For Pawnshops, the Recession Is a Golden Egg

Think pawnshops, and you probably conjure up old jewelry, desperate customers, and seedy storefronts. Hardly, it would seem, the ingredients for innovation. Yet amid recession, the country's largest chain, Cash America International (CSH), is using the credit-crunch boom time to lure new customers and expand. To woo the growing number of consumers facing a credit squeeze, Cash America is boosting the amount of short-term loans it offers online, and is adding a cash-advance feature to electronic payroll cards. Such cards are gaining popularity among employees with poor credit, or those without traditional bank accounts.

"We see the continued contraction of available consumer credit as a great opportunity to expand our offerings to try to attract new customers," CEO Daniel Feehan says. But amid the flush times, Cash America is becoming increasingly reliant on its payday lending division—just as many states and the Obama Administration are threatening to clamp down on that industry. On Jan. 7, Sterne Agee analyst Henry Coffey highlighted Obama's pledge to "cap outlandish interest rates on payday loans"—a note to clients that sent Cash America shares slumping 12% in a day. The prospect of regulation has caused the stock to slide more than 35% in less than a month. Shares are down from 48 in April 2008 and now trade at 18, their lowest point since June 2005.

Mexico Beckons

Cash America has been leveraging the downturn through the firm's 613 pawnshops and 248 stand-alone short-term cash-advance outlets (two-thirds of the pawnshops also offer cash-advance and payday lending loans). While most retailers and financial-services firms tanked in the fall, Cash America's total revenue increased 7% in the fourth quarter and 11% for 2008. The company added market share in December by acquiring an 80% stake in a Mexican pawnshop operator, which will let the firm open an additional 50 to 60 stores this year in Mexico, nearly double the amount it opens in a typical year globally. Moving into Mexico is smart, say analysts like Elizabeth Pierce of Roth Capital Partners, because the firm can open new outlets without building new stores. Mexico is also appealing because it is a cash-driven economy where approximately 80% of transactions are done in cash, says Pierce. "Given the fact that it is much more of a low-wage economy, there are tremendous growth prospects in Mexico."

Since its founding 25 years ago in Fort Worth, Cash America has sought to make the pawn industry respectable. Unlike the dark and dank shops with bulletproof glass featured in Hollywood classics like The Pawnbroker, Cash America's pawn stores more closely resemble mall jewelers or a local Blockbuster (BBI) outlet. Pawnshops lend customers money, without running a credit check, in exchange for pawned merchandise ranging from Grandma's diamond ring to iPods to electric lawn mowers. If a customer can't pay back the loan, then the shop sells the goods, usually at about 50% to 60% of the price of what an item would cost new. Though fees vary by state, the cost of a typical $100 loan is about $10 to $20 per month and 3 out of every 10 people "foreclose" on their goods on average, says the CEO.

Pawnshop operators like Cash America, its rivals EZ (EZPW) and First Cash International (FCFS), and the nearly 11,000 independent mom-and-pop shops, boomed in 2008 in large part because of the increase in gold prices. That meant that the collateral on loans actually increased in value. Gold—unlike an iPod—can also be melted down and resold. To attract customers who are starting to use their old gold as their ATM, Cash America started its own mail-in gold services. This strategy also allows the company to reach more affluent customers—who may not want to go into a brick-and-mortar store anyway—without having to invest in new real estate.

Regulation of Payday Loans

Still, the company faces a big challenge in 2009 if regulation of payday lending, a lightning rod for consumer advocates, increases. Payday lenders offer short-term loans that are often priced at a fixed-dollar fee. But the underlying annual interest rate in states without caps ranges from 195% to 574%. "The problem with payday [lending] is that it's just a debt trap," says Ginna Green, a spokeswoman for the Center for Responsible Lending. The group analyzed payday lending in California with the state Corporations Dept. and found that those who typically took out loans used the first loan to cover an emergency. "They get caught up for a minute but then two weeks later when the loan is due, they can't afford to pay off the loan and their other bills so they have to take out a new loan," says Green.

Currently, 16 states and the District of Columbia have interest rate caps of 36% or lower, which effectively make it unprofitable for Cash America to operate in those places. In 2008, Ohio lawmakers approved a bill to cap the interest rate at 28%, supported by 64% of voters when it was brought to a referendum. In response, Cash America closed 42 payday lending outlets, 24 of them in Ohio. If a nationwide rate cap materializes, Cash America could stand to lose a third of its annual revenue stream. Rising unemployment would also crimp the payday business, say analysts, since lenders need to have a job and receive a paycheck to get a loan.

But CEO Feehan says that if regulation constricts one part of the business, Cash America will continue expanding online and increase its focus on international business in countries lacking financial services for low-wage workers. Expanding electronic cash-advance loan options is another way Feehan is reaching more customers during the downturn without boosting operating costs by much. The online division now generates 60% of the company's cash-advance revenues and the firm is expanding online this year in the U.S., Britain, and Australia. While typical online loans are for $300 to $400 for two to four weeks, Cash America is developing new loans that could be up to $3,000 for 6 to 18 months. Cash America has also piloted a cash-advance feature on bank-sponsored electronic payroll cards, which employers in industries like construction or hospitality are increasingly offering to blue-collar and immigrant employees. Says Feehan: "We keep trying to find ways that will appeal to people other than walking into a storefront that says 'pawnshop' or 'short-term cash-advance outlet' to get past the stigma."

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