Cash Connection Case 8 Study Analysis

Cash Connection Case 8 Study Analysis

In 1986, Allen Franks, President of Cash Connection, opened his first check-cashing store in Shreveport, Louisiana. Not only did Cash Connection provide check cashing and payday advances, they also offered prepaid phone cards, bill payment services, and money orders--serving as Western Union agents to transfer funds for customers. In the early 1990s, payday advance services grew as a result of a strong customer demand and varying circumstances in the financial services marketplace. This includes:

* The exiting of traditional financial institutions from small-denomination, short credit market--a change largely due to the market's high cost structure.

* The soaring cost(s) of bounced checks and overdraft protection fees, late bill payment penalties, and other informal extensions of short-term credit.

* The continuing trend toward regulation of the payday advance services, providing customers with important customer protections. Strickland C-113)

During the mid to late 1990s, Cash Connection was one of numerous companies competing in the substantially growing industry of short-term cash lending. By 2010, it is estimated that there "were more than 22,000 payday advance locations across the United States", extending approximately "$40 billion in short-term credit to millions of middle-class households" (C-113). This is a much greater number than the 9,500 banks disbursed across the country.

Payday loans are short-term loans that are meant to cover the borrower's expenditures until their next payday. The main reasons customers take out payday advance loans are to cover unexpected expenses, avoid a bills late charge, prevent a check from bouncing, and to cover the gap of a pay reduction. (C-124) These loans are quick and convenient even though they could pose a high repayment amount due to their exorbitant interest rates. The borrower usually writes a postdated check, with loans fees included, that is used as collateral for the loan. Another option is having one's checking account debited on payday by signing an Automated Clearing House (ACH) authorization form. The average amount of a payday loan is $300 with a term of 14 to 30 days typically. Fees fluctuate but average between $15 to $20 per $100. The steep APR of 520% applies only if the borrower were to pay $20 every two weeks for an entire year. The companies' charge these APR's because of the high risk they carry; many borrowers never pay back their loans. Because of these practices, all levels of government are watching payday loan companies with concern and attempting to heighten its control over the financial service industry. They have gone so far as to call them predators. The following are just examples of how the federal government is trying to regulate payday lenders:

 Truth in Lending Act: Requires lenders to disclose loan APR's and finance charges.

 Fair Debt Collection Practices Act: While applying only to 3rd party collection, the industry best practices set out by the Community Financial Services Association (CFSA) suggested that members adhere to the Fair Debt Collection Practices Act.

 The federal Deposit Insurance Act: Under Section 27 of this act, insured state-charted banks were allowed to charge interest rates that applied to their home states, nationwide. This led to numerous financial institutions to create credit card banks in states with no interest rate limits.

 Gramm-Leach-Bliley Act: The privacy requirements of this act applied to payday lender and were imposed by the Federal Trade Commission with respect to nonbank lenders. (C-124)

Although these companies have some bad reputations, they have made a significant impact to the United States and the states economies. The payday loan industry added more than $10 billion to the United States GDP in 2007 and nationally maintained more than 155,000 jobs. These companies made $6.4 billion in income labor and created over $2.6 billion in federal, state, and local tax revenue. (C-114)(Exhibit 1)

Exhibit 1: Total U.S. Economic Impact of Payday Lending Industry in 2007

Value Added to GDP TTL Employment Labor Income (EE Compensation) Tax Revenues Generated

$10,212,730,000 155,581 $6,415,800,000 $2,630,000,000

SOURCE: http://www.cfsa.net/downloads/eco_impact.pdf

A steady decline in net income from 2007 to 2009 (Exhibit 2), the inability to differentiate itself from its rivals, competitor saturation, the decline in the economy, and the loss of existing customers are substantial problems facing Cash Connection. Any additional restrictions from the government's looming regulations and policy changes can become quite costly and take away their competitive advantage, not to mention block their gain to the largest amount of market share possible.

Exhibit 2: Cash Connection Profit & Loss Statement, 2007-2009

Cash Connection's competition is strong. Banks, credit unions, credit card companies, pawnshops, and auto title lenders offer different features that can make a customer shift from one kind of loan to another kind. This increased rivalry in the payday lending industry is somewhat due to the slackening of federal restrictions starting in the early 1980s. Increased regulation in the loan service industry along with the financial industry had amplified the effortlessness in which new companies could enter the industry and still protect the revenue and profit of existing companies. Another component to the competitor saturation is the substantial profits that can be made through interest charges, fees, high customer demand, and the fact that the start-up cost of an individual location is approximately $130,000. The profile of a payday loan customer is one who has a job and a checking account. Rivalry among the payday loan service industry includes such companies as Check & Go, Check America, and Cash Advance America. This level of industry competition is a huge barrier to entry.

Large retail banks such as Bank of America, Wells Fargo, and JPMorgan have comparative products to payday lenders with checking account overdraft protection being the closest substitute, but these fees (NFS) could be as high as those from the payday lenders. These banks also have the increased capacity to produce service loan portfolios--which