Don’t Fight Uncle Sam: Short Payday Lenders
The payday loan industry is on the verge of extinction.
In what appears to be the next phase of Operation Choke Point – reported for the first time here and here too – the Justice Department appears to be putting pressure on banks to shut down payday loan deposits. These are accounts that lenders use to conduct day-to-day business.
Operation Choke Point – a financial initiative that brought together the DoJ, the Federal Trade Commission, and the Federal Deposit Insurance Corporation – originally appeared to be aimed at preventing online lending by banning payment processors from processing online transactions.
That initiative followed the closure of the FDIC’s own paycheck advance product and the Office of the Comptroller of the Currency. It also comes in conjunction with the Consumer Financial Protection Bureau’s field hearing on March 25, at which the CFPB announced that it is in the final stages of issuing rules for the sector.
The DoJ seems to want to cut the heads off the payday lenders, and the CFPB might very well take care of anyone who kicks, much like the restrictions on lenders in the UK
To this end, a February 4 letter from the American Bankers Association to the DOJ protested:
“As we understand it, Operation Choke Point begins with the premise that businesses of any kind cannot operate effectively without access to banking services. It then takes advantage of this premise by pressuring banks to close down accounts of traders targeted by the Justice Department without any formal enforcement action or even charges being brought against those traders. “
None of the sources I have in the payday loan arena or at any of the major banks would go on record. My Opinion: There is a fear of reprisals.
But the situation for payday lenders appears dire.
In relation to the custodian situation Bank of America (BAC) spokesman Jefferson George told me:
“We haven’t pursued any new credit relationships in the payday lending industry in the past few years, and over time, many customers have shifted their banking relationships. In 2013, we decided to stop lending to payday lenders for good. Not only are we not pursuing new business opportunities in this sector, but we are also terminating our existing relationships over time. “
Fifth third (FITB) spokesman Larry Magnesen said practically the same thing.
From the spokesman for a payday company (emphasis mine):
“We have lost some long-term relationships with no warning or real explanation. It is certainly a challenge to run a business. I’m not sure where the program came from … it supposedly focuses on a number of “high risk” industries, however so far, apart from ours, I am not aware of any others who have been attacked.”
From the service provider of a major payday lender:
“The unhindered Chokepoint operation will paralyze this industry. My bank accounts will be closed. Not just ACH and not just transaction accounts, but company accounts because we are in that area. A friend of mine runs a pawn shop. He opened a new pawn shop, went to the local bank to open an account, and because he has a payday loan business elsewhere, the bank said they would not open the account – even though the payday loan business is in a different state, and had nothing with him to do this account. “
From a lobbyist:
“[I can] confirm that a prominent banker from a major bank in a Midwestern city told me they had been threatened with fines, even for opening an account for us. “
From a banker US bank (USB):
“This room has become even more difficult for my institution and I don’t think I could open accounts.”
It’s not just the big players. Even small chains are told to walk. A lender in the western US tells me, “We get nothing more from Wells Fargo than evasive general language. We have been with them for ten years. You make a lot of money with us. It is shocking. … For all the fees that banks can impose on us, they should attack us. Instead, we left the payday area. “
Of course, a large multiline operator told me that the company has no issues with its large bank, so these experiences may be decided on a case-by-case basis. He also suggested that right now it sounds like only payday accounts are being checked, and not installment loans, pawns, or check cashing accounts. He was even more concerned about the rules of the CFPB.
“We think there is one [revenue] Haircut, ”he said.
Another industry player tells me that they are in “full panic mode”.
Payday lenders cannot operate this cash-intensive business, with more than 100 million transactions per year, if no bank allows them to open an account at all.
How can this be implemented?
Your investment decision will depend on how you think things will play out.
On the banking side, I’m sure the payday lenders are looking for other options, but I don’t know what they are and I’m not sure if that matters. If Operation Choke Point does indeed threaten banks, it stands to reason that the DoJ and other authorities involved could threaten anyone else who tries to do business with the lenders.
If that’s okay with that, I would sell or short the publicly traded payday lenders: Cash America International (CSH), DFC Global (DLLR), EZCorp (EZPW), First cash financial services (FCFS) and QC stocks (QCCO). In fact, I am sufficiently concerned that I was short on some of them (see disclosure below).
At least all payday earnings are at risk as a company without a bank account cannot do business. If you examine each company’s 10-Ks, you will see that their US payday earnings exceed their net earnings, with the exception of First Cash. Only 7% of income in fiscal 2013 came from payday, although this amount is deducted from net income, it results in an EPS reduction of more than 50%:
If you think the industry is finding a way out – and it could be – then rate any company on its own merits, product mix, cash flow, and valuation … just like any other stock.
Are big banks affected?
Big financial stocks like BofA, US Bancorp, and JPMorgan Chase (JPM) seem to be leaving the room so they will lose the income from payday relationships. However, consumers who no longer have access to payday loans will revert to what they did before the product existed – bouncing checks – and overdraft revenues will increase.
But none of this should hurt sales much, and given the variety of huge financial flows, it shouldn’t change your investment strategy in the industry.
Lawrence Meyers is short and has put options on FCFS, CSH and EZPW. He’s been BAC for a long time. His short positions were opened on March 25th. shortly after the CFPB paper was published of its intention to post rules for the industry in the near future.