My high school math teacher, whom I profile in the book Teacher of the Year, The Mystery and Legacy of Edwin Barlow, had a fascination with Alice in Wonderland. I postulate that he found personal resonance in the need to apply logic and fortitude in the face of irrationality and insanity.
Neither he nor Lewis Carroll could have expected this story would be a metaphor for the payday loan debate. Stocks in this sector are First Cash Financial Services (FCFS), EZCorp (EZPW), Cash America (CSH), QC Holdings (QCCO), Dollar Financial (DLLR), Advance America (AEA).
Two extraordinary events took place in the U.S. Congress this past week concerning payday loans. First, Members of the House Subcommittee on Financial Institutions and Consumer Credit showed intelligence and thoughtfulness in their statements and questions. Second, one member introduced the best bill the American people have seen in a long time.
I've made the case for payday loans many times before, so I won't reiterate them here. However, this hearing is a must-view for anyone who wants to see an honest debate about the issue. I am admittedly shocked that this wasn't the typical PDL witch hunt.
The White Rabbit Speaks
Rep. Luis "White Rabbit" Gutierrez (D- IL) took the industry down the rabbit hole by introducing the flawed H.R. 1214, which caps PDL rates at $15 per hundred borrowed. This may sound reasonable, given that I have written that said rate is the minimum necessary to achieve profitability. The problem is that profitability does not exist in a vacuum. Stores have fixed costs, so there is a certain volume of loans necessary to achieve a net profit. The higher the volume, the lower the necessary rate. Some rural operators volumes are low enough that $20 per hundred is necessary.
His rationale for this bill makes sense only in Wonderland. Since some states had a higher permitted rate, or none at all, he wanted to bring them in line with the states that did have enabling legislation, so that the consumer groups could take over from there and push these newly-legislated states into states where payday loans are banned.
Not only did he make the greatest case ever for States' Rights, but it just makes him sound like he's late, he's late, to the tea party of over-regulating payday lenders. Let's just put him in the category of "Grandstanding Politician".
It isn't clear if the bill will move forward. The good news is that much of the committee showed they understood the product and its necessity, so it isn't a big leap for them to see the bill's downsides.
The Other Characters
Most importantly, we got to see the testimony and deserved grilling of Jean "Queen of Hearts" Fox, from the Consumer Federation of America. Despite having evidence and testimony that directly contradicted her rigid ideological position right there in the room, she rambled on insistently about irrelevant APR calculations, how the loans are bad for people, and why rates should be capped at a level so low as to effectively ban lenders. All this, while there was a real-life, flesh and blood Alice three seats away saying how glad she was that the product was there for her, and that she hopes it'll be there if she needs it in the future! But The Queen of Hearts kept insisting "Off with their heads!" Fox thus made her case perfectly – that opponents like her are living in Wonderland, out of touch with reality.
To the committee's credit, they drilled her on the most important issue: if you ban payday loans, where will people go for short-term credit? The Queen got slapped back on every ridiculous alternative, right down to obscure credit union programs that barely cover 1% of the country. To anyone who still doubts that payday loans have a place, watch her testimony. She represents you, and she made the industry's case for them.
We also were treated to the bumblings of Rep. Jackie "Mad Hatter" Speier, who said in response to the 36% cap that would kill payday lenders, "some of us feel that payday lenders have overstayed their welcome". Apparently, The Hatter wasn't paying attention to anything being said in the hearing at all. But why would she? Her wacky H.R. 1608 mirrors the equally wacky S. 500, introduced by Dick Durbin (D – IL), which rate caps every single form of short-term credit at 36% APR – except bank overdraft fees. At least we know that Durbin took $65,000 in bribes from Citigroup (C). I couldn't find any banking contributions to Speier. In a way, that's worse. She's just acting out of ideology and/or stupidity. Or maybe she's been smoking the Caterpillar's hookah.
Ugh. People like her and Fox are nothing but a pack of cards.
More good news: Rep. Joe Baca (D – CA), has introduced H.R. 1846, which not only provides lenders with rates needed to profit ($5 origination fee, plus $15 per hundred borrowed), but provides more in the way of disclosures than any of these other bills! Along with his California Democratic colleague Brad Sherman (my congressman), they showed that payday loans aren't a partisan issue – they're a common sense one.
The biggest clause is Rep. Baca's bill is that it pre-empts more restrictive state laws. So all the states that kicked payday lenders out will have to let them back in – allowing the saturated industry to expand again, creating modest growth opportunities for the public companies.
How It Affects The Stocks
The market seems to have gotten the message. When the Durbin bill was announced, the stocks fell down the rabbit hole, dropping about 30%, but have since recovered most of those losses. For those interested in which stocks would be affected, here's the rundown (although 50% of the U.S. store base is privately held, so don't forget that they get affected to, as do their customers).
If the Durbin/Speier bill passes, every stock pretty much gets wiped out. First Cash and EZ Corp have some insulation as they are rapidly expanding into Mexico, so they might remain going concerns, but the stock prices will likely get hammered.
If the Gutierrez bill passes (as is): Advance America, Dollar Financial, Cash America, and QC Holdings' operations in 23 states will have revenue cut. Payday loans only make up about 20% of First Cash's revenue, much of it is in Texas where the bill does not reach, and they are done expanding their PDL business in the U.S. They'll be relatively unscathed. EZ Corp will see some minor damage, but 80% of their revenue is in Texas, so not much will happen to them.
If the Baca bill passes: Bonanza for the sector. Twelve states open up and we'll probably see a land grab. In this case, EZ Corp and First Cash are not likely to move much because they're focusing on Mexico. Cash America and Dollar should see a lift if they move in. However, monoline operations like Advance America and QC Holdings have the most to gain. Their stocks are depressed because the market is saturated and they need this expansion, as well as pursuing other types of products. I think these two stocks would pop the most.
Of course, this is Wonderland politics, where anything can happen at the drop of a Mad Hatter's Hat.
Full Disclosure: At the time of writing, Lawrence Meyers was long the April 2.5 Calls of Advance America.