TEXT - S&P cuts Cash Store Financial Inc rating

Thu Jan 10, 2013 12:22pm EST

Overview
     -- The Cash Store Financial Services Inc. reported weaker-than-expected 
earnings and slower-than-expected growth during fiscal 2012.
     -- The company identified material weaknesses in internal controls during 
fiscal 2012, which resulted in restatements to the company's second- and 
third-quarter fiscal earnings.
     -- As a result, we are lowering our issuer credit and senior secured 
notes issue ratings to 'B-' from 'B'.
     -- Our negative outlook is based on uncertainty with respect to CSF's 
governance and accounting related to the acquisition of loan receivables in 
January 2012.

Rating Action
On Jan. 10, 2013, Standard & Poor's Ratings Services lowered its long-term 
issuer credit rating on Edmonton, Alberta-based The Cash Store Financial 
Services Inc. (CSF) to 'B-' from 'B'. We also lowered our ratings on CSF's 
senior secured notes to 'B-' from 'B'. The '4' recovery rating on the senior 
secured notes, indicating average (30%-50%) recovery of principal if a default 
occurs, is unchanged. The outlook on the ratings is negative.

Rationale
The downgrade is based on the company's weaker-than-expected earnings, 
slower-than-expected growth, and recent governance and accounting issues 
related to the consumer loan portfolio that the company purchased from third 
parties during January 2012. Over the past year, CSF has been undergoing a 
number of transformations stemming from its business model shift from being a 
broker for payday loans to funding loans on balance sheet. During January 
2012, the company raised debt and purchased third-party outstanding 
receivables that it previously brokered. By shifting its business model, 
management intends to capture payments that previously went to third-party 
lenders. Earnings, however, have been lower than we anticipated.

In our view, based on CSF's growth strategy and expense rationalization 
measures, the company may have difficulty improving earnings in line with our 
original expectations. Furthermore, we expected the company to increase its 
presence in the Canadian and U.K. markets in 2012. Growth, however, was 
relatively flat during the year, and the company closed 63 branches in Canada, 
primarily during the third and fourth fiscal quarters. Although CSF retained 
some of its customers and realized its goal of reducing operating expenses, we 
do not expect earnings to reach the level that we previously projected. We 
also believe that provincial regulatory frameworks put in place over the last 
three years have had a more restrictive effect on earnings than we previously 
expected. Regulations involve pricing caps, minimum and maximum loan sizes, 
minimum and maximum loan terms, and rollover (extending a loan term for a fee) 
restrictions. CSF's operating margin during fiscal 2012 was $25.9 million, a 
32% decline from fiscal 2011.

The company identified material weaknesses in internal controls during fiscal 
2012, which resulted in restatements to the company's second- and 
third-quarter fiscal earnings. The company noted that it did not maintain 
effective accounting processes and controls related to measurement of 
provisions for loan losses, premium paid to acquire the loan portfolio, 
intangible assets, and consumer loan receivables. For the second fiscal 
quarter ended March 31, 2012, management adjusted the fair value of its 
portfolio of acquired loans to $50 million from $80 million and recognized an 
expense of $36.8 million. Although these issues appear to be resolved without 
immediate impairment to the company's liquidity, CSF's tangible equity 
declined to negative $40.4 million as of fiscal year-end. We also believe that 
recent governance and accounting issues arising from the review of the loan 
portfolio purchase transaction could have implications for CSF's future 
operational and financial performance. Subsequent to year-end, the company 
noted that a special committee of the board was reviewing the receivables 
portfolio acquisition. We believe that this could distract the management team.

Outlook
Our negative outlook is based on uncertainty about CSF's governance and 
accounting related to the acquisition of loan receivables in January 2012. We 
could lower the rating if earnings decline because of expenses related to the 
review of the receivables acquisition transaction or if debt protection 
metrics deteriorate as a result of a combination of increased regulation and 
competition. We could revise the outlook to stable if governance and 
accounting issues abate while earnings, leverage, and interest coverage 
stabilize.


Related Criteria And Research
Rating Finance Companies, March 18, 2004

Ratings List
Downgraded; Outlook Action
                                        To                 From
The Cash Store Financial Services Inc.
 Issuer Credit Rating                   B-/Negative/--     B/Stable/--
 Senior Secured                         B-                 B
  Recovery Rating                       4                  4