Where there’s a Wonga, there’s a way
Where are we in the process of sanitising the UK payday market? Here’s a couple of news stories around Wonga’s recent financial results to update you:
Guardian: ‘Wonga losses more than double’
In our opinion the Guardian reporting is decent and independent in that it gives some context and history and does not just trot out a company PR press release. The FT, despite being an analytical business paper, doesn’t do such a good job. The first FT story looks as if it is a straight copy and paste of company PR. The second piece of “analysis” by Lex is super shallow with no real understanding of the business and an implicit approval of the ‘New’ Wonga.
However, none of the newspaper coverage gives either New Wonga or the general payday story any serious depth of thought. This is disappointing given that, along with concern groups and politicians, the press was pretty active in putting the boot into old pre-reconstructed Wonga and payday in general, and were a significant part of the noise that pushed government and regulators into action on the sector.
Action was indeed needed. Most productively that would be action that encouraged new entrants and product into the market. New and innovative is something that this market is sorely missing and all the fuss and “sanitisation” hasn’t ushered in real and hungry competition keen to make money and treat the customer better.
In terms of regulation, there was scope for some sensible and simple action. Sadly, that’s not what happened. In the end what we have ended up with is overly intrusive regulation by a regulator that does not really seem to understand how the combination of economic incentives, extended industry structure, barriers to new entrants and unintentional regulatory complicity with the status quo has made it extraordinarily difficult for new and genuinely innovative startups or products to enter this market.
Old incumbents have spent a lot of money in recent years on PR, advice, lawyers, etc to deal with the regulatory bullet that general opprobrium fired at them. We think they should give themselves a big pat on the back for money well spent. Why?
Full regulatory capture
Payday lenders have managed to shake the opprobrium monkey off their back and have persuaded the regulator into accepting a more cash generative product that is even worse for the customer as a product evolution that addresses regulatory and chattering class concern regarding affordability and vulnerability. This is a classic case of regulatory capture in an over-regulated and complex (partly now due to over-regulation!) market.
If you are an owner of Wonga or another ‘payday’ business then you have a lot to celebrate. Of course, best to do that behind closed doors and stay suitably po-faced in public and emphasis the pain (i.e. cost) of the journey you have been through. Journalists have unfortunately bought that simple line fed to them of pain and redemption. There are loads of comments in response to the Guardian article with a lot of ‘serves them right’ sentiment. PR job done! Concerned onlookers shaken off and issue put to bed due to the distraction of lower short-term profits and a reported beating by the FCA.
Losses are temporary and future profitability greater
Wonga’s profitability is about to recover spectacularly in the next couple of years. Most of the costs of FCA compliance (and public repentance) are sunk costs. There were many really rotten operators (whatever you think of Wonga, there were far worse) before the FCA got involved and they have disappeared now (a good thing and a success of FCA intervention). However, this thinning of competition is great for Wonga and will boost profitability as they pay less to compete for custom.
The industry will probably say that they have higher regulatory costs but we think this will likely be a transposition of costs from a reactive and defensive management posture to something that is more active in staying within FCA good books. Add a cost saving on top of that from the convenient loss of competition, and the FCA’s suppression of the high cost client aggregator sites that were a common source of custom for payday lenders, and unit cost per customer are probably going to look very good in the next couple of years. Again, thank you very much FCA. This will be called a management turnaround but really most back-slaps for future profitability will be owed to the FCA (and the politicians and concerned onlookers that prompted their action but didn’t pay attention to the results).
Wonga and others stepped back from seeking customers whilst the heat was on but they are now back aggressively looking for business. There has been a big increase in advertising and direct emails to old customers soliciting business now that they are fully authorised.
The not-for-profit and concern sector, for all their good work, can never meet the needs of this market. Its needs a commercial solution that respects and partners with the customer rather than exploits their lower wealth and more vulnerable financial status. Net income volatility is on an ever increasing path as benefits are trimmed back, living costs go up, wages are under pressure (even with minimum wage) and terms of employment are more volatile. The demand for short term credit is undoubtedly on an upwards trajectory.
Everyone is aware of the headline reduction in interest rate that the FCA mandated for short term credit and you will probably be thinking that this suppresses margin for payday lenders and protects the customer from being overly exploited. You need to understand the economics of payday and factor in the impact of product “innovation”…
Through the looking glass with FCA directed “innovation”
All the major payday lenders have moved from high cost classic payday loans (single repayment usually within one month) to even higher cost instalment loans. Yes, that’s right, even higher cost for the customer — it’s not a typo. This is being accepted as a good outcome in the press and by onlookers as APR is lower and the instalments are believed to be more affordable.
The new norm of high cost instalment loans is a shockingly bad outcome for customers and, prospectively, a shockingly profitable one for the lenders. We go into the details of payday economics in an earlier blog post ‘Paydaynomics’ so we won’t go into much detail here.
The sector has “innovated” 90 day high cost loans (at 0.8% per day price cap) rather than the old up to 30 day high cost loans (at a typical 1% per day). The 90 day product they now all sell as more “affordable” actually has much higher cash cost for the customer. Borrow £300 and payback approximately £450 over 3 months.
This compares to the old product that was typically borrow £300 for 15 days  and payback approximately £350. £100 extra over 2 months is a lot of money when personal budgets are tight and uncertain. Of course, £150 out of your pocket for the first repayment is much more “affordable” than £350 but it is clearly a false saving. Simple common sense says that £450 is a worse deal than £350 in most scenarios given the still very short time horizon of the loan .
If you need to payback £300 in instalments then there is high chance you have an affordability problem and the last thing you need is for the price to be increased by £100 to £450! And, where the customer is not vulnerable or assessed to have affordability issues, yet is still using high cost instalment loans, it seems quite likely that their problem is financial exclusion rather than affordability. This is financial vulnerability created by financial exclusion which is a circular problem for too many that alternative finance and ‘grimtech’ exploits for profit .
The Guardian article reports that Wonga’s defaults in the UK are 2.8%. That’s a high number relative to mainstream credit representing elevated affordability and vulnerability issues for people with less financial depth (partly a result of financial exclusion). But how does 2.8% default lead to £150 of interest on a £300 loan over 3 months? 2.8% of £300 is £8.40. We believe that a lot of the extra £141.60 the customer pays comes down to financial exclusion that results from a confluence of misrepresentative data (see our earlier post ‘The data and the damage done’) and the affordability/vulnerability nonsense providing the alibi to justify exorbitant prices.
It is perverse beyond comprehension that a cohort of people viewed to be more at risk of affordability issues yet only default at a rate of 2.8% are now charged 50% for a short term lump sum loan rather than the old rate of 16.7% when they defaulted at a rate of 6.6% .
Bad regulation helps keep people in the financial ghetto
For the moment, the inadvertent collusion provided by the FCA gives cover to the financial ghetto masters, making them seem reformed and more respectable. This allows them to exploit their unfortunate captives even more than before.
The perversity of historic concern about payday and the heat and thrash that led to FCA intervention is that it has resulted in a worse outcome for those payday customers that have the financial capability to afford a payday loan under the new regime. These customer are trapped in a twilight financial world where mainstream financial services tend to shun them as they are either not wealthy enough or don’t have a good enough credit score which makes them ideal victims for ‘alternative’ finance providers.
Real financial inclusion needs sympathetic commercial solutions. Good commercial solutions flourish with simple regulation and minimally intrusive regulators. Today in short-term credit we have a complex and escalating war between regulators and consumer finance firms that suits the incumbents as they are the best armed to fight this war.
Inadvertently, due to regulatory capture, the FCA has helped make loans more expensive for poor borrowers and probably more profitable for the “legal loan sharks” and no-one cares! Regulation has been woefully ineffective in creating a better outcome for borrowers. Only competition can do that and the FCA, and many industry factors that the FCA helps to persist, are an unnecessarily high barrier to competition.
In the meantime, watch as the volume of the new “innovative” payday loans mushrooms to meet the ever-increasing demand that’s out there.
 Lenders must use the average duration and value of loans in the representative APR calculation they displayed. Pre FCA market reforms this was approximately 15 days and £300 for Wonga.
 Don’t be fooled by the significantly lower APR on instalment loans. The 15 day loan has an APR of c.4,200% and the 3 month loan of c.1,200%. APR is not really a sensible tool for comparing very high rates of interest over relatively short periods of time where modest changes in rates, timeframes and repayment schedule cause massive APR changes. It is most sensible to focus on cash costs. The difference in cash cost for the loans discussed above is dreadful.
 We believe that many users of payday or high cost instalment loans are financially excluded more than they are financially vulnerable and the regulatory semantics (and the processes it feeds) around vulnerability and affordability hinder their path to financial inclusion. Of course, exclusion makes a consumer more susceptible to vulnerability as they lack the financial tools that the majority enjoy.
 Repaying £450 for a £300 loan is 50% interest, and repaying £350 for the same loan is 16.7%.