The Consumer Financial Protection Bureau's proposed rule cracking down on predatory payday lenders could wind up shutting down some credit unions' consumer-friendly payday loan alternatives.
State Employees CU, Raleigh, N.C., has run a successful, profitable payday loan alternative program for 15 years, but CEO Jim Blaine told Credit Union Journal he fears the new rules proposed by CFPB could lead to his credit union ultimately shutting down its payday products.
"They [CFPB] is focusing on customers' ability to repay loans to the point where many potential customers could not even apply for our payday loans," he said. "Plus, they want to place a limit on how many loans we can offer and to whom. I think, in the aggregate, these and other features of their rules might force us to close down our payday lending activities."
Given the magnitude of its payday business, he noted, closing down payday could have a serious impact on the $29 billion credit union.
"It is the most profitable loan product that we have," Blaine said. "I think we [SECU] are the poster child for credit unions that offer payday loans."
SECU's Salary Advance Loan program has stringent rules and terms: no loans higher than $500, the borrower must have a steady job, must belong to SECU, must have a SECU checking account and direct deposit, and the loan must be paid back within one month (31 days).
"We charge an interest rate of 12%, far less than stipulated," he said. "And it has been extremely successful for us."
Indeed, Blaine estimates that some 170,000 of SECU's 2 million members participate in this payday program, and 72% of them use it on a recurring basis.
"I would estimate we issue about $40 million in payday loans per month," he said. "A key component of our product is the supplemental savings deposit — that is, we require that the borrower place at least 5% of the money loaned back into their share savings accounts. This has helped break the so-called 'debt trap.'"
For example, if someone takes out a $100 loan, he must deposit $5 into the share account, which is pledged against the whole loan. As a result, SECU becomes a secured lender. If the deposit is withdrawn, the borrower cannot apply for another Salary Advance Loan for six months. SECU members now have some $30 million balances in these savings accounts.
Moreover, the payday lending program at SECU has experienced very insignificant charge-offs — an actual annualized loss ratio of only 2% outstanding.
"This would contradict the CFPB's assertion that payday borrowers cannot pay back their loans." Blaine commented.
But shutting down this loan program wouldn't just be bad for the credit union, Blaine said, it would also be bad for the members.
"These are basically loans for people with no other options," he said, noting that if SECU and other credit unions are forced to offer fewer of these payday loan alternatives, low-income consumers would likely be forced to get funds from higher-cost, predatory lenders — the very lenders CFPB is ostensibly targeting.
What CFPB is Proposing
The CFPB essentially is seeking to make it harder for payday companies to loan money to people who cannot afford to repay them, while limiting the number and amount of loans they can issue.
Among other measures, CFPB proposes imposing an interest rate or finance charge cap after the third payday loan is taken by a borrower. Theoretically, thereafter, the borrower may pay back the entire amount owed over any duration of time.
A core feature of the CFPB rules would require payday lenders to verify the income of borrowers prior to approving a loan. In addition, the proposed rules would limit the payment collection methods used by lenders.
According to a report released by the CFPB itself, roughly one-fifth of payday borrowers ultimately default on their short-term loans and nearly two-thirds renew such loans — meaning, a "short-term loan" can metamorphose into a very long-term liability for the weary borrower.
Also, according to a fact sheet from the White House, the average payday loan borrower is in debt for about 200 days a year and most loans are either rolled over or followed by another loan within two weeks.
Aside from payday loans, the CFPB rules would also apply to a plethora of other high interest rate products, including vehicle title loans, deposit advance products and open-ended loans, among others.
"We are taking an important step toward ending the debt traps that plague millions of consumers across the country," CFPB director Richard Cordray said during a field hearing on payday lending in Richmond, Va. "Too many short-term and longer-term loans are made based on a lender's ability to collect and not on a borrower's ability to repay. The proposals we are considering would require lenders to take steps to make sure consumers can pay back their loans. These common sense protections are aimed at ensuring that consumers have access to credit that helps, not harms them."
Defining Payday Loan'
The definition of what exactly constitutes a "payday" loan is somewhat ambiguous and leads to various estimates regarding the size of the industry. The Community Financial Services Association of America (CFSA), a trade group representing the payday lending industry, estimates that some 20,600 payday loan stores in the U.S. extend about $38.5 billion in short-term credit (loans) annually, citing analyst reports. However, the Center for Responsible Lending, an advocacy group, estimates the market at about $27 billion annually.
The credit union industry's share of that market is quite small — according to NCUA Call Report data, there were just 554 federal credit unions that originated payday alternative loans (PAL) — during 2014. (This figure does not include state-chartered credit unions,nor those credit unions that offer similar loans with interest rates at or below 18%, which are not tracked by NCUA).
But it could be a growing market. NCUA data also indicated that in the fourth quarter of 2014, PAL loan volume amounted to only about $37 million — but that figure represented a 36% jump from December 2013.
The reaction of credit union advocates to CFPB's proposed outline of rules could perhaps best be described as cautious and wary.
CUNA, NAFCU Express Concern
CUNA CEO Jim Nussle said in a statement that his organization supports the ability of credit unions to provide "beneficial" short-term, small loans as alternatives to predatory payday lending, which has "no place" in the financial marketplace.
"The extent to which credit unions will be able to continue to productively, efficiently and responsibly serve their members' short-term, small-dollar credit needs will be a key measure we use in evaluating these proposals," Nussle cautioned. "If the [CFPB] rule results in consumers having reduced access to credit from credit unions or if the access to credit is made more expensive by regulatory burdens imposed on credit unions which would be more appropriately targeted toward the abusers of consumers, it will have failed to adequately protect consumers."
Alicia Nealon, director of regulatory affairs at National Association of Federal Credit Unions (NAFCU), told Credit Union Journal that the industry has been awaiting such proposals from CFPB for at least five years, but that it is too early to discern a direct impact on credit unions, citing that CFPB has only released an outline of its agenda on payday loans.
She noted that while the comments made by the CFPB thus far would generally apply to payday loans that charge at least 36% APR, Nealon also raised concerns over the CFPB's ideas for short-term, small-dollar loans which would impose several requirements on federal credit unions that offer PALs under NCUA's rules.
PALs were described by the NCUA as a "practical alternative to predatory lenders" and a good way to offer much needed funds to low-income communities. Typically, a PAL can charge an annual interest rate of up to 28%, as established by NCUA, which is significantly higher than the 18% limit for all other loans offered by credit unions, but below the aforementioned 36% rate.
However, Nealon also noted that she and many in the credit union industry are concerned about the potential "unintended consequences" arising from CFPB rules and regulations should they come to fruition.
For example, NCUA's rules allow federal credit unions to offer up to three PALs in a six-month period. The CFPB, however, is considering limiting federal credit unions to two PAL loans in a six-month period, and requiring that they be at least 45 days in length.
"The CFPB is also indicating that it may impose an advance notice requirement on credit unions who offer PALs," Nealon added. "Currently, NCUA's rules do not require a credit union to notify a member when it accesses the member's deposit account for purposes of making a payment on a PAL. The CFPB, however, is considering requiring a credit union to provide its members with notification three business days in advance before it accesses their accounts for purposes of paying a PAL."
Still, Nealon praises CFPB for seeking to remove 'bad actors' — that is, unscrupulous predatory lenders that exploit the poor — from the payday industry. "But we are concerned that too much regulation could inadvertently sweep away some of the good actors in the business as well," she added.
NCLC: Proposal Could Help CUs
Lauren Saunders, associate director and managing attorney at National Consumer Law Center (NCLC) suggested the best way to stop the payday loan debt trap is to adopt a 36% rate cap for all payday loans. "High rates enable improvident lending and make lenders insensitive to significant levels of borrower distress," she wrote in a commentary. "A 36% cap reduces costs for borrowers while giving lenders an incentive to minimize defaults and do appropriate underwriting."
But she also noted that the CFPB does not have authority to cap interest rates. "State interest rate caps will remain critical even with federal rules to regulate payday loans," she said.
Saunders told Credit Union Journal that the CFPB proposals could actually help credit unions by leveling the playing field of this business."Just as responsible mortgage lenders were hurt by others who offered fast no-doc loans, credit unions who take the time to ensure that a consumer can afford to repay a loan should not have to compete against irresponsible 'fast-cash' payday lenders," she said. "Most credit unions offer small-dollar loans at far lower rates than payday lenders, and many offer loans with installment payments instead of lump sum balloon payments."
