Cash America International Inc.'s strategy of de-emphasizing its payday stores in favor of Internet lending is producing the "eye-popping" growth its executives anticipated - both in loans and loss provisions.
The company says it is happy to trade near-term credit quality for fast growth in an effort to sign up online customers who will pay back their loans and frequently come back for more. Though Cash America is not the only company in its field using the Internet to make loans, it has been the most aggressive by far.
Following a strategy of plowing into new online markets such as Texas and Florida, loading up on new customers, and absorbing heavy amounts of bad debt, Cash America wrote $443.8 million of cash advances in the first quarter, more than twice its volume a year earlier. The Fort Worth company's loss provision grew more than sevenfold over the same period, to $32.7 million, and its loss provision as a percentage of cash advance fees more than tripled, to 41.7%.
"The loss rates were a little higher than I was expecting," Daniel R. Feehan, Cash America's chief executive, said on an April 26 earnings call. Thomas A. Bessant Jr., its chief financial officer, said on the call that as a "general rule of thumb," loss rates should be twice as high as a typical brick-and-mortar operation experiences.
But Mr. Feehan said, "If I was doing it all over again, I would have done exactly the same thing."
"We believe the preferred strategy for moving in a new territory is to book the business, load up on collection staffing, man the data, and continuingly adjust the underwriting model for optimum long-term profitability," Mr. Feehan said.
He said "a more timid approach" designed to keep a lid on bad loans would have meant fewer customers and hence fewer potential return borrowers, who offer the possibility for vast long-term "payoff" as the company moves past customer acquisition costs and gathers payment history data.
Though Cash America does not break out online volume, the channel is clearly driving its growth in loans and loss rates, since the company added a net of only 10 payday stores in the first quarter compared with a year earlier. (It also added 21 pawnshops, but the volume of cash advances extended from its pawnshop network only increased 8.2%, to $15.5 million.)
Cash America, which operates the nation's largest chain of pawnshops and has been making payday loans since 2000, entered the online payday business in September, when it bought Check Giant LLC and its operating subsidiary CashNetUSA for an initial purchase price of $35.9 million.
At the end of last year, Cash America had 487 pawnshops and 295 stand-alone payday offices.
In a conference call on fourth-quarter earnings, Mr. Feehan said that the company would restrain its brick-and-mortar investments in favor of building CashNetUSA and that he expected online revenues and operating income to exceed payday earnings from its store network by the end of the year.
The surge in Cash America's first-quarter volume, which Mr. Feehan said on the April call reflected "hypergrowth" from its acquisition of CashNetUSA, suggests it is already nearing that mark, at least for revenues. The company has provided limited financial data on its online business as a separate segment, but Jeff Schollaert, an analyst with Wachovia Capital Markets LLC, estimated Tuesday in an interview that about 45% of $115.5 million in total outstanding cash advance balances at the end of the period were attributable to it.
CashNetUSA had a cash advance portfolio of about $22 million when Cash America agreed to acquire the business last July.
Other operators of large microloan chains have entered the space more cautiously.
Dollar Financial Corp. of Berwyn, Pa., provides installment loans over the Internet, but the offering is a small part of its business.
Donald F. Gayhardt, Dollar's president, said in a March interview, "Overall, clearly we need to get more comfortable with the economics of the business. … It's safe to say that at some point in the near future, we'll be in it, hopefully in a meaningful way."
On April 2, CompuCredit Corp. of Atlanta bought a 95% stake in MEM Capital Ltd., an online microlender in the United Kingdom.
Darrin J. Anderson, the president QC Holdings Inc. of Overland Park, Kan., said on a May 3 conference call that it had developed an online lending platform, "but it's not a material piece of our business. We have also looked for acquisition opportunities in the online space. Unfortunately, we have not found one that made sense to us."
Mr. Feehan said on the first-quarter call, "We are still climbing the learning curve ourselves of the online space."
Mr. Schollaert said that the "key question" about the model is whether loss rates will "come down over time as the repeat customer base increases. But I don't think we'll know the answer to that … at least until the end of this year."
On the first-quarter call, Mr. Bessant said Cash America's leads cost "in the high 20s to the low-mid 30s," a significant sum for small short-term loans - the company's average cash advance in the first quarter was $409. Mr. Bessant said the company hopes to convert a "minimum of 50% and hopefully closer to 60%" of the leads to customers.
Mr. Feehan said the rate of return for online customers has been in the "85% to 90% range," which is comparable to its storefront experience and would be sufficient to put the business "in good shape."
Mr. Schollaert sees the possibility for cracks in Cash America's loan volume.
"As this product matures over the next few years, you'll see the people that used it once just to try it out. If those people don't come back, then you'll see a drop-off in volume," he said. "As you see more retail stores being built, people may like to go the retail route."
However, Mr. Schollaert also said the Internet can reach customers - such as those in rural markets - who will never have access to a store.
Mr. Feehan said that so far, online borrowers appear to be a distinct constituency defined by their desire for "convenience and anonymity" and that the latter factor underlies the channel's higher loss rates.
"It is clear to me that very significant demand exists for this product online, and the online traffic today is not dominated by customers migrating out of the bricks-and-mortar locations," Mr. Feehan said on the first-quarter earnings call.
Though such "migration" is ultimately likely, he said, it will "probably take years."
