Are Payday Alternatives Worth Effort?

WASHINGTON - As the Federal Deposit Insurance Corp. pushes more banks to offer payday lending alternatives, a key question remains - about profit.

The agency unveiled plans this month to let banks receive Community Reinvestment Act credit for offering small, short-term loans, and FDIC Chairman Sheila Bair has been actively promoting such alternatives.

But industry representatives disagree on how profitable such products are. Some argue that the short-term loans they offer have only a long-term benefit of turning credit-challenged borrowers into mainstream customers who qualify for more lucrative products.

"If you're talking about profitability, there's not up front any profitability," said Tammy Jo Snyder, a vice president and branch manager at First National Bank in Midwest City, Okla., speaking Dec. 6 at an FDIC-sponsored conference on the topic.

Others at the conference countered that such products can offer immediate benefits.

"It's the most profitable loan we have," said Jim Blaine, the chief executive officer of the North Carolina State Employees' Credit Union, which allows members to take out a $500 loan with a maximum term of 31 days and a 12% interest rate.

Mr. Blaine said most borrowers qualify, as long as they are "breathing" and not in bankruptcy, and he said the program's return was 4.75% in November.

"That's called obscene profitability," he said.

The issue could be key for bankers, who face a 36% annual percentage rate cap - including fees - on loans to military members and their dependents. The cap, sponsored by Sen. Jim Talent this year and enacted in October, is designed to thwart payday lending near military bases. But industry representatives worry it will interfere with other types of lending as well.

Ms. Bair, who hosted the conference in conjunction with the Association of Military Banks of America, joked that some bankers appeared embarrassed to say if their alternative products have been profitable, since serving underserved markets is viewed as more of a social benefit.

"I don't think there's any shame in that," Ms. Bair, who researched alternatives to payday loans while a professor at the University of Massachusetts Amherst, said in an interview. "We have a very important public-policy issue that needs to be addressed. If you can make a fair profit with a responsibly priced product, you shouldn't feel embarrassed about admitting that."

But it was clear some products had proved more profitable than others, with several bankers suggesting that loans designed to get customers out of trouble, called "workout" loans, did not make a profit in the short term.

Eisenhower National Bank offers workout loans for customers with multiple overdrafts. The bank, a division of Broadway National Bank in San Antonio, serves five military bases in Texas and offers a program to help service members move their debt into a special account and pay it off in 90 days without fees or interest charges.

"It's been a win-win, because it allows people to get out of that debt with three monthly payments," Greg Oveland, the president of Eisenhower National Bank, said in an interview.

Yet bankers offering workout programs said the price of keeping customers out of credit trouble means taking losses. Ms. Snyder estimated that First National chargeoffs for its checking accounts for military personnel can be 25% to 30% in a year.

But some bankers argued that in the long term, the program could help get a customer out of serious debt and develop a relationship that is more lucrative down the road.

"There's not a lot of money to be made, but it's in salvaging those relationships," Dawn B. Bannwolf, the customer advocate and local market manager for Bank of America Military Bank in San Antonio, said at the conference.

Ms. Bair said workout programs can be profitable "once you get people out of that system and more into a mainstream product."

Panelists said other alternative products come with a cost as well. Eisenhower offers two other special loan products under its program. Roughly a quarter of its unsecured loans of $1,200 to military members - with a 12-month payment period - were charged off before the bank required borrowers to sign up for direct deposit. "With the unsecured loan, you're going to take some losses," Mr. Oveland said.

The bank has had better success with a secured car loan - with a maximum amount of $12,000 - but even with that product, "at the rate that we're charging, it's break-even at best on the vehicle loan," he said.

Alden J. McDonald Jr., the president of the $336 million-asset Liberty Bank and Trust Co. in New Orleans, spoke for many at the conference by asking for more details on chargeoffs.

"It sounds like the program is not very profitable, if profitable at all," said Mr. McDonald, whose bank serves communities devastated by Hurricane Katrina. "It would be appreciated if we would know how much money we would lose from going into the program."

But Mr. Blaine of the North Carolina State Employees' Credit Union attempted to counter the bleak assessment offered by some bankers. He said money can be made from small, short-term loans if they are handled correctly.

"There is fear of the unknown about the risk levels in the products, but there are also a lot of myths," he said. "It's an unsecured loan. It's a marginal borrower. There are a lot of reasons why people should be conservative.

"But I think hopefully our program is a demonstration project - we can demonstrate that the myths are not true. The borrowers do repay. Chargeoffs are low and delinquencies are low."

Mr. Blaine said during his presentation that the credit union's product is within the 36% APR cap for military personnel that was included as an amendment to the 2007 Defense Authorization bill. Some bankers at the conference praised the intent of the cap but said it might affect some of their products.

"It just needs a little tweaking," Ms. Snyder said in an interview.

Rep. Barney Frank, D-Mass., the incoming chairman of the House Financial Services Committee, has said that he plans hearings next year on the amendment and that the panel may consider refining it. Still, speaking at the conference, he said he supports limiting high-cost debt suffered by military personnel and others at the hands of predatory lenders.

Ms. Bair went a step further. In the interview, she reiterated that revisions to the Talent amendment were unnecessary and that banks can find a way to make it work.

"Our first line of strategy should be to work on regulatory implementation" of the amendment, she said. "Opening up the statute, I think, would be a real can of worms."

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