Pay day loans firms benefit from rising bank funding costs

Credit cards are barely mentioned in this week’s UK report on the future of banking. Yet the report suggests once more that funding costs will rise for banks. This has a knock on effect for their credit card businesses, which make up a decent proportion of retail banking revenue. We will focus on credit related companies with high short interest that could benefit from a clear-out of credit card customers at the big banks including: Cash America (NYSE:CSH), World Acceptance Corp (NASDAQ:WRLD), Dollar Financial (NASDAQ:DLLR), Provident Financial (LSE:PFG).

There is a general lack of transparency regarding how much revenue banks make from their credit card arms other than Barclays, which notes GBP791m of global revenues in 2010 - three quarters the size of the overall retail bank revenue. Funding this capital-intensive operation is only going to get more expensive, such that Barclays could choose to turn away certain unprofitable customers. However, demand to borrow Barclays’s shares is low.

Many of the securitization issues that were created (mainly in the US) to fund the credit card spending are due to join the long list of debt rolling this year – another potential roadbump for this activity. Further, banks have enjoyed access to cheap funds by borrowing directly from central banks under various forms of post credit crunch “quantitative easing.” This is coming to an end, leading to more expensive “wholesale” funding costs.
Rejected by the major banks, folks in need of money could turn to the short term providers of cash, those referred to as the “pay day loans” crowd.

As already noted in October, these companies are “marmite” stocks whereby investors either love them or hate them. Short selling is reducing but remains very high in: World Acceptance Corp (21%), Cash America (15%), Dollar Financial (6.5%), Provident Financial (17%). The average number of days it would take to close all the shorts in these stocks, in the order they are mentioned above, is: 20, 22, 7, 45. This is well above the average days to cover for the Financial Services sector, which is around six.

The rise in the cost of funding is seen by some as hurting bank earnings by between 5% and 10%. Some think this will lead others to follow Barclays’ CEO, Bob Diamond’s lead in dropping the guillotine on any units that do not produce his minimum stated return on equity (rumored to be 15%). One wonders: which departments will have to change and which firms will stand to benefit most?