Any product that remotely resembles a payday loan could be headed for extinction.

That has led many banks to steer clear of anything that even remotely resembles a payday loan. Others are pressing ahead with small-dollar products, believing that they can be tailored to pass regulatory muster. That includes First Financial Service (FFKY) in Elizabethtown, Ky., and State Employees' Credit Union in Raleigh, N.C.

First Financial's PaySound product resembles a payday loan in the sense that it involves low-dollar balances and is tied to a checking account. But the company's president insists that PaySound is definitely not a "payday" loan.

In nearby North Carolina, SECU President Jim Blaine says the credit union’s Salary Advance Loan is so profitable, and so beneficial to members, that banks should offer the same product.

Concerns are mounting that such products are on regulatory life support, industry observers say. The Consumer Financial Protection Bureau has anything that looks like a payday loan squarely in its sights and there’s very little that bankers can do about it, says Stan Orszula, a banking lawyer at Quarles & Brady in Chicago.

“The CFPB just opened it up where people can complain online about the various supposed violations of payday lending,” Orszula says. “Quite frankly, that’s the tip of the iceberg.”

There are plenty of influential bankers and former regulators — including Sheila Bair, former Federal Deposit Insurance Corp. chairman, and Sendhil Mullainathan, the CFPB’s former assistant head of research — who believe there is a need for small-dollar, short-term consumer loans.

Regardless, Blaine says feedback he received from a recent visit from CFPB representatives was far from encouraging. SECU invited the bureau to come and see how its loan works. But Blaine got the impression that the CFPB was going to require payday loans to be installment loans, per a recent recommendation from the Pew Charitable Trusts. And he believes the CFPB will require lenders to fully consider a borrower’s ability to repay.

Either move would force SECU to discontinue its product, Blaine says. “We’re perhaps going to have to be thrown under the bus,” he says.

CFPB Director Richard Cordray, at a House Financial Services Committee meeting in September, told lawmakers that more banks could offer small-dollar loans, and that it would not be cost-prohibitive for them.

It “would be helpful to provide more of that kind of credit to people who need it, and potentially could avoid some of the higher cost cycles of indebtedness that they get into," Cordray said.
A CFPB spokesman declined to comment further.

Schreacke says he believes First Financial’s PaySound product would pass all regulatory tests. The loan is “compliant with all of the guidance” from the CFPB and FDIC on how small-dollar loans should be structured, he says.

The average loan is $300 with a 15% annual percentage rate and a required $50 monthly payment toward the principal. Most importantly, PaySound meets two key regulatory goals — it’s an installment loan, and its underwriting takes into account a borrower’s full ability to repay, Schreacke says.

“We look at their cash flow coming in and their cash flow going out,” Schreacke says. “We look at whether they have the excess cash availability to pay on the loan.”

The FDIC is working on guidance for deposit-advance loans, says spokesman Greg Hernandez, who declined to comment further.

The $850 million-asset First Financial expanded the availability of PaySound in September to its 17 Louisville, Ky., area branches after a six-month trial period. Schreacke says the product is profitable, largely because of an automated underwriting process that cuts costs. The company also bases credit decisions on a customer’s deposit activity, rather than a credit bureau report. He would not provide financial details.

SECU’s payday loan is not only profitable, it’s the $27 billion-asset credit union’s most-profitable product, with an annual return on assets of 4%, Blaine says. “It’s a huge rate of return for any institution,” he says.

SECU’s payday loan has encouraged members to open savings accounts, something that many members had never done, Blaine says.

Mullainathan has said that payday loan-type products that include a savings account have the potential to address a need for short-term credit without becoming a burden on consumers.

SECU’s loan is easy to administer and should be adopted by other financial institutions, Blaine says. Its annualized loss ratio of outstandings is 4%.

Some in the industry are skeptical of Blaine’s claims that SECU’s product is profitable. When the FDIC launched a test program of banks offering small-dollar loans, none said they were able to turn a profit, says Nessa Feddis, senior vice president at the American Bankers Association.

Since it is a credit union, SECU “may rely on unpaid volunteers to help counsel borrowers,” Feddis says. “They have a particular customer base, teachers and state employees, [who] may have more reliable continued income stream,” that would make a payday loan less risky.

Blaine denies that SECU uses unpaid volunteers in the loan program, adding that many members are not teachers or state employees — so they lack a stable source of income. “Those are the kinds of rationales they use to pooh-pooh” SECU’s payday loan, he says.

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Corrected January 9, 2014 at 10:27AM: Editor's Note: The second and third paragraphs of this story have been amended since the original version appeared to more accurately reflect the status of First Financial Service's PaySound product.