Friends, Americans, countrymen, I come here not to debate the relative merits of short-term cash advances and the companies that offer them, but to bury the hopes of their investors.
The bill to create the ballyhooed Consumer Financial Protection Agency (CFPA) is in the Senate. Between expected amendments, other unrelated bills, and the CFPA itself, the payday loan industry is facing its greatest challenge yet: being regulated out of business. This isn't hyperbole, as you'll discover. Advance America
Listen well, ye traders of equities in a sector unfairly maligned, for this government-created scourge of consumer choice seeks to cap the interest rates payday lenders may charge and limit the number of loans they may issue to customers. Should these ill-conceived notions come to pass, your investments will surely crater, because they will irreparably damage revenues for payday loan providers.
Up until now, payday and pawn loans have been regulated by the states. The payday industry has always been the target of consumer activists who don't understand the economic model behind these short-term loans. Little by little, they've been hacking away at lender revenues, passing restrictive legislation. States including Ohio, Washington, and New Hampshire have already enacted laws restricting payday lenders. Similar measures are brewing in Colorado and Kentucky.
However, many state laws have exemptions that have allowed lenders to continue operating. So now Congress is getting in on the act.
What's in the works
The federal threat is three-pronged.
Prong No. 1: A 36% rate cap, supported by Sen. Dick Durbin, D-Ill., has been introduced before and has a chance of passing. This would make the payday loan business unprofitable because it allows lenders to collect only $1.38 every two weeks per $100 borrowed, compared with the $15 or more that some lenders now collect. The resulting 90% revenue cut would likely drive all payday lenders out of business.
Prong No. 2: Sen. Kay Hagan, D-N.C., yesterday filed an amendment that would limit people to a maximum of six payday loans per year. According to Hagan, 60% of payday loans are made to customers who borrow at least 12 times per year. New limits would cut payday revenues sharply. In my view, this threat has a greater chance of passing.
Prong No. 3: The CFPA will have the authority to regulate lending transactions. At this point, it's impossible to tell just how far-reaching that regulation might be -- or the impact on revenue and earnings for payday lenders. Uncertainty and fear certainly won't make shareholders happy.
What does all this mean in hard numbers? The impact of the proposed loan limit is easiest to quantify. The average customer takes out between nine and 10 loans per year, based on figures compiled by George Washington University's School of Business. Although some businesses have lower averages, that range suggests that a limit of six could reduce revenue from these loans by as much as 33% to 40%.
Below, I've come up with figures on just how big a role these loans played in 2009 for companies in the industry:
- Advance America -- $647.7 million in total revenue (100% from cash advance fees).
- QC Holdings -- $220.6 million in total revenue (78% from payday loan and credit service fees).
- Cash America -- $665.3 million in net revenue (36% from cash advance fees net of loss provisions).
- EZCORP -- $597.5 million in total revenue (22% from signature loan fees).
- Dollar Financial -- $527.9 million in total revenue (15% from U.S. consumer lending fees).
- First Cash -- $366.0 million in total revenue (14% from U.S. short-term loan and credit service fees).
The bad news doesn't stop there. Playing the role of Brutus, knife in hand, may be Elizabeth Warren, chairwoman of the Congressional Oversight Panel, who has repeatedly spoken out against "predatory lenders" and may end up running the CFPA. Another name bandied about for the CFPA role is Eric Stein, former head of the Center for Responsible Lending.
Advice for investors
So what does this mean for Fools who want to make sure they don't get stabbed on the steps of the Senate? The uncertainty surrounding this sector makes these stocks difficult to recommend. In fact, in the case of Advance America and QC Holdings, which are concentrated on payday loans in the U.S., I'd definitely recommend selling. I'd also sell Cash America, even though it gets substantially more of its revenue from pawn-based lending. That isn't quite the hot-button issue that payday loans represent, although pawn shops could conceivably end up falling under the CFPA umbrella.
The other lenders have expanded beyond U.S. borders, which should help blunt the impact of potential legislation. EZCorp and First Cash have been expanding into Mexico, where there is no usury cap and pawn loans have been popular for generations. They don't have a lot of revenue at stake and have little to no debt. Dollar Financial offers many different financial services and has a presence in several countries, so I think it's safe as well.
But investors definitely need to pay attention to happenings in Washington. My friends, Americans, and countrymen, I urge you -- stay away from payday loan exposure. The Ides of May are upon us!
Educate thyself further, Fool!