By Jeff Bailey
News that JPMorgan (JPM) is ending its banking relationships with certain borrowers - the Wall Street Journal reported these less-desirable customers might include pawn shops, payday lenders, check cashers and certain low-transaction-value car dealers - suggests investors in the lower end of the lending business ought to at least begin to worry about liquidity at those companies.
Typically, such lenders operate using a line of credit from a bank or banks, though some have issued notes and bonds on their own. Those funds, along with capital already in the business, are used to make super-high-interest-rate loans to less-creditworthy consumers, be it in the form of pawnshop loans, payday loans or other short-term small-amount loans.
In the past, liquidity has dried up for some such lenders when their loan losses increased to worrisome levels. JPMorgan's retreat from the business, however, appears to be part of a broader effort to make peace with banking regulators in the wake of multiple scandals at the giant bank.
YCharts reported last year that major banks were once again getting more involved in the sub-prime business.
If the reassessment of sub-prime lenders is limited to JPMorgan alone, liquidity concerns could be short-lived. If other major banks that have embraced the small-loan industry as a customer also begin to reduce exposure, then the sub-prime world would have bigger worries.
Some of the stocks, including Cash America (CSH) -- named in the Wall Street Journal as a loan company JPMorgan has ceased doing business with -- First Cash (FCFS) and World Acceptance (WRLD) have been strong performers since the financial crisis five years ago. World Acceptance and First Cash shares, in particular, have been rockets, as seen in a stock chart.
Sky-high gold prices brought the pawnshop lenders in the industry - Cash America and First Cash among them - a windfall in recent years, as consumers pawned gold jewelry, or sold it outright, and the pawnshop chains were able to later sell the gold at a large profit. As gold's price has plunged over the last year, those easy profits have mostly dried up.
Cash America operates nearly 1,000 locations, nearly all of them pawnshops, in the U.S. and Mexico. Revenue and net income were both essentially flat for the first six months of 2013, as the gold price decline and lower-than-desired loan demand cut into growth.
First Cash operates more than 700 mostly large-format pawnshops in Mexico and the U.S., and about 100 smaller consumer loan shops. Revenue was up about 14% during the first half of the year and net income rose about 6%.
World Acceptance, which operates about 1,200 loan offices in the U.S. and Mexico, making personal loans from about $300 to $4,000, is more of a traditional loan company that the pawn outfits. World Acceptance's fiscal first quarter, ended June 30, included a 9% increase in revenue and a 2% increase in net income.
The companies are all solidly profitable (and we're not suggesting any of them currently have liquidity problems), using high interest rates on loans to offset a relatively high level of loan charge-offs. Of World Acceptance's roughly $1 billion in loans at March 31, for instance, about 24% carried interest rates of 21% to 36%, the lowest rate range. About 9% of the loans, including most of the loans in Mexico, carried rates above 100%.
World Acceptance, in the fiscal first quarter, charged off 13.5% of loans, on an annualized basis. It's a rough business.
For a look at the inner workings of the small-loan business, which resembles hand-to-hand combat, see the earlier YCharts article on Advance America, which was sold to a Mexican billionaire last year and is no longer publicly-traded.
Liquidity is a concern for every company. Witness J.C. Penney (JCP) selling stock, which has diluted the interest of existing shareholders, in anticipation of the holiday retail season when it will need more cash to pay suppliers (and ward off rumors that it doesn't have enough cash).
But the financial sector, which operates with lots of leverage and is reliant on the confidence of markets, is particularly vulnerable to liquidity problems. That's why Golden Sachs (GS), Bank of America (BAC) and General Electric (GE), all reached out to Berkshire Hathaway's (BRK.B) Warren Buffett for an infusion of both his cash and his reputation during the financial crisis. And why the U.S. Treasury so thoroughly threw its support behind the entire banking system.
Banks, at least, can raise money with the lure of federal deposit insurance, giving them liquidity in all but the worst of times. But specialty lenders often rely on funding from a small group of banks, and those big lenders can cut-and-run for just about any reason.
Jeff Bailey, The Editor of YCharts, is a former reporter, editor and columnist at the Wall Street Journal and New York Times. He can be reached at firstname.lastname@example.org. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.