Payday crackdown puts Cash Store debt in distress

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Cash Store Financial Services' bonds are trading at distressed levels after a crackdown on payday lenders by Ontario regulators threatens its ability to do business in Canada's most populous province.

The Edmonton-based company won't be able to offer its main type of loan in Ontario, where it operates a third of all of its stores, without an operating license by Feb. 15 after an amendment to the Payday Loans Act this month. Moody's Investors Service downgraded Cash Store's debt to Caa2, eight steps below investment grade, and said Dec. 23 it may cut the rating further. The yield on the company's C$133 million ($125 million) of 11.5 percent bonds soared to 29 percent.

"The regulator can put the company out of business overnight," Jie Liu, head of credit at Sentry Select Capital Corp., said by phone Dec. 24. Liu said he avoids payday lenders in general. "The business model of those companies really worries me. It's way too vulnerable in the way your business model completely hinges on your ability to get government support."

Payday lenders, which charge higher interest for cash sums over shorter periods than a bank loan, have come under criticism by the Archbishop of Canterbury as well as consumer groups and regulators for charging high interest-rates to low-income people least able to shoulder the burden.

In February, Prince Edward Island joined seven other Canadian provinces in announcing new regulations on the practice. Ontario, Canada's most populous province, said in September it would review the maximum borrowing fee and the use of mobile applications to sell loans, and explore new ways to monitor the market.

"The regulatory environment for this company has intensified, and that's why we downgraded," Moody's analyst Olga Khodosh said by phone from New York Dec. 24.

The downgrade by Moody's and the spike in yields will be resolved when Ontario grants the lender a new license, Craig Warnock, the company's chief financial officer, said by phone from Edmonton Dec. 24. Ontario's new regulatory regime doesn't threaten the company's ability to make bond payments, he said.

"We fully intend to comply with these regulations," Warnock said. Moody's "wants to wait and see if we get a license. They're just being cautious."

Cash Store charges annual interest of 59.9 percent to new borrowers. The rate ratchets down to 39.9 percent for more established customers, Warnock said.

Elsewhere in credit markets, the extra yield investors demand to own the debt of investment-grade corporations rather than of the federal government was unchanged on Dec. 24 from a day earlier at 118 basis points, or 1.18 percentage points, according to the Bank of America Merrill Lynch Canada Corporate Index. Yields rose to 3.1 percent, from 3.07 percent on Dec. 23. Canadian financial markets were closed for the past two days for the Christmas and Boxing Day holidays.

The premium investors demand for provincial debt compared with federal benchmarks held steady at 63 basis points on Dec. 24, according to the Bank of America Merrill Lynch Canadian Provincial & Municipal Index. Yields advanced to 3 percent, from 2.97 percent the previous day.

Corporate debt has returned 1 percent this year, compared with losses of 2 percent for provincial debt and 2.1 percent for federal-government securities, Merrill Lynch indexes show.

DFC Global Corp., which runs Money Mart payday lenders, withdrew a $650 million sale of high-yield bonds partly denominated in Canadian dollars last month amid a squeeze on revenue by rising regulation. DFC's revenue came under pressure last quarter as U.K. authorities moved to tighten rules on unsecured consumer lenders, causing Standard & Poor's to downgrade the company's credit rating.

This month's amendment by Ontario is the second time this year Cash Store faces regulatory scrutiny from the province, according to Moody's. In February, the Ontario Ministry of Consumer Services was preparing to revoke the company's payday license when it substituted a new one-year Line of Credit product to continue lending, Khodosh said.

The one-year loan has drawn attention because "it's a high-cost product for the consumers," she said. "They have to pay a significant percentage of principal on a regular basis."

Payday loans are most often taken out by low-income people willing to pay high interest rates to avoid falling behind on their bills or to cover emergency expenses, according to studies commissioned by the Canadian government and the Canadian Payday Loan Association.

The Church of England pledged to put payday lenders such as Wonga.com Ltd. out of business by starting a credit union to offer financial products to communities. The move, announced by Archbishop of Canterbury Justin Welby in July, drew support across the political spectrum.

"The annualized interest rate is so high it is almost unethical, and the business itself depends on irresponsible consumer behavior," Sentry's Liu said. "I don't want to encourage it, and I don't think it will last."

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