Fat Times for the Poverty Industry

There's a saying popular among those in the business of making small-denomination, short-term loans against a person's next paycheck.  A banker may want 100 customers worth $1 million, the payday lender likes to say,  but we prefer 1 million customers each worth $100.

The pawnbroker, the subprime auto lender, and the rent-to-own operator might say the same.  These and other merchants, part of what might be called the poverty business, thrive on an upside-down universe in which customers without money are good for the bottom line.

You'd figure, then, that these storefront lenders operating on the economic fringes would be making out like bandits with financial misery at a high. Yet to hear them tell it, they're struggling through hard economic times like most everyone else.  Defaults are up, they claim.  An economy with fewer jobs means less people with paychecks to borrow against.  

Meanwhile, despite their protestations, somehow they're managing to continue to make fat profits off people with thin wallets.

At quick glance, the payday lenders might seem to be struggling.  Just check out the stock of the country's largest payday chain, Advance America.  Its share price is down nearly 30 percent compared to two years ago.  That compares to a 19 percent drop in the Dow Jones Industrial Average over that same period.  Stock prices of the other publicly traded companies making payday loans (hard to believe, but there are at least six others) have similarly suffered.

But dig a little deeper and you find that the payday industry's woes have little, if anything, to do with the health of the payday racket.  The average size of a payday loan is up, according to public filings.  So, too, is the average fee a customer pays for a loan.  Maybe most significantly, the number of customers stopping by each store has been on the rise over the past couple of years.  The payday lenders say they are losing customers on the bottom of the economic pyramid.  But with credit harder to come by these days, more people are suddenly noticing the corner payday lender, at least in the 34 states where the laws allow operators to earn triple-digit returns on the money they put on the street.
 
"People who might have been able to take out a home equity loan in the past are now going to the payday lender," Larry Meyers, an investor in payday stores and a prolific pro-payday blogger, told me.  "People who could borrow through their credit card -- that's not an option anymore for a lot of them."  

Of course, high unemployment poses a concern for payday lenders.  It's hard for someone to borrow against their next paycheck if they're no longer receiving one.  But some of the big chains have maneuvered around that problem by offering payday loans against a customer's next unemployment check.  

The bottom line: Advance America is earning more at each individual store today than it did in 2007.  So, too, was Check Into Cash back, a 1,200-store chain, at least back in 2009, when its owner, Allan Jones, was still talking to me and before he started reading reviews of a book I wrote about payday and other lunchpail lenders.

"I had a real good January," Jones told me when I visited with him in the winter of 2009, smack dab in the middle of the worst times.  "It's looking like I'm going to have a real good February, too."

So why the lousy stock prices?  One reason is the payday industry's orgy of overbuilding.  When Advance America went public in 2004, it was reporting a profit margin of 23 percent.  By 2009, that figure was below 10 percent.

"As an industry, we just overbuilt," Billy Webster, co-founder of Advance America and today its board chairman, told me.  By 2006, the industry had reached 24,000 stores -- more than the combined number of McDonalds and Burger Kings in the U.S.  The real problem wasn't so much rival stores competing for the same customer, Webster said, as what he dubs "the multiple loan problem": it's too easy for a person to owe money to several stores at once.

The multiple loan issue has helped create a second, bigger problem for those in the quick cash advance business: states all around the country have been changing their policies that govern how storefront lenders operate.  Ohio, Arizona, New Hampshire, Oregon -- that's just a partial list of jurisdictions that recently clamped down on the payday lenders, either through legislative action or popular vote.

And then there's the national rate cap floated by, among others, Illinois Senator Dick Durbin, the Majority Whip.  That could wipe out most of the industry in a stroke of a pen.  "It's hard to say a stock is worth very much if tomorrow the government could put you out of business," Advance America's Billy Webster said with a sigh.

The pawn industry offers a similar narrative.  On one level, business is great, several pawnshop owners told me.  Every day brings in more people who never imagined going to a pawnbroker -- with a flat-screen TV or an expensive piece of jewelry in hand, desperate to make the next house payment or cover some other bill.

Cash America, for instance, with 600-plus pawnshops, has seen its revenues grow by more than 20 percent between 2007 and 2009.  Its stock price has soared by nearly 50 percent over the past two years.  The two other publicly traded pawn chains have seen a similar jump in their share prices.   

But years back Cash America jumped aggressively into the payday business.  So, too, did its publicly traded rivals -- and now all three are suffering the consequences.

"For a lot of these guys, payday was like adding rocket fuel to the bottom line," said Jerry Robinson, a former payday lender who also worked as an investment banker advising those wanting to get into what he calls the 'specialty finance sector.'"  But the future of the payday business is so cloudy that it's been more like rice in the gas tank for these stocks that might otherwise be the toast of Wall Street.  

These days pawn envy is rampant inside the payday industry, just as payday envy gripped the pawn industry through much of the 2000s.  But Robinson, who today hangs out his shingle as a consultant based in Atlanta, wishes he were in the 'buy here, pay here' business right about now.  That's the industry nickname for used auto lots that not only make money moving metal but also the paper by financing the cars that they sell.

" 'Buy here, pay here' will be a fabulous business for at least the next five years," Robinson told me in 2009.  "People always need transportation, no matter how bad their credit."  A 'buy here, pay here' customer is typically paying an annual interest rate of between 18 and 25 percent, Robinson said, "but there are a lot of people out there right now who don't have any other option."

A customer base with a sense of desperation and few options: now what can be better for business than that?

Robinson was also bullish on another sector of the poverty industry -- those in the business of renting furniture, electronics, and appliances by the week or month.  Aaron Rents, for instance, one of the giants of the rent-to-own field, saw its stock price soar by 38 percent in 2008, though it was probably the market's worst year since the 1930s.  

"There will always be cash- and credit-strained customers out there,"  Aaron CEO Robin Loudermilk told The Wall Street Journal at the end of 2008.  "That's why our business is so strong."