Credit union executives and consultants have mixed views of new rules recently proposed by the Consumer Financial Protection Bureau on small-dollar loans, which include the business of payday lending.
Among other aspects of the proposal, CFPB seeks to remove "payday debt traps" by compelling lenders to make sure their customers can repay their loans and to eliminate "repeated debit attempts" that only serve to further push up fees.
The CFPB proposals for small-dollar lending also call for limiting extensions or renewals to two per year, or three loans in total—including the originating loan—and capping extensions at three in succession, followed by a 30-day "cooling off" period between extensions.
"These strong proposed protections would cover payday loans, auto title loans, deposit advance products, and certain high-cost installment and open-end loans," the CFPB said in a statement.
The agency also noted that payday loans offered by "storefront" lenders typically charge a median fee of $15 per $100 borrowed, and have median loan terms of just 14 days, which results in an annual percentage rate of 391% on a median loan of $350.
But George Hofheimer, chief knowledge officer at Filene Research Institute, noted the CFPB highlighted the payday alternative loan (PAL) program of the National Credit Union Administration as a potential model vehicle for offering these loans. "That's a good sign for the credit union movement," Hofheimer said.
In the first quarter of this year, there were 600 federally insured credit unions providing payday loans and 737 CUs providing PALs, according to NCUA data.
CUNA: IT'S ALL TOO MUCH
Indeed, as an alternative to the kind of predatory loans that CFPB wants to stamp out, Ryan Donovan, chief advocacy officer at Credit Union National Association, said CUs offer "consumer-friendly" options for their members.
But Donovan said that while CUNA appreciates efforts the CFPB has made to curb "abusive practices" in the payday lending market, the trade group still thinks that CFPB has "underestimated how burdensome" the proposed rules will be on consumer-friendly credit union products.
"The final rule must be more narrowly tailored to target the for-profit lenders [that are] abusing consumers, and not add arbitrary new requirements to credit union products, which are offered as a service to members," he said. "Exempting credit unions entirely from the rule is the only solution we see to allowing credit unions to remain in the market or grow participation in the market." (The CFPB has acknowledged that is has the authority to provide such an exemption).
Noting that credit unions typically break even, lose money, or make a small profit on small-dollar loans, Donovan noted the CFPB rules would add new compliance burdens that would make these programs unsustainable, particularly in light of all the other new rules and regulations already burdening the industry.
"Credit unions may not be able to participate in this [payday lending] market because the cost will be too great to the membership as a whole," he added.
KINECTA: TOO COSTLY
Kinecta Federal Credit Union, a $3.9 billion institution based in Manhattan Beach, Calif., has been offering payday and installment loans to members since 2007, when the CU acquired a company called Nix Check Cashing (now called Nix Neighborhood Lending) as a way to enter the Central and South Los Angeles markets.
Keith Sultemeier, who has served as Kinecta's president and CEO since early 2012, said that while the CU does not earn any profit on its short-term, small-dollar loans, it regards the product as a "necessary service" for many of its members who live in under-served areas like Central and South Los Angeles.
"Our loans are designed to meet the immediate needs for liquidity, provide a way to get out of debt, improve credit scores and position members to access lower-cost traditional forms of credit," Sultemeier said. "It is our hope that by offering these loans today, these members will choose to access our more conventional loan products when they are ready."
He estimates that Kinecta issues about 14,000 to 17,000 small-dollar, short-term loans per month, or about $7 million in volume. "We charge a $32 application fee to cover origination and servicing costs on a $400 loan and cap our interest rates at 18%," Sultemeier said. "That represents a significant discount to the typical rates charged by payday lenders under California law, or $15 per $100 borrowed."
Small-dollar loans offered by Kinecta have a default rate somewhere between 6% to 8% on average, Sultemeier estimates—and this is the ceiling of tolerance for the product's viability. "As it is, our contribution margins are positive, but quite low. We can cover variable costs; however, so we couldn't withstand higher default rates, higher origination costs or increased servicing costs."
Kinecta is encouraging members away from its payday loan offerings toward "installment loans"—which charge a similar 18% rate, but have longer terms and potentially larger balances. Their installment loans limit the loan amount so that the monthly payment is not more than 5% of monthly income.
As for the newly released CFPB rules on small-dollar loans, Sultemeier thinks this will primarily become a compliance issue—meaning higher costs in originating and servicing these loans, making it harder for Kinecta to keep selling them and thereby reducing members' access to credit. He referred specifically to the costs of documentation, imaging, as well as rising costs for collections and payment processing.
"But what bothers me the most is that the CFPB hasn't adequately considered the point-of-view of the users of small-dollar loans, many of whom need these short-term loan products. What does the consumer believe is the proper trade-off between access and protection?" he added.
But it's too early to tell, Sultemeier cautioned, what the final impact of the rules will be." The comment period for CFPB lasts until October and the final ruling may be different than what has been proposed," he noted.
FILENE: NET POSITIVE
But Hofheimer of Filene sees the new CFPB rules on small-dollar lending as a "net positive" for credit unions that offer payday loans.
"I think, overall, the rules appear to suggest that credit unions offer payday loans in a safe and responsible manner, in stark contrast to alternative and unregulated financial institutions which charge very high rates," he said. "I don't see any chilling effects from these rules upon credit union's ability to sell payday loans."
But Hofheimer cautioned that, given that the vast majority of credit unions do not offer payday loans due to their risky nature and lack of profitability, credit unions still face some hurdles in this segment of the loan business. "They have to find a way to streamline and simplify the costly and complex underwriting procedures for these loans," he said. "Many credit unions just don't have the experience or know-how of managing these loan products."
More CUs would like to offer payday loans because they would satisfy an "unmet financial need" for millions of Americans who need short-term loans and can't go to other financial institutions for them, according to Hofheimer.
Indeed, the opportunity to serve this market is huge.
According to Filene, one in five households in the U.S. is under-banked and lacks access to affordable financial services, while Pew Charitable Trusts, an independent NGO, said that Americans spend about $7.4 billion on payday loans per year.
Moreover, a pilot program by Filene found that CUs could offer payday loans to underserved members in a safe and responsible manner by using factors other than credit scores—like stable employment and residence, relationship with the credit union, and other "character-based" techniques.
"I expect that more credit unions will enter the payday loan market in the years to come," Hofheimer concluded.
SECU: DISAPPOINTMENT
One of the most prominent long-term providers of payday loans is $33.3 billion State Employees' Credit Union (SECU) of Raleigh, N.C., which began offering a Salary Advance Loan (SALO) product in 2001 as an alternative to the predatory payday loans that typically result in excessive fees and interest charges.
Spencer P. Scarboro, SVP of lending integrity at SECU, said that the institution currently has about 225,000 active SALO accounts with credit lines of close to $100 million.
But Scarboro said he is "disappointed" by the CFPB's new rules on small-dollar lending.
"I would have preferred that there be an exemption for loans that charged rates and fees that fell below a maximum permitted threshold," he stated. "I believe our program could serve as a model for how to provide these type of loans in a consumer-friendly manner. It appears CFPB took the stance that all payday loans were bad, but didn't properly address the consumer's needs for this type of service."
Scarboro also noted that millions of consumers struggle to make it from one payday to the next and will likely look to borrow to cover these needs from some source. "Unfortunately, the only sources remaining may be pawn-brokers or loan sharks which will result in high costs, the possible loss of personal possessions or the threat of violence if the funds are not repaid," he warned.
In essence, he lamented, the higher costs linked to increased compliance and monitoring will make it more difficult for some credit unions to offer payday loans.
A VIEW FROM NCUA: PAL
The new proposed CFPB rules included a laudatory reference to the PAL program of the NCUA, citing it as a model of safe and responsible manner of offering such loans. "On a first read, CFPB's specific call out of NCUA's PAL program is a directionally positive indication that credit unions are operating in a capacity that models consumer-friendly behavior for all other financial institutions," said Hofheimer of Filene.
CFPB is apparently exempting from its proposed rules loans that are made under the NCUA's PAL program, although it includes several new conditions.
The NCUA PAL program has a 28% interest rate cap and maximum application fee of only $20, explained Donovan of CUNA. State-charted credit unions also offer similar small-dollar loans, he added.
Generally speaking, CUs may not issue more than three PAL loans to any member over a rolling six-month period.
According to data from NCUA, federal credit unions originated $123.3 million in PALs over the four quarters ended in the fourth quarter of 2015, up 7.2% from the fourth quarter of 2014.
For first quarter of 2016, NCUA data showed that payday alternative loans originated at federal credit unions rose 8.1% to $106.1 million on an annualized rate, from the first quarter of 2015.
MCU: NYC ALTERNATIVE TO PREDATORS
Municipal Credit Union, a $2.45-billion institution in New York, offers a payday alternative product, known as the Short-Term Emergency Personal (STEP) Line of Credit—a small-dollar loan for people with low or no credit and who are in need of access to funds for an emergency purpose.
Michael Mattone, a spokesperson for MCU, noted that payday lending is banned in New York State, "which is good for consumers who would otherwise be tempted to enter into a harmful predatory loan cycle." Understanding that members sometimes need immediate access to credit, he added, MCU began offering their STEP loan -- they range from $250 to $750, and require the member to have direct deposit with MCU. The interest rate is 15.99% APR, and payments are automatically debited from the member's paycheck that is directly deposited into their MCU account, Mattone explained.
Mattone added that part of the process of handing out STEP loans involve financial literacy programs. "In order to qualify for the loan, the member must agree to attend MCU's "Financially Fit" seminars as well as sit down for a personal financial consultation with a member relations representative at the time of funding," he said. "The educational aspect helps the members figure out a plan of action to no longer need access to emergency funds and prevent a harmful cycle of predatory lending before it starts."
MCU, Mattone said, thinks it is "great" that the CFPB is working to find ways to better regulate the payday loan industry. "Nevertheless, we feel that any new rules should not allow for any 'loopholes' that keep payday lenders in business."
As the rules are currently proposed, there are some opportunities for payday lenders to comply within the rules and still prey on consumers, he said. "The fact that the conversation is being had on the federal level is a step in the right direction, but if we accept a proposal that provides payday lenders with ways to charge astronomical interest rates and fees to consumers, or allows for payday lenders to enter new markets such as New York, we are not doing our job."
