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Suddenly, Community Choice Financial's Debt is Losing its Security

Adam Rust's picture

Posted May 5, 2015

Moody's says it is considering a possible rating downgrade of loans to the parent of high-cost lender Check$mart, an outcome which would hamper the company's ability to borrow money.

Moody's says that credit costs are making it harder for Community Choice Financial, the corporate parent of CheckSmart as well as nine other consumer finance brands, to make a profit.

Community Choice's empire includes storefront and online companies that offer a broad milieu of AFS: auto title, short-term payroll advance, medium-term consumer loans, prepaid cards, and check cashing. 

At the end of last year, Community Choice had $469 million in outstanding debt. This included (but was not limited to) the following borrowings:

  • $395 million in senior secured notes bearing an annual interest rate of 10.75 percent. The notes mature in April 2019.
  • A four-year $40 million revolving credit facility bearing a rate of LIBOR plus 5 percent. Of note - this commitment was scheduled to mature last week. At the end of December, the company was not using this credit. However, the company has to pay 0.75 percent for undrawn funds.
  • Remaining debt on $25 million in eight-year senior secured notes that mature in May 2020. 
  • An Alabama subsidiary has its own $7 million line of credit, but as of the end of the year, it was not being utilized. 

They also have secured loans associated with the purchase of an airplane and for software. 

Debt downgrades scare any company. But this prospect should be especially concerning to a company with a capital structure like CCFI's. At the end of last year, stockholder equity was just $45.3 million - or about 1/10th of its debt.

Since lenders often choose to tie their debt covenants to the borrower's cash flows, it helps to review trends in their profitability. The chart below graphs operating income (brown line linked to left axis) against liabilities (green line linked to right axis):

 More Debt, Less Profit

Liabilities have been increasing while operating income has been declining. That's a recipe for a potent brew of "bad." Covenants in their debt agreements can be triggered when cash flows fail to realize the right debt-service ratios. Moody's concerns will not affect their current debt, but if the company was forced to find new sources of capital, a rating downgrade would increase the cost of future borrowing. Thus, any trouble today can create a cascading effect where the company sees its borrowing costs rise iteratively over time. 

The process, if it were to happen on a materially significant scale, would go something like this:

  • Cash flows decline
  • A downgrade of debt occurs; simultaneously, loan covenants are violated. 
  • Lenders re-negotiate the terms of existing loans. Some withdraw and others insist on a higher rate, shorter term, or both.
  • Cash flows drop again due to increased debt service costs.

It also isn't helping that some banks are cutting their relationships with payday lenders. In its annual report, CCFI references a lawsuit filed by Community Financial Services of America, the trade association for short-term lenders: 

The lawsuit says that Bank of America Corp., Capital Financial One Corp., Fifth Third Bancorp, J.P. Morgan Chase & Co. and many smaller banks have terminated their relationships with payday lenders.  

CCFI is also concerned about NACHA's new amendment (slated to go into practice shortly) to curb or condition access to the ACH system for originators who incur returns on a high share of their debit entries.

If our access to the ACH system is impaired, we may find it difficult or impossible to continue some or all of our business, which could have a material adverse effect on our business, prospects, results of operations, financial condition and cash flows. 

Both of these developments present challenges to CCFI's business model.