Rentcash tripped up investors with troubling disclosure

…the company's market value has shrunk by $335-million after a hilarious display of ineptitude — hilarious, that is, to everyone but Rentcash shareholders, who've lost 57 per cent of their investment in six days.

The Globe and Mail
September 15, 2005

Rentcash tripped up investors with troubling disclosure
Derek DeCloet

Rentcash is one of the hottest growth stories in Canadian finance, with a fast-moving stock price that has turned $1,000 into $12,000 in less than a year.

Scratch that. That was the story a week ago. Since then, the company's market value has shrunk by $335-million after a hilarious display of ineptitude — hilarious, that is, to everyone but Rentcash shareholders, who've lost 57 per cent of their investment in six days. Things got so ugly during a one-hour conference call on Tuesday that Gord Reykdal, the chief executive officer, cried no mas and asked the operator to stop the fight. Er, end the question period.

We'll get to that little dustup, but a little background is required. Rentcash, based in Edmonton, sells payday loans, the business of advancing money for a week or two to people who often can't afford to repay it, at interest rates that border on usury. This is a growth business. A year ago it had 144 outlets; now it has 361, primarily under two banners, The Cash Store and Instaloans.

The rapid growth is one of the things investors loved, but not the only thing. Rentcash isn't really in the business of high-risk loans. Rather, it's a broker that matches customers with lenders. Rentcash does the paperwork, acts as the collection agent and takes a commission, but it's someone else's money on the line.

This setup has two benefits. First, it allows the company to sidestep anti-loan-sharking provisions in the Criminal Code that make it illegal to lend money at more than 60-per-cent interest. Customers pay 59 per cent to the lender and a 20-per-cent "brokerage fee" to Rentcash — ergo, they're not paying 60 per cent to anyone. Nifty.

Second, and just as important from the investor's point of view, it means Rentcash can participate in the industry's growth without much credit risk. To quote the company's own regulatory filings from March: "To the extent that the advance is not collected, the private third-party lender and not The Cash Store absorbs the loss."

The arrangement seemed pretty clear. And that one line was critical to the market's bullishness, because as you might expect, Rentcash customers tend not to live in Rosedale or West Vancouver. They're often people with no savings or poor credit histories, or both. Very often, they can't pay back the money (hence the 59-per-cent annual rate). Rather than default, a large number of customers would simply "roll over" the loans — paying only the interest, plus another commission.

This was too much for provincial regulators, who objected to payday loan providers charging another fat fee just to continue a loan that was made only days or weeks earlier. In response, the industry crafted what amounts to a code of ethics that prohibits fees for rollovers.

For Rentcash, the policy began in January. Rather than just scrap the commission on rollovers, though, management decided to end the rollovers altogether, with predictable results. Faced with actually repaying the money they've borrowed, many customers couldn't. The default rate skyrocketed. But it wouldn't hurt Rentcash because they're just a broker, right? Uh … maybe not.

Last week the company released fourth-quarter results with a bombshell. Rentcash set aside $7.2-million for "the company's future share" of bad loans — you know, the ones they supposedly weren't on the hook for. Profit fell to $243,000 from $3.3-million in the previous quarter.

For shock value, the disclosure was matched only by Mr. Reykdal's bumbling attempts to explain it. "We did not anticipate the extent of the increase in loans going into default following the implementation of the no-rollover policy," he told investors on the conference call. The grilling began. Why is Rentcash bailing out the lenders, who were being well-compensated to take on the risk? "They've got to remain being viable too, and if they were to absorb all those losses, we felt that would have affected the relationship between the lenders and our customers." The lenders wouldn't be viable? So why not find new lenders? "The next lender along the line is probably not going to lend to our customers if the last guy went broke doing it," says chief financial officer Darin Coutu. Oh. So what they're really saying is, they have to backstop the lenders so they don't lose money. Comforting.

There are a number of questions that need to be answered, though. When did the company know it might have to cover bad loans? And was it reasonable to make that known to investors a week ago? This may be a matter for the lawyers to sort out. A prediction: The short-sellers aren't done having fun yet.

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