payday lenders prevail, it could be just the catalyst needed for many of these companies' stock prices to rise.

The lawsuit
Upon learning of Operation Choke Point, however, players in the space screamed bloody murder and they are refusing to just sit back and take it.

At the beginning of the month, Community Financial Services Association of America sued several federal banking regulators. They charge that the initiative is "a clear attempt by certain federal agencies to circumvent the law."

Choke Point sticks it to banks too
The way the initiative is to be enforced is also troublesome. It is calling for banks to step up their investigation into payday lenders to determine if they are fraudulent. The last time I checked, banks handled money, not criminals. Regardless, this Justice Department-supported task force is passing the buck to banks.

Michael Bresnick, the executive director of the task force, defended Operation Choke Point. He said banks should consider whether originating debit transactions on behalf of Internet payday lenders violates federal law that guards against money laundering.

The fallout of such a task has already resulted in at least 80 banks severing ties with payday lenders. These banks include JPMorgan and Bank of America. The banks are either refusing to open new accounts, closing existing accounts or both.

The rational behind holding banks more accountable for the businesses they allow accounts for is to force them to choke off the way these businesses receive their funds.

Shifting business models
Many payday lenders had already begun shifting to other areas to make money. This includes offering more pawn shop and retail services.

Take First Cash Financial, for example. Last year it paid about $70 million to buy pawn stores in Texas. This was a smart move considering the growth of the pawn market in the Lone Star State, especially in the Houston area.

When it reported its first quarter earnings this year, it said that its core revenues from retail sales and pawn fees increased 20%. This was great news considering its payday loan business suffered a 17% decline.

The company blamed the decline on increased competition and regulatory pressures. Referring to its payday lending business as "non-core," the company noted that it accounted for just 6% of its total revenues during the first quarter. Furthermore, it was expected to account for less than 5% of its revenues by the end of the year.

EZCORP also saw its retail sales increase. They were up by 4% with jewelry sales accounting for much of that growth during its most recent quarter. It's struggling with its pawn business however, expecting it to be roughly flat by the end of the year.

Operation Choke Point simply unfair
Operation Choke Point is the brainchild of President Obama's Financial Fraud Enforcement Task Force. I understand that its goal is to stomp out fraud. However, this is the wrong way to do it. The opponents of the initiative are correct in arguing that the federal government cannot take regulatory action at the expense of legitimate businesses' liberties and rights to due process.

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A previous version incorrectly stated Cash America as a plaintiff. The Fool regrets the error.

Tedra DeSue has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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