The American banking industry has had a rough few years. The subprime meltdown, financial crisis and economic hardship have slammed stocks, slashed bonuses and crunched jobs. But life has been pretty sweet for a motley crew of companies - from cash checkers and credit bureaus to money wirers and debt collectors - operating on the edges of the regulated financial services industry. That may be about to change.
The recent recess appointment by President Barack Obama of Richard Cordray to lead the newly formed Consumer Financial Protection Bureau will, for the first time ever, throw a federal regulatory lasso around the biggest players in the shadows of finance. In the same way that enhanced regulation has curbed many of the excesses on Wall Street, so, too, may the increased scrutiny of this netherworld of the money industry.
To measure the CFPB’s impact, Breakingviews has created a proxy equity index of companies who may now fall under the purview of the agency. The “Cordray Index” consists of 15 publicly traded companies. It comprises big firms like $11 billion Western Union and $15 billion credit scorer Experian (the one non-U.S. component of the index) and those with market caps below $1 billion, such as repo-man Portfolio Recovery Associates and Advance America, a chain of stores making cash advances.
Taken as a whole, this non-bank universe has had a lucrative crisis. The index, in which we have given equal weighting to the stocks, has returned some 25 percent since the beginning of 2007, when the first rumbles of the subprime crisis began to hit the markets. By comparison, the S&P 500 Index is just now returning to its 2007 levels and banking stocks are down by nearly two-thirds.
It’s not hard to explain these divergent fortunes. For starters, few members of the Cordray Index have credit exposure. So, unlike banks, they have not had to work through piles of crummy loans. And as chartered banks pulled back, that pushed millions of customers - particularly those labeled subprime - into the arms of the alternative financiers. Economic distress, in short, has given this industry a whole new slug of newly impoverished customers.
New rules included in the Dodd-Frank Act, however, put them under a national regulatory spotlight for the first time. Just last week the CFPB announced its first formal plans to oversee some players in the non-bank financial sector. It proposed supervising debt collectors with more than $10 million in annual receipts and consumer credit reporting firms with more than $7 million in annual receipts. Additional non-bank sub-sectors will be added to this list.
Even if these companies already eschew rotten practices, with new cops on the beat, it’s hard to imagine they won’t be sweating a little more and increasing their compliance procedures. The bureau’s consumer protection mission is broadly defined, so what may seem perfectly legal to these firms might appear unfair to the watchdog. Its new oversight introduces a layer of regulatory risk that these companies have never experienced on a national level.
That should at least offer some consolation to banks, which have suffered regulators for decades, but also complained about competition from these less-regulated entities. Community lenders took their gripes about some of the CFPB’s new initiatives aimed at banks public at a Federal Deposit Insurance Corp conference just a week ago. They don’t seem to recognize the young watchdog’s potential to help level the playing field by shining light into dimly-lit corners of financial services.
Under the efficient market hypothesis, of course, investors should have already priced the CFPB’s new oversight into the Cordray Index components’ values. Yet the index’s performance doesn’t imply much concern on shareholders’ part - it’s up 39 percent since mid-July 2010, when Congress approved the CFPB’s creation. That raises the question of whether the market is taking these new regulatory risks seriously enough.
Or it could just be that investors don’t put much stock in Cordray’s ability to enforce change. The CFPB is unquestionably the most politically controversial element of Dodd-Frank, which a majority of Republicans opposed and GOP presidential candidates have vowed to overturn. It’s hard to know what investors are thinking - but at least now they have a way to assess the impact of another roll of government red tape.