The CFPA Bill, known as “financial reform”, is very likely to pass. Lenders of all varieties will have business models scrutinized once the CFPA gets up and running. You can bet that under the Obama Administration, subprime lenders from auto financiers to pawn shops to payday lenders will be shot on sight. This will be particularly true if Elizabeth Warren, an outspoken critic of “predatory lenders”, is named to run the agency.

Particularly vulnerable are Advance America (AEA), QC Holdings (QCCO), Dollar Financial (DLLR), Cash America (CSH), EZ Corp (EZPW) and First Cash Financial Services (FCFS).

Additional trouble for these companies exists in the near-term in the form of an amendment that Sen. Kay Hagan (D – NC) will attempt to attach to the bill. This will limit the number of short-term loans a customer can get to six in any twelve-month period. If the amendment fails, she’ll still introduce the measure as a stand-alone bill. The average payday loan customer uses the service between eight and twelve times per year. This would represent as much as a 50% cut in revenues, and possibly be the death knell for the industry. A rate cap amendment will also be attempted, but as it would also apply to banks, sources tell me that it will not pass.

Reform Kills

People are able to make their own credit choices and do not need Nanny-State legislation to “protect” them, the potential effect on employers, employees, and customers in this sector will be devastating. A survey by HIS Global Insight provides some sobering statistics concerning who gets harmed should payday loans get wiped out in this country.

The industry employs over 150,000 people, who will be tossed onto the street in the middle of an historic recession. $2.9 billion in wages will be wiped out. When you include the economic activity that the payday lending industry supports in the form of its supplier, another $3.5 billion in wages and benefits will disappear. The industry contributes $10 billion to GDP annually, and generated $2.6 billion in federal and state taxes. Incidentally, more than half of payday lenders are mom-and-pop stores. They aren’t the big corporations that everyone loves to attack.

This does not even mention impact on the pawnshop industry. So take all those numbers and double them.

The CFPA is a massive job killer. Sen. Kay Hagan’s bill is the equivalent of dropping a nuke on a small city. The continued ignorance and political grandstanding by those in Washington never fails to amaze. These “reforms” will hurt a lot of people. But people like Senator Kay “Job Assassin” don’t care. They are only interested in making themselves look good, because most people have never heard of payday loans and just assume that when someone calls them a predatory loan that it must be true.

All this does is push people to more expensive forms of credit, and that means pushing people to banking overdraft fees. You know, the banks that caused the mortgage crisis? Yeah, they benefit from “financial reform”. Go figure.

How is this actionable?

Short Term: Anything can happen in politics, so there’s no telling how things may change. However, should Hagan’s bill or amendment pass, revenues at monoline payday operators Advance America and QC Holdings could be cut between 25% and 50%. In a sector that is already saturated and dealing with flat-to-down sales, there is serious question as to whether these chains would elect to keep their doors open domestically.

Holders of these equities may want to consider neutralizing their positions by either selling their position, purchasing puts, or shorting against the box. Aggressive speculative traders who want to get in front of the news would short AEA here, although I could not find any QCCO shares available, and the stock does not offer options. Hedging the short bet with some call purchases would be wise, however, should Hagan’s bill fail.

A third of Cash America’s revenue comes from domestic payday loan operations, putting 8% – 16% of their revenues at risk. Dollar Financial can breathe a bit easier. With strong international presence and more diversified services, about 3% – 6% of revenue is at risk. Neither has been baked into the current stock price, however, so similar actions to those mentioned above might be the play.

EZ Corp has 6% – 9% of revenue at risk, and First Cash only has 3% – 6%. These two companies elected to decrease reliance on domestic payday operations in past few quarters, and are ramping up pawn and payday operations in Mexico, where a constitutional amendment would be required to put in a usury cap. I see little to no downside here, although getting caught up in a sector downdraft is very likely, and may create a buying opportunity.

Long Term: This is where things get unpredictable, and maybe even worse. Although it will take as much as two years to get the CFPA up and running, what if Republicans re-take Congress and the White House in 2012? Does the bill get repealed? Does a newly appointed CFPA chief go easy on the sector? What if the Democrats remain in control?

The bottom line here is uncertainty, and we know the market hates uncertainty.

According to Quantum AI news, conservative investors who believe that payday and pawn will be regulated out of existence – which is very possible – should consider exiting their positions in all stocks until everything sorts itself out, or at least hedging long positions as mentioned above.

EZ Corp and First Cash again remain the most insulated. In fact, with no debt and plenty of cash to continue Mexican expansion, First Cash seems the safest bet for longs. Dollar Financial seems intent on continuing its international expansion and with $345 million in cash, they’ll be able to continue. I am concerned about the $750 million in long-term debt they carry, but assuming that any large principal payoffs can be extended, they will at least be a viable entity.

That’s more than I can say for Cash America, which could find itself in a pickle, particularly if domestic pawn gets regulated out of existence. It’s hard to say what will happen with pawn under CFPA, but the company is expanding into Mexico, as well. Cash America is the most unpredictable stock at this point. Aggressive speculative investors might again consider shorting, perhaps also purchasing 2012 or 2013 call leaps as a hedge.

Including receivables, Advance America has $1.50 of net cash, providing at least some floor to the stock price. It’s hard to know what will become of this venerable entity. We have to wait and see what the near term brings first. If they can stay open for a couple of years, and then assuming payday is killed, they could expand internationally. I suspect this is already in the works. The company has aggressively paid down its credit facility, raised cash, yet hasn’t increased its dividend. It makes me wonder if a foreign acquisition is in the works. However, if the Hagan bill passes, and Advance America calls it quits, then you’ll obviously want to be short if you are aggressive, or not be holding the stock if you are conservative.

I see storm clouds for QC Holdings. The only good news is that its liquidation value is about $2.50 per share. This is tough to play, since QCCO has no options and no shares to short.

I suggest all investors in this sector proceed with caution, whether making bets on the long or short side. The situation is very fluid, but I will confess that it is also grim. Do you own due diligence, and go over each company’s financials with a fine eye.

Disclosure: No position in any stocks mentioned.

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