Think this represents the average payday loan company CEO? Think again. Profitability is hardly out of sight, even if it has allowed the industry to grow. (Photo: flickr.com)

Infinite profits earned off the backs of the infinite suffering masses. If you take your news from the multi-colored, sugar-laden toothpaste tube that is the mainstream media, then you believe that the payday loan industry is reaping massive profits while those who crawl about on their bellies are drowning in six inches of debt. It’s such an affecting image that it resides in some nether-region beyond belief. In other words, don’t buy the hype.

Payday loan companies aren’t a charitable organization, to be sure. They profit from the service they offer to consumers, but as studies like “The Profitability of Payday Loans” by Paige Skiba of Vanderbilt University Law School and Jeremy Tobacman of Oxford University indicate, the profits derived from interest are very much in line with those taken by more “traditional” lending institutions.

Short-Term Liquidity Has its Price

That’s exactly what payday loans and similar forms of short term loans provide. Their convenient immediacy (sans an extensive battery of credit and background checks) presents a certain amount of risk for lenders, so price protection is understandable. Skiba and Tobacman use financial data from the Center for Research in Security Prices (CRSP) and SEC filings, as well as loan data from several major payday loan companies.

While the most expensive payday lenders charge what amounts to over 1,000 percent APR (somewhat moot; payday lenders typically charge 12 to 20 percent for two- to four-week loans), the authors find that “lenders’ firm-level returns differ little from typical financial returns.” The implication here is that on a per-loan and per-store basis, the payday loan industry experiences high costs that bite into their “profits.”

Methodology of the Study

The authors examine the CRSP and SEC numbers for seven First we summarize publicly available, firm-level profitability data from CRSP and SEC filings. They find average returns of 10 to 25 percent each year in profit. That’s on a per-firm level.

On the individual level, it is observed that loans are generally small, yielding a meager $49 in interest on average. Yet five percent loss ratios eat up more than one quarter of that interest. Net returns (interest minus defaults) amount “in expectation over all of the marginal borrower’s loans to only about $100,” find the authors. Payday lenders, then, would appear to exist in a highly competitive environment where per-loan and per-store costs are indeed large when compared with interest earnings.

Firm-Level Profits

According to the data, payday lenders have performed well on average, earning 10.1 percent profit. Yet because returns have been volatile, the Sharpe ratio (of excess return) is close to zero. Stock data has revealed little indication of excess dividends and SEC 10-K and 10-Q show only “moderate” return on equity, find the authors. Looking at the data of the payday loan firms involved in the study and comparing their returns against those of companies in the S&P 500, the authors once again find that there is “a profile of firm-level profits that fails to approach annualized payday loan interest rates.”

It should be noted that government regulation of the payday loan industry, particularly the September 2006 Talent-Nelson Amendment cap on lending to active-duty military, have impacted firm-level large risk premiums, to the point where the FDIC even released a report (http://www.fdic.gov/regulations/safety/payday/) suggesting that the “unusual risk” accepted by payday lenders justifies the interest and suggests ways payday loan companies can effectively handle this risk.

Individual-Level Profits

How does interest as high as 7,295 percent (the highest instance in the authors’ study) per year lead to only a 10 percent equity return? The authors look at individual-level data for payday loan origination, repayment and instances of customer defaults. The authors determine a mean payday loan size of $283 and median of $269. Eighteen percent interest leads to average revenue of $49 per payday loan, but once losses are taken into account, the story changes. The authors observed that approximately nine percent of post-dated collateral checks bounce. Collections were found to be pursued internally for 60 days, during which time the lenders collected on about half.

Credit standards tell an important tale as well. The better the short term loan applicant’s credit score, the greater revenues payday lenders derive. The authors find that “the intercept of the best-fitting line at the credit score threshold is $100.49. Thus, if the industry is competitive, the total economic costs of servicing the marginal borrower equal $100.49.”

Small Money, Big Default

Returns are astronomical in theory only. Stock returns are also observed to be modest for payday lenders. Store-level costs have to play a major role in this. A 2003 study by Jerry Robinson and John Wheeler estimated 40,000 employees in the payday lending industry. Their wages totaled $1.4 billion annually. They also found that total interest revenue for payday loans totaled $4.0 to $4.3 billion in 2002, indicating that employee salaries eat up a significant portion of that (about one-third).

A 2003 study by Michael Stegman and Robert Faris found that while the 2000 per-payday loan outlet profit in North Carolina was $57,999, the capital requirements for these outlets amount to at least $35,606. This doesn’t factor in wage costs, rent, marketing or administrative expenses, but it does include bounced-check fees, screening costs and loan losses.

You begin to see how expensive it is to operate a payday loan business. Flannery and Samolyk (2005) found that store costs and their revenues are related to store age, too. Start-up costs and establishing a clientele are difficult hurdles that have led newer entrants into the payday lending market to consider the online payday loan market.

A Cash Flow Example

Skiba and Tobacman present this hypothetical. Let’s say a payday loan store has $10,000 in capital at the beginning of the year. If risk is loan default risk is eliminated from the equation and 18 percent interest is earned every two weeks, the take would be $739,500 by year’s end. If annual wages amount to $30,000 (paid out every two weeks), that bill would be a large part of the $1,800 in interest income at the beginning of the year. At that time, the store would only early six percent on its capital. The year-end result would be an annual net of 2,150 percent, which is profitable but hardly extortionary.

So Someone Thinks Payday Lenders Should Only Charge by Cost?

Critics want a flat fee for payday loans – regardless of loan size – but the truth is that so many cost variables exist such as the cost of firms to originate payday loans that per-store differences in fees charged are necessary. Considering the explosive growth within the industry (200 stores observed in 1990 according to the authors vs. 30,000 in 2004), which came in no small part due to lobbying, there is both a consumer need for the product and an environment in which they can successfully exist on the subprime market.

Pricing behavior is largely regulated by oversight organizations like the Community Financial Services Association and the Online Lenders’ Association, but businesses that exist outside these member organizations may unfortunately set rates that are far beyond what is necessary. This is where government regulation can help rein in payday loan companies with the most excessive prices (even if this group may be in the minority of the industry), but excessive regulation is not desirable. Stifling market competition and limiting consumer choice are hardly a desirable alternative.

Every once in a while, I think that perhaps I should invest in the stock market. People make a lot of money doing that, or so I’ve heard. I always shy away from going through with it, though,  because I feel like I don’t know what I’m doing.

Today is one of those days when I’m glad I haven’t tried to participate in something I don’t fully understand. I could have been one of the Sky Capital investors who got bilked out of all their money. Check out this tidbit from Courthouse News Service:

Sky Capital and the six men who run it sold millions of dollars of securities in a fraudulent boiler scheme to investors who were restricted from selling the stock, which became worthless, the Securities Exchange Commission claims in Federal Court.

Beware aggressive salespeople

Any investors who were counting on being able to sell their stock and use the money might have to turn to paycheck loans instead. This is another example of why sometimes people shouldn’t trust fast-talking salespeople. If a person tries to sell you something and seems to be withholding information, use your money somewhere else.

The SEC claims the firm’s founder, president and CEO Ross Mandell, of Boca Raton, Fla., directed Sky Capital brokers to make material misrepresentations and omissions and use high-pressure sales tactics to push stock in two related companies – Sky Capital Holdings Ltd. and Sky Capital Enterprises, says Courthouse News Service.

Give me the names

Courthouse News Service also printed the names of each person named in the Federal Court case:

Also charged are COO Stephen Shea of Brooklyn, and four former registered representatives: Robert Grabowski of Staten Island, Adam Harrington Ruckdeschel of New York City, Michael Passaro of Boca Raton, and Arn Wilson of Dix Hills, N.Y.
The SEC seeks disgorgement, penalties and injunctions.

Who can we trust?

Image by Matthew Stubstad

It’s tough nowadays to distinguish a good idea from a bad scam. Con artists have come out of the woodwork as the economy has deteriorated. Scammers promise help getting out of debt or lower mortgage payments, charge fees upfront at then make off with the cash.

There isn’t one good answer for how to avoid scams. A few simple tips, though:

• If it seems too good to be true, it probably is.
• If you’re unsure about a financial decision, don’t give in to pressure.
• Be wary of financial services that charge fees up front. Most debt consolidators don’t charge you until they have already completed their jobs, and likewise with mortgage adjusters.

Scary stock market

The only tip that would have helped those who were defrauded by Sky Capital is not to give in to pressure. If a business people or sales people really have great, legitimate deals, they won’t feel the need to pressure you into buying from them. After all, if they’ve got a great thing going, they should be able to find lots of buyers, right?

It’s a sad fact that humans will lie, cheat and steal for money, but it’s true. Be careful with your money.

"Nice one, James."

The fallout from the Bernie Madoff disaster continues. So, when is it that you’re going to step up your monitoring of financial fraud, SEC? Any time now…

Alistair Barr of MarketWatch brings our attention to James Nicholson, 42, the manager of the investment firm Westgate Capital Management LLC. Mr. Nicholson has been ceremoniously arrested at his Saddle River, New Jersey home on charges of securities fraud and bank fraud, according to the Department of Justice.

I learned it from you, Bernie

Nicholson told investors that Westgate Capital had assets within the company that ranged anywhere from $600 to $900 million. However, in true Bernie Madoff style, the real value of Westgate’s assets was substantially lower. As a result, investors dumped as much as $100 million into a variety of funds managed by Westgate since 2004.

It’s in the brochures; must be right!

Futhermore, Nicholson’s associated Westgate Strategic Growth Fund was audited by an independent accounting firm. However, the DOJ determined that this accounting firm was actually a virtual firm registered at a virtual address. In case of telephone inquiries, an answering service was set up that would direct calls to a phone number that Nicholson provided.

Brochures for Strategic Growth claimed “positive returns for each month from January 2004 through August 2008.” Similar brochures that made similar claims were produced for other Westgate funds. Reports were uniformly positive, despite what was happening in reality, said the DOJ.

Surprise, surprise – a Madoff connection

When Bernard Madoff’s $50 billion Ponzi scheme occurred, a number of Westgate investors wanted out. Around 24 of them got checks which totaled $5 million, but guess what? Those checks bounced! Bernie, James, Westgate Capital… you’ve made a killing!

Related links:

Found Fund Managers Charged with Securities Fraud

RealityTrader Trading Log: Feb 25 2009

George S. May Business BlogWG Trading, Westgate Capital sued by …

Here, let me take that money of yours...

BBC News reports that FBI agents in Virginia have located and served Sir Allen Stanford with civil papers, a quick loan courtesy of the SEC. They would like to see him pay it back with other people’s money… and jail time.

Stanford has been accused of $8 billion fraud against investors. The claim is that they were lured by the promises of “improbably and unsubstantiated high returns on certificates of deposit and other investments.” The SEC calls the case “fraud of shocking magnitude” that loans itself quickly and easily to the recent memory of Bernie Madoff’s $50 billion Ponzi scheme.

Richard Kolko of the FBI revealed that agents had served the legal papers to Stanford in Fredericksburg, Virginia, at the request of the Securities and Exchange Commission. This step was necessary in order to ensure that Stanford would turn in his passport and be made aware of what he faced, said the BBC’s Richard Lister from Washington. Criminal charges have yet to be filed, so Stanford is not currently being held in custody.

Bank terror bonanza

As a result of Stanford’s fraudulent operations, branches of banks controlled by the Stanford Group have been shut down or placed under national control in Peru and Venezuela. The former nation suspended operations for 30 days, while Venezuela has announced it will take control. Panama, Ecuador and Antigua have also have taken action against Stanford’s interests there.

Regulators would have liked to allay investor fears about the banks Stanford is associated with, but runs on banks were perhaps inevitable in light of the news.

A US civil court judge has frozen Stanford’s assets and those of the Stanford Group, Stanford International Bank (SIB) and investment adviser Stanford Capital Management. Experts predict that criminal charges will be brought on Stanford soon. Until then, Bernie Madoff remains the sole charged financial shyster to light up the news boards from 2008. Eventually, when Stanford joins the club, perhaps both will go on quick loan to jail. Quick, because the resourceful never stay for long…

Related articles

• SEC files charges in another “massive” fraud (americablog.com)
• Stanford charges spark run on banks (guardian.co.uk)

Oklahoma Sooners:

Coach Bob Stoops has leaded this team to a great season only losing once in the Southeastern Conference and winning their conference title.  They rank first in the BCS ranking system and are also ranked first in the nation in scoring averaging 54 points per game. Playing for the BCS national championship is nothing new to the sooner’s, this will be the eighth time playing for the title and the first since 2000 and the fourth time under Coach Stoops. Offensively they have a great quarter back in Sam Bradford who just won the Heisman trophy this year and threw a total of 48 touchdowns this season alone. Hopefully this team will pull together in one more great game of this season and show the Florida Gators who is boss.

Florida Gators:

Coach Urban Meyer brought his team to a similar season of only losing one game to the Texas longhorns in the Big 12 standings they won their conference. They came in ranked second for the BCS rankings right behind the Oklahoma Sooners. They are currently ranked third in the nation for scoring at 45.15 points per game coming behind of course none other than the Sooners. This team has fought hard and has kept their standing in their SEC conference, but they too have a Heisman trophy winner from last year tucked behind in the quarter back position Tim Tebow, who this year alone account for 40 touchdowns for his team.  This team is playing in their home state so let’s see who can beat the heat and win at the FedEx BCS national Championship, unlike those who get caught in the heat and need to take out payday loans to cool down.

Who Will Win?

With both teams showing great stride in their own league it is amazing that they are still thriving now. Some could dispute that the Oklahoma Sooners shouldn’t be playing at all and that it should be the Texas Longhorns but who knows with how closely their seasons were intertwined. All that matters now is that both of these teams are ready and rearing to go with the BCS National Championship only a few days away let’s wait and see who can prosper under the hot sun in Miami and win this year’s BCS Championship. With all this talk of heat and winning try to be more prosperous with your finances and only rely on  payday loans when you are in an emergency crunch.