Let them eat overdraft fees

There’s an interesting report posted at the NPR website detailing the extent to which Americans, particularly those at the lower end of the economic spectrum, depend upon the alternative banking system of pawn shops and check-cashing centers. The NPR report does a nice job of tapping into the reasoning and resentments that guide these folks away from mainstream banking, including the array of “hidden charges” that people living a paycheck-to-paycheck existence often have to pay, like overdraft fees and fees in connection with minimum balances.

As we entered the recession, I looked very closely at companies in the alternative banking industry as investment possibilities, figuring that these companies’ businesses would be enhanced by a glut of refugees from the traditional banks. One company in particular, First Cash Financial Services (FCFS), made it into the group of companies that I follow closely. In fact, it almost made my Top 5 stocks for 2009. The only factor weighing against it was the arrival of the Obama administration and its stated intention to introduce new regulations upon the shadow banking industry in order to curb loan-sharking and predator lending.

These regulations never really came to pass as Team Obama quickly discovered it had bigger fish to fry. So maybe it’s time to take another look at FCFS. Year to date, it is up 11.44 percent, but has seen 47% growth from the March bottom, much of it coming in just the last few weeks; FCFS’s share price is up nearly 17% since early November.

The upper end of earnings projections for 2010-11 put the company’s growth at a little under 50% over the next 24 months. If the stock were to see a similar rise, you’d be looking at a target price of around $30 a share by the end of 2011. The company’s financial ratios are solid. I’m not wild about the fact that the stock trades at 16x earnings – it is not cheap – but the growth story deserves some attention, particularly given the marketplace as described by the NPR report.

Concerning the regulatory environment, is the alternative banking industry out the woods? Hard to say. While there are certainly bigger fish to fry for financial regulators, the industry fits the profile of the kind of industry that gets clobbered when Washington enters a period of do-gooderism. The industry can’t boast the lobbyists or influence of mainstream commercial banking, and there is the potential for legislators to scapegoat the industry in its endless search for villains after the financial crisis.

For example, despite admitting that the alternative banking industry’s success is a product of rational decision-making by its customers, FDIC Chairwoman Sheila Bair is pushing policy that would transition people into the mainstream banking system by forcing banks to “lower transaction and penalty fees for poorer bank customers, as well as [providing] easier access to credit,” according to NPR. Mainstream banks, of course, are loath to do so, because there is no profit in FDIC’s recommendations. For the banks, providing banking services to poorer folks is more trouble than it’s worth. That’s why the alternative banking industry thrives – it fills a niche that the traditional banks have no interest in filling. I can’t bring myself to pull the trigger on FCFS just yet, especially after the recent run-up in its stock price, but it’s worth watching closely in 2010.