It's been a tough start to the year for shareholders of Cash Converters International Ltd (ASX: CCV) and Money3 Corporation Limited (ASX: MNY), with their share prices down 11% and 3%, respectively.
Their poor share price performances come amid an 8% rise in the S&P/ASX200 (Index: ^AXJO) (ASX: XJO) and despite cheap-looking share prices.
So what's going on?
Like any share market investment, before buying shares in either one of these companies, it's imperative to have an understanding of how their businesses operate and the markets they serve.
As payday loan providers, Money3 and Cash Converters are likely to target customers with lower disposable incomes because they are more likely to need small loans to help them meet their financial commitments.
As a result of the higher lending-risk profile of these individuals, the two companies must charge higher interest rates and fees on their loans in compensation for the added risk.
However the potentially unconscionable higher interest rates and fees, often incites political debate and regulatory intervention.
In recent years we've seen caps on fees which hurt payday loan providers. In 2013, the small amount lending provisions of the Consumer Credit Legislation Amendment (Enhancements) Act 2012 was introduced.
Over in the UK, where Cash Converters also operates, similar regulatory intervention is ongoing.
Here in Australia the payday loan market represents just 0.4% of the total consumer credit market but has grown 125% since 2008. According to The Age, Money3 and Cash Converters are believed to control 75% of the market share combined.
In a report by the Australian Securities & Investments Commission (ASIC) released earlier this week, a number of short-comings were identified within the $400 million payday loan market.
For example, ASIC reported, "We found that approximately a quarter of the 288 loans we reviewed were entered into with consumers who received more than 50% of their income from Centrelink." Under the enhancements introduced in 2013, protections were developed for consumers who derive more than 50% of their income under the Social Security Act.
Further, under the enhancements, lenders cannot issue loans which have repayments exceeding 20% of their customer's income. However, whilst ASIC found no evidence to suggest this provision wasn't being adhered to, it said, "Our review found that in many instances lenders were not complying with their own policies."
Should you buy or sell Money3 and Cash Converters shares?
According to ASIC's report, since the recent legislative changes on small loans were introduced, 70% of payday lenders diversified their business (including entering the medium-sized loan market) and the industry saw a 14.2% reduction of lender licences between December 2013 and December 2014. In 2013, Cash Converters' share price fell around 23%.
Looking ahead increased regulation will undoubtedly have an adverse impact on existing payday lenders who cannot easily adapt to increased oversight.
Personally, I own shares in Cash Converters but given its track record in dealing with these matters and its recent distasteful capital raising, I'd be much more comfortable holding Money3 Corporation shares instead. However if you choose to buy and hold shares in either company you must accept that increased regulation is a key risk to profits and payday lending is a tough business at the best of times.
