The payday loan industry faces imminent extinction.
In what appears to be the next phase of Operation Choke Point — first reported here, and also here — the Department of Justice seems to be pressuring banks to shut down payday lending depository accounts. These are accounts the lenders use to transact daily business.
Operation Choke Point — a financial effort combining the DoJ, Federal Trade Commission and Federal Deposit Insurance Corporation — seemed originally designed to shut down online lending by prohibiting payment processors from handling online transactions.
This initiative came on the heels of the FDIC and Office of the Comptroller of the Currency shutting down major banks’ own paycheck advance product. It also comes in conjunction with the March 25 field hearing by the Consumer Financial Protection Bureau, in which the CFPB announced it is in the late stages of issuing rules for the sector.
The DoJ appears to want to cut off the payday lenders’ heads, and the CFPB could very well finish off anyone still kicking, similar to the restrictions placed on lenders in the U.K.
To that end, a Feb. 4 letter from the American Bankers Association to the DOJ protested:
“As we understand it, Operation Choke Point starts with the premise that businesses of any type cannot effectively operate without access to banking services. It then leverages that premise by pressuring banks to shut down accounts of merchants targeted by the Department of Justice without formal enforcement action or even charges having been brought against these merchants.”
None of the sources I have in the payday lending sector, or at any of the major banks, would go on record. My opinion: There’s fear of reprisal.
But the situation for payday lenders appears grim.
In regards to the depository situation, Bank of America (BAC) spokesman Jefferson George told me:
“Over the last several years, we have not pursued new credit relationships in the payday lending industry, and over time many clients have moved their banking relationships. In 2013, we made the decision to ultimately discontinue providing extensions of credit to payday lenders. In addition to not pursuing any new business opportunities in this sector, we are also exiting our existing relationships over time.”
Fifth Third (FITB) spokesman Larry Magnesen said virtually the same thing.
From one payday company’s spokesman (emphasis mine):
“We have lost some long-term relationships with no warning or real explanation. It is certainly a challenge to operating a business. I am not sure where the program originates…it is ostensibly focusing on a number of “risky’ industries, but so far I am not aware of any others besides ours that has been targeted.”
From a large payday lender’s service provider:
“Operation Chokepoint left unfettered is going to cripple this industry. My bank accounts are being closed. Not just ACH, and not just transactional, but operating accounts because we’re in this space. A friend of mine operates a pawn business. He opened a new pawn store, went to the local bank to open an account, and because he operates a payday loan business elsewhere, the bank said they wouldn’t open the account — even though the payday lending operation is in another state, and had nothing to do with that account.”
From a lobbyist:
“[I can] confirm that I was told by a prominent banker at a large bank located in a Midwestern town that they’ve been threatened with fines for even as much as opening an account for us.”
From a banker at U.S. Bank (USB):
“That space has become even more challenging for my institution, and I don’t think I’d even be able to get accounts opened.”
It’s not just the big players. Even small chains are being told to walk. One lender in the western U.S. tells me, “We’re not getting any more than evasive, general language from Wells Fargo. We’ve been with them for ten years. They make a lot of money on us. It’s shocking. … With all the fees banks can charge us, they should be falling over themselves for us. Instead, we’ve exited the payday space.”
Of course, one large multi-line operator told me that it the company is not having any problems with its large bank, so perhaps these experiences are being decided on a case-by-case basis. He also suggested that, right now, it sounds like only payday accounts are being scrutinized, and not installment lending, pawn lending or check-cashing accounts. He actually expressed more concern with the CFPB’s rules.
“We think there will be a [revenue] haircut,” he said.
Another industry player tells me they are in “full-on panic mode.”
Payday lenders cannot operate this cash-intensive business, engaging in more than 100 million transactions a year, when no bank will permit them to even have an account.
How Is This Actionable?
Your investment move depends on how you think things will turn out.
As far as the banking issues are concerned, I’m sure the payday lenders are seeking other options, but I don’t know what they are, and I’m not sure it matters. If Operation Choke Point is actually threatening banks, it stands to reason that the DoJ and other involved agencies could threaten anyone else who tries to do business with the lenders.
If you agree, my move would be to sell or short the publicly traded payday lenders: Cash America International (CSH), DFC Global (DLLR), EZCorp (EZPW), First Cash Financial Services (FCFS) and QC Holdings (QCCO). In fact, I am sufficiently concerned that I have taken short positions in some of them (see disclosure below).
At a minimum, all revenue from payday is at risk because a company cannot conduct business without a bank account. If you examine the 10-K’s of each company, you’ll see their U.S. payday revenues exceeds their net income, with the exception of First Cash. Only 7% of its FY13 revenue came from payday, although subtracting that amount from net income is a 50%-plus EPS cut:
If you think the industry finds a way out of this – and it might — then you evaluate each company on its own merits, product mix, cash flow and valuation … just as you would any other stock.
Are Big Banks Affected?
Major financials such as BofA, US Bancorp and JPMorgan Chase (JPM) appear to be leaving the space, so they stand to lose the revenue from the payday relationships. However, consumers who can no longer access payday loans will go back to what they did before the product existed — bouncing checks — and overdraft revenue will rise.
But none of this should make a big dent in revenue, and considering how diverse big financials’ streams are, you shouldn’t let this change your investment strategy in the industry.
Lawrence Meyers is short, and holds put options on, FCFS, CSH and EZPW. He is long BAC. His short positions were opened on March 25, shortly after the release of the CFPB’s paper on its intent to announce rules on the industry in the near future.