Poor personal loan portfolios in a weak economy equals a lot of trouble. Couple that with a presidential administration completely against your specific business model and things go from bad to worse.
Poor personal loan portfolios in a weak economy equals a lot of trouble. Couple that with a presidential administration completely against your specific business model and things go from bad to worse. These are the current circumstances surrounding publicly traded payday loan companies. The risks associated with many of the these companies are shocking – including the complete elimination of the payday loan business model as we know it. The negativity doesn’t end there. Most of of the payday loan companies target citizens in “vulnerable” financial condition with many practices being borderline abusive. All of these areas add up to one huge problem in the consumer finance sector sparking widespread reform and lawsuits.
Let’s first take a look at the business models of most of these companies without mentioning specific names. A typical payday loan company deals with individuals in “high-risk” financially distressed situations. These types of loans are usually advertised for people with emergency or unexpected expenses. Most of the companies use “installment” based loan payment systems that are heavily front-loaded and uncollateralized. This implies a certain tendency for “extended credit” to be given to individuals already behind on their current loan through refinancing. People inside the system know this as “loan flipping”. While it seems like a nice gesture, all it really does is ensure an individual will get deeper into debt. Being financially “trapped” by payday lenders is brought about through triple digit interest rates – something many people never recover from. Well over half of loan portfolios of most of the payday lenders fall into this category.
In a strong economy with high inflation this type of business model works great. In a credit strapped economy with high unemployment, high-risk “payday” loans, refinanced many times over is the worst place for money to be. In strong economies these types of loan practices often “fly under the radar”, but when the economy is weak people get into real financial trouble. Then important people really start to take notice. Things have turned so sour that the Obama administration has taken notice and responded with potential new policy suggestions – in turn sending payday loan operators down double digits in recent trading sessions.
Cap Outlandish Interest Rates on Payday Loans and Improve Disclosure: In the wake of reports that some service members were paying 800 percent interest on payday loans, the U.S. Congress took bipartisan action to limit interest rates charged to service members to 36 percent. Barack Obama believes that we must extend this protection to all Americans, because predatory lending continues to be a major problem for low and middle income families alike. Obama also believes that we need to ensure that all Americans have access to clear and simplified information about loan fees, payments and penalties, which is why he’ll require lenders to provide this information during the loan application process…
…Barack Obama will work with his Secretary of Treasury and the Federal Deposit Insurance Corporation to encourage banks, credit unions and Community Development Financial Institutions to provide affordable short-term and small dollar loans – and to drive the sharks out of business.
These words have surely sent chills down the spines of payday lenders. A President who calls payday lenders “predatory” and “sharks” definitely means business. At the very least payday loan companies will face restrictions on interest rates. This will severely weaken current business models and lead to the destruction of market share. Industry giants like Well’s Fargo who also offer payday loan service will take current loan sharks to the cleaners. Worst of all, the attention given to the industry will put lending practices under a microscope, exposing potentially illegal loans. Several payday loan companies like First Cash Financial (NASDAQ: FCFS , FREE Analysis) , World Acceptance Corp (NASDAQ: WRLD, FREE Analysis) and EZCORP Inc (NASDAQ: EZPW, FREE Analysis) reside in the state of Texas. Coincidentally, the lone star state has some of the most lax and unregulated lending laws in the United States. The list of lawsuits against payday lenders is virtually endless. A simple search on google brings up pages of indexed lawsuits against the aforementioned companies.
- Attorney General Darrell McGraw Sues to Enforce Subpoenas and Enjoin Predatory Practices of 12 Internet Payday Lenders and Collection Agencies – 2009
- Payday lending lawsuit can proceed, court says Plaintiff OK’d as class representative – 2009
- Lawsuit Filed Against Payday Loan Companies – 2007
- Cordnyn Files Suit In Austin and Mcallen Against “Payday” Lenders – 1999
It is our belief that the business model of payday loan operators may be near the end as we know it. President Obama’s recent policy release may in fact be “the drop of water that makes the jar overflow”. Recent attention given to potential policy revision will most likely open the floodgates for predatory loan lawsuits by affected citizens. If lawsuits succeed in highly unregulated states like Texas, loan companies will no longer have a place to hide.
Consequently, much of the inherit downside risk associated with publicly traded payday lending companies may not be sufficiently factored into share price at the present time. We believe businesses engaged in payday loan operations may face substantial and potentially catastrophic loss during the Obama presidency – or at the very least, until the US can reinflate the credit bubble. One of the highest risk payday lenders is World Acceptance Corp (NASDAQ: WRLD) due to their specific loan business model. While many companies operate pawnshops, World Acceptance Corp engages exclusively in uncollateralized loans, putting them at extremely high risk in the present economic environment.