If we were to believe the national press coverage of the Wonga collapse, it would seem that the payday loans industry is in terminal decline. All the urban myths of the Financial Conduct Authority’s payday regulation are coming out again:
- That hundreds of firms left the industry when the FCA’s high cost short term credit regime started in 2015 (Reality Check: This is based on a comparison of the number of firms with Office of Fair Trading licences to provide payday loans – most of which were inactive or very small – with those authorised by the FCA after it took over regulation of the sector).
- That borrowers now have no option but to turn to unregulated lenders following the FCA regulation (Reality Check: Many of the fastest-growing payday lenders today are new to the market since the FCA regulation started, backed by major international investors)
- That payday loans sold to debt purchasers somehow escape regulation (Reality Check: They don’t, so as a result debt sold will have been robustly tested during the purchaser’s due diligence).
Apex Insight’s annual research on the payday market (the 2018 edition was published in May) found that the FCA interventions have still left opportunities for firms to operate profitably in the market, provided they targeted their offers very carefully. Industry revenue started to increase last year for the first time since the FCA took regulatory control of the sector.
Our financial modelling suggests that it’s near-impossible for payday lenders to offer loans for periods under two months. Offering smaller loans, e.g. less than £200, is also unprofitable for loans under 12 months. This is because the FCA price cap doesn’t allow even the most efficient firms to cover the variable costs of offering those loans.
The effect of the regulation has, therefore, been to push the market towards more profitable lending options. As shown below, the ‘sweet spot’ for lenders are loans of 2 to 6 months, for values £400 to £1,000. Other loans may be offered, for example a typical minimum is £100, which we believe is offered to attract first-time customers, with a view to extending higher value loans later if the first is repaid on time).
Profitability of High Cost Short-Term Credit loans (Apex Insight Analysis)
It doesn’t roll off the tongue so well, but it’s now more accurate to use the FCA’s terminology of ‘High cost short-term credit’ to describe the industry, rather than payday lending. For better or worse, these aren’t loans that will be repaid at the end of the week.
Payday 2.0 firms – those that have successfully adapted to the FCA regulation or have created new business models designed precisely for it – are growing fast. Several are as well-recognised in the market today as Wonga would have been a few years ago, which is key to profitability as it lowers customer acquisition costs.
The firms have high trust ratings in online surveys and generally low complaints levels. Critically, given the way in which Wonga was shown to be exposed to the work of claims management companies, their compliance is likely to be nothing less than absolute. That is achieved through technology, as lenders have moved away from high street stores and brokers to focus on their direct online sales. Most firms were unprofitable last year, but we expect to see several breakeven by 2019.
Wonga may not be the last legacy firm to leave the market but don’t write-off the payday industry – there’s plenty of new investment and activity taking place to ensure high cost short term credit remains a high profile niche part of the UK credit market.
Frank Proud, Director, Apex Insight