Good Loans Gone Bad - The Truth From A Lending CEO

We hear a lot of bad things about payday loans in the news. Things like:

• Pursuing “customers” who are actually victims of fraud
• Emptying customers’ bank accounts at random
• Unfair treatment of people in default
• Rollovers (turning a short-term loan into long-term one with high monthly fees)
• Allowing customers to take out multiple loans at once

All whilst the lenders are, supposedly, laughing all the way to the bank.

In truth a lot of this stuff has actually happened in the past, but since 2011 a raft of new regulations have cleaned up the industry: the CCTA’s Good Practice Consumer Charter, the OFT’s Irresponsible Lending Guidance, and more recently the drafted CONC Sourcebook from the hard-as-nails new regulator, the FCA. But how did it get so bad in the first place?

The answer lies in that since payday loans moved into public eye, there have been a huge number of new entrants. Many entrepreneurs came to the industry doing sums like this:

“Lend £100, get back £130, do this 13 times per year… 1.3^13… I can turn my £100 into £3000! I can turn my £500,000 into £15m!”

A lot of people, including many journalists, probably think that’s how it works. The fact is that because there was so much competition in the market, the economics of the industry are not kind.

Take that £100 loan, where you pay back £130. If you don’t go directly to Wonga or Quick-Quid – the only two with a decent brand exposure – your application will end up in a “ping tree” lead distributor. There are so many portal sites for these ping trees that it’s now almost impossible to gain any market share through direct traffic. Once in a ping tree, lenders bid in real time for your application, and pay between £5 and £80 for the lead.

Any competent lender will be rejecting at least 50% of applications based on affordability, suspected fraud etc. So even at the middle of the ping trees (£40), a funded loan has cost £80 in marketing.

But those affordability and fraud checks cost a lot too. Wonga has gotten people used to quick cash, so lenders are under pressure to do things quickly and approve as many applications as they can. Lenders will certainly do an ID check and a bank account check, and all should do a credit check and some form of affordability check. The best will then take some proof of income, by ringing you to discuss your credit file and employment or by contacting your employer. Credit reports are quite unreliable here in the UK – there is no sure thing as “your credit file” unless you keep one yourself – so the chances are that only a small amount of information is visible to the lender. There is certainly no up-to-date information of who has a short term loan and who has not. All this will cost the lender £10 to £25 depending on the approach and how many applications are rejected.

Then there are the payment transaction costs. Sending money so quickly usually costs the lender £2 – £3 depending on volumes. Card transactions can be had for about 50p. Most lenders make a great many declined transactions, which might cost something like 5p each, but new regulations will stop this from April 2014.

A lot of these costs will be lower for the biggest lenders with the most purchasing power.

Then there are the defaults. If a company lends £100 to several customers, then some won’t repay. If 9/10 pay back, then I leant £1000, was supposed to get £1300, but actually only received £1170. If two customers default, then I only get £1040. With one defaulter, our 30% loan yield has been reduced to 17%. With two, it’s been almost wiped out.

Actually, it’s worse than that. According to Teletrack, 25% of short term loans are not repaid at 30 days past due date (Source: Payday in Numbers, 2013).

So if the new lead for an £100 loan is costing £80 to market, £15 to underwrite, £3 to charge and (say at a better than average rate) £19.50 in bad or dubious debt, then we have turned our £100 into £12.50. New business makes a huge loss. Repeat business for the same customer will start to turn a profit – as long as they don’t eventually default.

So, to turn any real profit (not just overdue debts on the balance sheet), payday lending companies have to:

• Have a huge amount of money to start with – spend a massive amount buying customers and cyclicly convert the lending funds into irrecoverable debt or low-yielding payment plans. A smaller proportion on top will be cycled for the actual loans.
• Get customers borrowing frequently or rolling over their loan (2-3 times just to break even), but this is not how this form of credit should be used!
• Pursue bad debt doggedly and add on lots of fees to try to cover the irrecoverable debt.
• Push the loan price as high as they can.

Smart-Pig does things very differently.

We don’t roll over loans, we don’t sit on ping trees, we don’t lend to people who can’t afford to repay and we are kind to ones whose circumstances change. We have a few trade secrets that let us sit outside this “bubble”.