January 19, 2012 / 3:57 PM / in 6 years

Analysis: Payday lenders point fingers to blunt crackdown

WASHINGTON (Reuters) - Payday lenders facing oversight from the new consumer protection agency are warning that tough regulations may push customers into the arms of unscrupulous online lenders, in a pitch for lighter, or at least equal, new rules.

The storefront payday lending industry has been slowly bleeding over the last few years as states, until now the industry’s major regulators, have enacted tougher laws designed to protect consumers from the controversial short-term high-interest loans.

But lenders say the tough new laws have pushed consumers into the murky world of lightly regulated online lenders, many of which have been accused of aggressive collection practices, unauthorized charges, and violations of disclosure laws.

Storefront lenders fear the Consumer Financial Protection Bureau could unleash new regulations that strip their profitability while letting online competitors flourish. The argument is strikingly similar to the one that traditional banks have used to encourage federal regulation of payday lenders.

Payday lenders will get a formal chance to deliver their pitch on Thursday when the CFPB holds a field hearing about the industry in Birmingham, Alabama.

“Regulators sometimes with good intentions don’t take into account that there are true issues that come up in peoples’ lives where they need access to short-term cash,” said Tony Scales, founder of Express Check Advance, which has 120 storefront payday lenders in eight states.

“If mandated regulation makes it where it is not profitable, it will drive customers to higher-cost products.”

Jamie Fulmer, a spokesman for Advance America, the country’s largest payday lender, also warned that overregulation could drive consumers to online lenders that have been able to operate under the regulatory radar.

“ end up paying more, being more susceptible to being taken advantage of and don’t have anybody to turn to,” Fulmer said.

With Obama’s recess appointment of Richard Cordray earlier this month to head the CFPB, the agency gained new powers to write rules that govern the short-term loans.

It now has the power to crack down on conventional payday lenders and the more shadowy online lenders, but it is unclear how the CFPB will prioritize its approach.

“We will begin dealing face-to-face with payday lenders... and other firms that often compete with banks but have largely escaped any meaningful federal oversight,” Cordray said on January 5, a day after he was installed.

SCOURGE ON THE POOR OR HELPFUL HANDOUT

Consumer groups for decades have called payday loans “debt traps” that hook the poorest in an endless cycle of mounting interest payments.

Payday loans got their modern start in the late 1980s in Kansas City, according to the Center For Responsible Lending. The industry boomed over the next decade, winning carve-outs from state mandated interest-rate caps, and targeting low-income borrowers with low credit scores that most banks wouldn’t touch.

In a storefront payday loan, borrowers get cash from a lender in return for a check postdated for payday that covers the loan amount plus a high interest rate of around 17 percent over two weeks on average, according to The Community Financial Services Association of America, an industry trade group. The average amount borrowed is $345.

Payday lenders justify the high interest charge, saying they provide a much-needed service to people who have no other options, adding that they must price a high risk of default into the product.

With just under half of payday loan users without credit cards, according to a 2009 study, and the median bank overdraft charge clocking in at $27 according to 2008 figures, payday lenders say their clients lack an alternative.

“If their access to credit is limited, if they need small-dollar, short-term loans now, there aren’t any other options for consumers,” said Scales from Express Check Advance.

Consumer groups don’t buy it.

“The reality is if you are paycheck-to-paycheck, you have minimal savings, whether it is a financial emergency or not. The typical family cannot pay back a $350 loan plus 400 percent (annualized) interest rate in just 5, 6, 7 days,” said Uriah King, a vice president at the Center for Responsible Lending.

Judi Smith, now a bank manager in Delaware, said she began taking out payday loans in California six years ago as income from her job as a sales account executive at a direct subprime lender began to dwindle.

After maxing out her credit cards, Smith took on three payday loans, and paid fees on them for six months to a year, eventually losing her home and declaring bankruptcy.

“You get into a rut,” Smith said. “You would just keep rolling it over every two weeks.”

Smith said payday loans are worthwhile for borrowers who don’t have alternatives, but she said those borrowers are the most likely to get themselves into further financial trouble.

The storefront industry reached its peak in the mid 2000s, with $44 billion in loans in 2007, and $6.8 billion in revenue the same year, according to Stephens Inc, an industry analyst.

“It was a land grab kind of mentality, everybody trying to go everywhere they could to get the best visible retail location,” said Darrin Anderson, President of QC Holdings Inc, a Kansas-based payday lender with 484 branches.

ONLINE LENDING GROWS

As the industry grew, so did the outcry against it. North Carolina let its law permitting payday loans to sunset in 2001, and other states have followed suit.

Some states banned the loans all together, others capped the interest rate, lengthened the duration of loans, or simply limited the number of loans a borrower can take a year.

The impact - combined with a worsening economy and industry maturity - has been dramatic. More than a fifth of U.S. payday stores have been shuttered since 2006, and storefront loan volume has decreased by more than a third since 2007.

“Regulatory risk is by far the biggest risk factor for the payday loan industry,” Stephens Inc Analyst David Burtzlaff wrote in his 2011 industry report.

But an online relative seems ready to meet the demand.

Internet payday loan volume has nearly doubled, to $10.8 billion in 2010 from $5.7 billion in 2006, causing the industry as a whole to recover slightly in 2010.

Many online lenders are owned by storefront lenders licensed in the states where their customers are.

But an unknown number operate with less transparency and with less state regulation. Some are incorporated offshore, others through Indian tribes exempt from state regulation, or in the United States but simply not licensed in the states where their customers are.

“We are kind of at a competitive disadvantage because of our best practices that we follow,” said Andersen from QC Holdings.

In an August 2011 study of 20 online lenders, the Consumer Federation of America found many online lenders charged rates nearly 50 percent higher than their storefront counterparts.

They also paid up to $110 for online customer referrals, increasing the need to collect fees to make a profit, and many automatically entered customers into a fee-payment plan, effectively pushing them to roll the loan over.

Since 2000, the Federal Trade Commission has used its powers to enforce federal consumer protection laws to bring enforcement actions against a handful of online lenders. The allegations include aggressive collections, not disclosing annual percentage rates, and charging customers for products they did not buy.

State attorneys general in West Virginia, Colorado, Pennsylvania, and Arkansas have also sued unlicensed internet lenders.

Lisa McGreevy, president of the Online Lenders Alliance, defends the industry, arguing its growth is part of a natural movement online. “Consumers are flocking to the Internet to purchase goods and services, short-term lending is no exception,” McGreevy said in an email.

She said that in an increasingly competitive marketplace, short-term lenders who mistreat customers “don’t deserve their business.”

BUREAU TURNS TO NON-BANK LENDERS

A core mandate for the CFPB, created by the 2010 Dodd-Frank financial oversight law to police consumer products like mortgages and credit cards, is to step up the federal oversight of financial products offered outside of traditional banks.

Now that Richard Cordray has been installed as director, the agency can write new rules for that sector.

But that may be a while coming.

“We are looking at state models and assessing the outcomes of those models,” said Leslie Parrish, program manager for payday and small dollar loans at the new agency.

“We will be examining to get to know the practices - to see if payday lenders comply with existing laws, and then do a data driven analysis to see are there other problems, and if rulemaking would be the path to address them.”

The agency says it also has the power to regulate tribal and offshore lenders.

But a lawyer who has represented store-front payday lenders thinks there are limits to what regulation can do.

“Money is money, and if people are desperate enough they will get it from any place they can find it,” said Hilary Miller, a Connecticut-based attorney who is president of the Payday Loan Bar Association.

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