I don't need 'em and haven't used 'em, but I have an affinity for payday lenders. Whenever an industry is under attack from the government, regulators, or various do-gooders, the strong libertarian streak in me wants to defend them. Of course, it also doesn't hurt that investing master Peter Lynch considers industries with a high "ick factor" ideal sources of good investments.
Payday lenders are simple businesses to understand. A customer with short-term cash flow problems walks into an Advance America (NYSE: AEA ) store, hands over a postdated check as collateral, and walks out with a fistful of cash. Most of the time, these loans are for a two-week period -- just until the next paycheck arrives (hence the industry name) -- and the borrower pays a fee for the service.
That fee, however, gets everyone riled up. A $15 fee per $100 borrowed doesn't seem particularly onerous, but consumer advocates want to liken it to the annual percentage rate you'd be charged on a regular loan. When you do that, it equals a 391% APR.
There are a couple of reasons why the fees are so high. Payday customers can be bad credit risks, and default rates can run high. First Cash Financial (Nasdaq: FCFS ) had loss provisions of 23% in 2006, while Cash America's (NYSE: CSH ) were 30% last year. And there's the convenience issue. Customers simply can't get small, short-term loans from their local bank. Folks in need of short-term financial solutions have been abandoned by traditional lending sources.
Though many associate bad credit practices with the poor, EZCORP (Nasdaq: EZPW ) has found that the typical customer in Texas using its maximum $1,500 payday loan service has an individual income of around $60,000 to $70,000 annually.
While Advance America and QC Holdings (Nasdaq: QCCO ) have remained solely payday lenders, the others have branched out into related fields. EZCORP runs pawn shops, as do First Cash Financial and Cash America, while Dollar Financial (Nasdaq: DLLR ) does payday loans, check-cashing, bill payment, and money transfers. Buy here/pay here used-car dealerships are another new area payday lenders are beginning to explore.
In a very Lynchian way, payday lenders are good investments. They're disliked by large swaths of people, and they have a high ick factor, but they provide a necessary and highly profitable service. Despite attacks from regulators, payday lenders will survive and thrive. That's good for investors, and it's why I love 'em.
What's setting Fools' hearts aflutter? Go back to our intro page to see what else we have a crush on.