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We recently reported on a bill introduced in the House of Representatives by Congressman Dan Kildee (D-Michigan) that would amend the Military Lending Act (“MLA”) to require that creditors provide additional disclosures to covered members of the armed forces and their families. The text of H.R. 2697 is now available.

Titled the “Transparency in Military Lending Act of 2017,” the bill would add the following items to the list of mandatory disclosures required under the MLA:

  • A statement that the Department of Defense (“DoD”) and each service branch offers a variety of financial counseling services.
  • A statement that other, lower interest rate loans, including potentially 0 percent interest loans, may be available through other financial institutions and military relief societies.
  • Contact information for the nearest Department of Defense financial counseling office.
  • A statement of the actual cost of the extension of credit, prepared as an amortization table showing what the cost to the member or dependent will be if the extension of credit is paid off at different points over time.

H.R. 2697 would require the disclosures to be provided on a single sheet of paper and be in a bold, 14-point font.  In addition, the bill would require creditors to (1) obtain separate, signed acknowledgments for each of the four disclosures and (2) compile and make publicly available a list of Department of Defense financial counseling offices. As the bill is drafted, the additional disclosures appear to be required for any consumer credit covered by the MLA, as currently implemented by the DoD.  Nevertheless, in a subsection titled “TRANSPARENCY FOR PAYDAY LOANS AND VEHICLE LOANS,” the bill separately provides that “the term ‘consumer credit’ shall include ‘payday loans’ and ‘vehicle title loans’ as those terms were defined” by the MLA regulations in effect on July 1, 2015.  Perhaps Congressman Kildee expects the scope of the bill to be narrowed during the negotiation process to reach only payday and vehicle title loans.  Or perhaps he was uncertain whether the new regulations, which went into effect on October 1, 2015, still cover payday and vehicle title loans (they do).

If unedited, H.R. 2697 would represent a significant expansion of the MLA’s already onerous disclosure requirements.   While the bill does not expressly call for promulgation of new rules, the DoD would likely have to prescribe additional regulations if it becomes law.  For instance, the bill is bereft of details concerning the cost of credit disclosure other than to say it must be prepared as an amortization table showing the cost of credit if the credit is paid off “at different points over time.”

The bill has been referred to the House Armed Services Committee, and we will provide updates as developments occur.

The CFPB has announced that a summer meeting of its Consumer Advisory Board is scheduled for June 18, 2015 in Omaha, Nebraska.  Director Cordray is slated to attend the meeting.

The meeting will focus on trends and themes in consumer financial markets and recent proposals related to payday loans, auto title loans, and other longer term credit products.  It requires an RSVP and is open to the public.

 

Yesterday, I had the opportunity to participate as an advisor to a small entity representative (“SER”) at the small business review panel on payday, title and installment loans.  (Jeremy Rosenblum has four posts—here, here, here and here—that analyze the rules being reviewed in detail.)  The meeting was held in the Treasury Building’s Cash Room, an impressive, marble-walled room where President Grant held his inaugural reception.  Present at the meeting were 27 SERs, 27 SER advisors and roughly 35 people from the CFPB, the Small Business Administration and the Office of Management and Budget.  The SERs included online lenders, brick-and-mortar payday and title lenders, tribal lenders, credit unions and small banks.

Director Cordray opened the meeting by explaining that he was happy that Congress had given the CFPB the opportunity to hear from small businesses.  He then described the rules at a high level, emphasized the need to ensure continued access to credit by consumers and acknowledged the importance of the meeting.  A few moments after he spoke, Dir. Cordray left the room for the day.

The vast majority of the SERs stated that the contemplated rules, if adopted, would put them out of business.  Many pointed to state laws (such as the one adopted in Colorado) that were less burdensome than the rule contemplated by the CFPB and that nevertheless put the industry out of business. (One of the most dramatic moments came at the end of the meeting when a SER asked every SER who believed that the rules would force him or her to stop lending to stand up.  All but a couple of the SERs stood.)

A number of the SERs emphasized that the rules would impose underwriting and origination costs on small loans (due to the income and expense verification requirements) that would eclipse any interest revenues that might be derived from such loans.  They criticized the CFPB for suggesting in its proposal that income verification and ability to repay analysis could be accomplished with credit reports that cost only a few dollars to pull.  This analysis ignores the fact that lenders do not make a loan to every applicant.  A lender may need to evaluate 10 credit applications (and pull bureaus in connection with the underwriting of these ten applications) to originate a single loan.  At this ratio, the underwriting and credit report costs faced by such a lender on a single loan are 10 times higher than what the CFPB has forecasted.

SERs explained that the NCUA’s payday alternative program (capping rates at 28% and allowing a $20 fee), which the CFPB has proposed as a model for installment loans, would be a non-starter for their customers.  First, SERs pointed out that credit unions have a significant tax and funding advantage that lower their overall business costs.  Second, SERs explained that their cost of funds, acquisition costs and default costs on the installment loans they make would far exceed the minimal revenues associated with such loans.  (One SER explained that it had hired a consulting firm to look the expense structure of eight small lenders should the rules be adopted.  The consulting firm found that 86% of these lenders’ branches would become unprofitable and the profitability of the remaining 14% would decrease by two-thirds.)

A number of SERs took the CFPB to task for not having any research to support the various substantive provisions of the rule (such as the 60-day cool period); failing to contemplate how the rule would interact with state laws; not interviewing consumers or considering customer satisfaction with the loan products being regulated; assuming that lenders presently perform no analysis of consumers’ ability to repay and no underwriting; and generally being arbitrary and capricious in setting loan amount, APR and loan length requirements.

Those from the CFPB involved in the rulemaking answered some questions posed by SERs.  In responding to these questions, the CFPB provided the following insights: the CFPB may not require a lender to provide three-day advance notice for payments made over the telephone; the rulemaking staff plans to spend more time in the coming weeks analyzing the rule’s interaction with state laws; it is likely that pulling a traditional Big Three bureau would be sufficient to verify a consumer’s major financial obligations; the CFPB would provide some guidance on what constitutes a “reasonable” ability to repay analysis but that it may conclude, in a post hoc analysis during an exam, that a lender’s analysis was unreasonable; and there may be an ESIGN Act issue with providing advance notice of an upcoming debit if the notice is provided by text message without proper consent.

A few SERs proposed some alternatives to the CFPB’s approaches.  One suggested that income verification be done only on the small minority of consumers who have irregular or unusual forms of income.  Another suggested modeling the installment loan rules on California’s Pilot Program for Affordable Credit Building Opportunities Program (see Cal. Fin. Code sec. 22365 et seq.), which permits a 36% per annum interest rate and an origination fee of up to the lesser of 7% or $90.  Other suggestions included scaling back furnishing requirements from “all” credit bureaus to one or a handful of bureaus, eliminating the 60-day cooling off period between loans and allowing future loans (without a change in circumstances) if prior loans were paid in full.  One SER suggested that the CFPB simply abandon its efforts to regulate the industry given current state regulations.

Overall, I think the SERs did a good job of explaining how the rule would impact their businesses, especially given the limited amount of time they had to prepare and the complex nature of the rules.  It was clear that most of the SERs had spent weeks preparing for the meeting by gathering internal data, studying the 57-page outline and preparing speaking points.  (One went so far as to interview his own customers about the rules.  This SER then played a recording of one of the interviews for the panel during which a customer pleaded that the government not take payday loans away.)  The SERs’ duties are not yet fully discharged.  They now have the opportunity to prepare a written submission, which is due by May 13.  The CFPB will then have 45 days to finalize a report on the SBREFA panel.

It is not clear what changes (if any) the CFPB might make to its rules as a result of the input of the SERs.  Some SERs were encouraged by the body language of the SBA advocate who attended the meeting.  She appeared quite engaged and sympathetic to the SERs’ comments.  The SERs’ hope is that the SBA will intervene and support scaling back the CFPB’s proposal.

This is the last of a series of blog posts in which we share our reactions to the CFPB’s contemplated proposals taking aim at payday (and other small-dollar, high-rate) loans (“Covered Loans”).  In this blog post, we share our thoughts on the CFPB’s proposed limits on payment collection practices.  (Our previous blog posts have looked at the CFPB’s grounds for the proposals, how the proposals will impact “short-term” Covered Loans, the flaws we see in the CFPB’s ability to repay analysis, and the 36% “all-in” rate trigger and restrictions for “longer-term” Covered Loans.)

The contemplated rules on payment collection practices would require lenders making Covered Loans to give written notice at least three business days in advance of charging the borrower’s deposit or prepaid account for a payment and would require a new payment authorization if two successive payments fail.  See Press Release, “CFPB Considers Proposal to End Payday Debt Traps” (Mar. 26, 2015), p. 4.  Depending upon the details of the ultimate rules and the CFPB’s willingness to make appropriate modifications, we are somewhat less critical of these ideas than the other contemplated rules.  Our suggestions include the following:

  • Importantly, the CFPB suggests that it is considering allowing notice of impending payments to be made by email or any other “electronic means to which the consumer consents, such as by phone call, text message, or mobile application.”  See Outline of Proposals under Consideration and Alternatives Considered (Mar. 26, 2015), p. 30.  Hopefully, the CFPB will ultimately endorse notice of this type and conclude that it should not be necessary for lenders to comply with ESIGN’s (overly) rigid “reasonable demonstration” requirement.
  • The requirement to provide written notice of a payment attempt at least three business days in advance would force lenders to wait at least three business days to resubmit a failed payment.  We think this will interfere with current practices and make it far harder to collect Covered Loans.  Moreover, consumers likely expect that lenders will promptly re-submit dishonored payments.  Accordingly, while some advance notice of re-submission might be warranted, we do not believe that it should entail a delay of three business days.
  • Additionally, the CFPB should clarify that it is permissible for the creditor to take the new payment authorization required after two consecutive dishonored payments by a recorded telephone call and not just in writing.
  • Currently, the CFPB contemplates treating dishonored debit card payments the same as other types of dishonored payments.  This ignores a fundamental distinction between debit card payments and other forms of payment—when debit card payments fail, it is at the time of authorization and not at the time of processing.  Accordingly, a rejected debit card payment does not give rise to bank NSF fees.  Due to this circumstance, we would submit that there is no compelling need to require three days’ advance notice of a debit card re-submission or to limit re-submissions without new authorization to a single attempt. In short, the rules should not restrict debit card re-submissions.

The upcoming rule-making will not be easy.  We plan to blog frequently along the way.

In this blog post, we share our thoughts on the 36% “all-in” rate trigger and restrictions for loans considered to be “longer-term” under the CFPB’s contemplated proposals taking aim at payday (and other small-dollar, high-rate) loans (“Covered Loans”).  (Our previous blog posts have looked at the CFPB’s grounds for the proposals, how the proposals will impact “short-term” Covered Loans and the flaws we see in the CFPB’s ability to repay analysis.)

36% “all-in” rate trigger.  CFPB rules under consideration for “longer-term” Covered Loans, with terms exceeding 45 days, are limited to loans that: (1) have “all-in” annual percentage rates (APRs) exceeding 36%; and (2) either create a security interest in the consumer’s motor vehicle or authorize the lender to collect payments by accessing the consumer’s bank account or paycheck.  See Press Release, “CFPB Considers Proposal to End Payday Debt Traps” (Mar. 26, 2015) (“Press Release”), p. 3.  As with short-term Covered Loans, the CFPB contemplates that lenders will be allowed to make longer-term Covered Loans either using an ATR analysis or, at the lender’s option, without an ATR analysis but subject to elaborate restrictions.

The CFPB skates on very thin ice when it chooses to severely restrict longer-term Covered Loans based on “all-in” APRs exceeding 36% while it leaves lower-rate loans outside the coverage of its contemplated rules.  Section 1027(o) of Dodd-Frank explicitly denies the CFPB authority to set usury limits, yet the contemplated proposal does just that.  With the 36% rate trigger, the CFPB is effectively saying that specified longer-term loans are perfectly lawful if the all-in APR is 36% or less but unlawful at a higher rate.

There is one type of higher-rate loan the CFPB apparently intends to leave alone—unsecured “signature” loans payable more than 45 days after origination.  While the CFPB seems to believe—incorrectly, in our view—that it can restrict interest rates when they are coupled with other loan features, there is no obvious way it could regulate signature loans without nakedly addressing rates in isolation.  Conversely, eliminating the rate trigger on longer-term Covered Loans would seriously interfere with credit products for which there is virtually universal support, such as the unsecured installment loans offered through the Lending Club and Prosper online marketplaces.

Restrictions.  As with short-term Covered Loans, the CFPB contemplates two options for longer-term Covered Loans. Press Release, pp. 3-4.  Under the first option, the longer-term Covered Loan would need to pass an ATR analysis.  Under the second option, the lender could make Covered Loans with terms from 45 days to six months (no maximum term applies to longer-term Covered Loans made under ATR authority) provided that debt service is limited to five percent of the borrower’s verified gross income and the lender does not make more than two such Covered Loans within any 12-month period.  (We do not address a third option here, based on an NCUA program, since it does not appear at all viable to us.)

Once again, the contemplated CFPB limitations are severe. For Covered Loans made on the basis of an ATR evaluation, the issues discussed above would apply, although ATR issues are necessarily more severe for short-term Covered Loans than for longer-term Covered Loans.  Only a small segment of longer-term Covered Loans will meet the five percent and six-month limitations contemplated by the CFPB.  Indeed, for Covered Loans studied by the CFPB, only 18 percent had payment to income ratios below five percent and only nine percent had ratios below five percent and terms of six months or less.  See Outline of Proposals under Consideration and Alternatives Considered (Mar. 26, 2015), p. 50.

The materials released by the CFPB do not explain its basis for selecting five percent and six-month thresholds for longer-term Covered Loans that do not utilize ATR authority.  In the absence of any compelling explanation, a rule that threatens to eliminate over 90% of the market seems overly tough.  If one were to accept the CFPB’s theory that it is entitled to regulate on the basis of interest rates—and we do not—should it not be more liberal when rates are at the low end of the regulated range rather than the upper reaches?  If a lender can make a six-month loan at a triple-digit interest rate, we believe it should be able to make a one-year loan at a 37% rate.

In our next blog post, we will look at the CFPB’s contemplated rules for payment collection practices.

In this blog post, we share our thoughts on how the CFPB’s contemplated proposals taking aim at payday (and other small-dollar, high-rate) loans (“Covered Loans”) will impact “short-term” Covered Loans and the flaws we see in the CFPB’s ability to repay analysis.  (Our last blog post looked at the CFPB’s grounds for the proposals.)

Impact.  The CFPB plans to provide two options for “short-term” Covered Loans with terms of 45 days or less.  One option would require an ability to repay (ATR) analysis, while the second option, without an ATR evaluation, would limit the loan size to $500 and the duration of such Covered Loans to 90 days in the aggregate in any 12-month period.  These restrictions on Covered Loans made under the non-ATR option make the option plainly inadequate.

Under the ATR option, creditors will be permitted to lend only in sharply circumscribed circumstances:

  • The creditor must determine and verify the borrower’s income, major financial obligations (such as mortgage, rent and debt obligations) and borrowing history.
  • The creditor must determine, reasonably and in good faith, that the borrower’s residual income will be sufficient to cover both the scheduled payment on the Covered Loan and essential living expenses extending 60 days beyond the Covered Loan’s maturity date.
  • Except in extraordinary circumstances, the creditor would need to provide a 60-day cooling off period between two short-term Covered Loans that are based on ATR findings.

In our view, these requirements for short-term Covered Loans would virtually eliminate short-term Covered Loans.  Apparently, the CFPB agrees.  It acknowledges that the contemplated restrictions would lead to a “substantial reduction” in volume and a “substantial impact” on revenue, and it predicts that Lenders “may change the range of products they offer, may consolidate locations, or may cease operations entirely.”  See Outline of Proposals under Consideration and Alternatives Considered (Mar. 26, 2015) (“Outline”), pp. 40-41.  According to CFPB calculations based on loan data provided by large payday lenders, the restrictions in the contemplated rules for short-term.  Covered Loans would produce: (1) a volume decline of 69% to 84% for lenders choosing the ATR option (without even considering the impact of Covered Loans failing the ATR evaluation), id., p. 43; and (2) a volume decline of 55% to 62% (with even greater revenue declines), for lenders using the alternative option. Id., p. 44.  “The proposals under consideration could, therefore, lead to substantial consolidation in the short-term payday and vehicle title lending market.” Id., p. 45.

Ability to Repay Analysis.  One serious flaw with the ATR option for short-term Covered Loans is that it requires the ATR evaluation to be based on the contractual maturity of the Covered Loan even though state laws and industry practices contemplate regular extensions of the maturity date, refinancings or repeat transactions.  Instead of insisting on an ATR evaluation over an unrealistically short time horizon, the CFPB could mandate that creditors refinance short-term Covered Loans in a manner that provides borrowers with “an affordable way out of debt” (id., p. 3) over a reasonable period of time.  For example, it could provide that each subsequent short-term Covered Loan in a sequence of short-term Covered Loans must be smaller than the immediately prior short-term Covered Loan by an amount equal to at least five or ten percent of the original short-term Covered Loan in the sequence.  CFPB concerns that Covered Loans are sometimes promoted in a deceptive manner as short-term solutions to financial problems could be addressed directly through disclosure requirements rather than indirectly through overly rigid substantive limits.

This problem is particularly acute because many states do not permit longer-term Covered Loans, with terms exceeding 45 days.  In states that authorize short-term, single-payment Covered Loans but prohibit longer-term Covered Loans, the CFPB proposals under consideration threaten to kill not only short-term Covered Loans but longer-term Covered Loans as well.  As described by the CFPB, the contemplated rules do not address this problem.

The delays, costs and burdens of performing an ATR analysis on short-term, small-dollar loans also present problems.  While the CFPB observes that the “ability-to-repay concept has been employed by Congress and federal regulators in other markets to protect consumers from unaffordable loans” (Outline, p. 3), the verification requirements on income, financial obligations and borrowing history for Covered Loans go well beyond the ability to repay (ATR) rules applicable to credit cards.  And ATR requirements for residential mortgage loans are by no means comparable to ATR requirements for Covered Loans, even longer-term Covered Loans, since the dollar amounts and typical term to maturity for Covered Loans and residential mortgages differ radically.

Finally, a host of unanswered questions about the contemplated rules threatens to pose undue risks on lenders wishing to rely upon an ATR analysis:

  • How can lenders address irregular sources of income and/or verify sources of income that are not fully on the books (e.g., tips or child care compensation)?
  • How can lenders estimate borrower living expenses and/or address situations where borrowers claim they do not pay rent or have formal leases?  Will reliance on third party data sources be permitted for information about reasonable living costs?
  • Will Covered Loan defaults deemed to be excessive be used as evidence of ATR violations and, if so, what default levels are problematic?  Unfortunately, we believe we know the answer to this question.  According to the CFPB, “Extensive defaults or reborrowing may be an indication that the lender’s methodology for determining ability to repay is not reasonable.” Id., p. 14.  To give the ATR standard any hope of being workable, the CFPB needs to provide lenders with some kind of safe harbor.

In our next blog post, we will look at the CFPB’s contemplated 36% “all-in” rate trigger and restrictions for “longer-term” Covered Loans.

Last Friday, we posted a summary of the contemplated CFPB proposals taking aim at payday (and other small-dollar, high-rate) loans (“Covered Loans”).  In this blog post, we share our thoughts on the CFPB’s grounds for the proposals.  Over the next few days, we will be publishing several additional blog posts to share our reactions to the proposals’ details.

As discussed in our summary, the contemplated rules are sweeping.  We believe that, if they are adopted, the rules will lead to many lenders exiting the business of making Covered Loans and radically contract consumer access to Covered Loans.

The sweeping nature of the rules under consideration is premised on the CFPB’s conclusion that Covered Loans are “debt traps that plague millions of consumer across the country.” See Press Release, “CFPB Considers Proposal to End Payday Debt Traps” (Mar. 26, 2015) (“Press Release”).  In the CFPB’s view, Covered Loans present borrowers with the “risk that they will lose their transportation to work, incur bounced check fees and other charges, or experience other bank account problems if they fall behind.” See Outline of Proposals under Consideration and Alternatives Considered (Mar. 26, 2015) (“Outline”), pp. 3-4.  The CFPB warns that “consumers may take costly measures to avoid reborrowing or defaulting on the loan. A consumer may default on other obligations or forgo basic needs.” Id., p. 9.  Further, “consumers may lose control over their financial choices” if the lender is able to access the consumer’s bank account or take a security interest in the consumer’s vehicle. Id., p. 3.

Consistent with its past statements, the entire CFPB focus is on the dangers of Covered Loans. The reality of the situation is that, without access to Covered Loans, consumers will frequently “default on other obligations or forgo basic needs,” Id., p. 9, whether or not they obtain Covered Loans, and the CFPB has not shown that the frequency of default or severity of financial hardship increases with Covered Loans.  Covered Loans can help borrowers obtain needed car repairs (or medical care) and avoid bank account NSF and overdraft fees, late payment charges and even utility disconnection and reconnection fees.  Thus, the CFPB has not established that any consumer injury resulting from Covered Loans exceeds the benefits provided by Covered Loans.

In fact, the unsupported CFPB belief that Covered Loans are bad for consumers conflicts with a number of recent empirical studies.  (See our blog posts about the Navigant, Toth, and Mann and Priestley studies.)  This is critical from both a policy and legal perspective because, under Dodd-Frank, a practice cannot be “unfair” if any injury it causes is outweighed by countervailing benefits.  And generally, an “abusive” practice must take “unreasonable” advantage of consumers.  It is hard to see how a practice can take “unreasonable” advantage of consumers if the benefits it provides outweigh any injuries it causes.  Accordingly, the cost-benefit analysis the CFPB has thus far eschewed would seem to be a necessary precondition of regulation of the contemplated type.  If the CFPB moves forward based on the current record and without regard to the benefits of Covered Loans, its actions will presumably be challenged in court under the Administrative Procedures Act.

In our next blog post, we will focus on how the proposals will impact “short-term” Covered Loans and the flaws we see in the CFPB’s contemplated ability to repay analysis.

On March 26, the CFPB held a public hearing on payday and auto title lending, the same day that it released proposed regulations for short-term small-dollar loans. Virginia Attorney General, Mark Herring gave opening remarks, during which he asserted that Virginia is perceived as the “predatory lending capital of the East Coast,” suggesting that payday and auto title lenders were a large part of the problem. He said that his office would target these lenders in its efforts to curb alleged abuses. He also announced several initiatives aimed at the industry, including enforcement actions, education and prevention, legislative proposals, a state run small-dollar loan program, and an expanded partnership with the CFPB. The Commissioner of Virginia’s Bureau of Financial Institutions, E. Joseph Face, also gave brief remarks echoing those of the Attorney General.

Richard Cordray, director of the CFPB, then gave lengthy remarks, which were published online the morning before the hearing took place and are available here. His remarks outlined the CFPB’s new “Proposal to End Payday Debt Traps.” Cordray explained and defended the CFPB’s proposed new regulations. While most of what he said was repetitive of the lengthier documents that the CFPB published on the topic, a few lines of his speech revealed the impetus behind the CFPB’s proposed regulations and one reason why they are fundamentally flawed.

In discussing the history of consumer credit, he stated that “[t]he advantage[, singular] of consumer credit is that it lets people spread the cost of repayment over time.” This, of course, ignores other advantages of consumer credit, such as closing time gaps between consumers’ income and their financial needs. The CFPB’s failure to recognize this “other” advantage of consumer credit is a driving force behind several flaws in the proposed regulations, which we have been and will be blogging about.

Following the opening remarks, the CFPB moderated a panel discussion during which participants from industry and consumer advocacy groups had the opportunity to comment on the proposed regulations and answer questions. The CFPB panel included:

  • Richard Cordray, Director, CFPB
  • Steven Antonakes, Deputy Director, CFPB
  • Zixta Martinez, Assistant Director of Community Affairs, CFPB
  • Kelly Cochran, Assistant Director for Regulations, CFPB.

On the consumer advocate panel were:

  • Paulina Gonzales, Executive Director, California Reinvestment Coalition
  • Michael Calhoun, President, Center for Responsible Lending
  • Dana Wiggins, Director of Outreach, Virginia Poverty Law Center
  • Wade Henderson, President and CEO, The Leadership Conference on Civil Rights and Human Rights

The industry panel included:

  • Lisa McGreevy, President & CEO, Online Lenders Alliance
  • Edward D’Alessio, General Counsel (former), Financial Service Centers of America
  • Lynn DeVault, Board Member, Community Financial Services Association of America
  • Stanley P. Leicester, II, Senior Vice President and CFO, BayPort Credit Union

After the panelists’ opening remarks, they answered questions posed by the CFPB such as: (i) What should the role of “ability to repay” standards be in the payday loan market?; (ii) How do payday loans’ rollover feature impact the ability to repay?; and (iii) “What is the appropriate balance between protecting consumers and ensuring that they have access to credit?”

Not surprisingly, in answering these questions, the consumer advocate panel took every opportunity to condemn payday and auto title products. They generally cited anecdotal evidence of consumers who became financially and emotionally distressed when they found themselves unable to repay their loans. One panelist purported to cite “data” compiled by his own organization in support of the proposed regulations. Unfortunately, these consumer advocates offered no viable alternatives to payday and auto title products to help consumers who find themselves in need of money and with nowhere else to turn.

The industry panelists generally expressed concern over the CFPB’s proposed regulations. Ms. McGreevy, speaking for online lenders, stated that any new regulations should not stifle innovation, rely on outdated underwriting methods, or dictate when consumers would be allowed to take out a loan. All of the industry panelists, in some way or another, expressed concern that new regulations not be implemented in a way that defeats the purposes of payday and auto title products. If, for example, the new regulations dramatically increase the time it takes to get a loan, they may strip away the value that these loans provide to consumers who need them.

After the panel concluded, the CFPB entertained comments from approximately 40 members of the public who had registered in advance. The speakers were each afforded one minute to comment. Employees of payday and auto title loan stores made up the largest group of speakers, followed closely clergy and consumer advocacy groups. A fair number of consumers also made remarks. One consumer claims to have taken out a $300 loan on which she now owes more than $5,000. Others expressed gratitude towards the payday and auto title lenders whose loans allowed them to stay out of financial peril or to respond to an emergency situation.

The CFPB has moved a step closer to issuing payday loan rules by releasing a press release, factsheet and outline of the proposals it is considering in preparation for convening a small business review panel required by the Small Business Regulatory Enforcement Fairness Act and Dodd-Frank.  The CFPB’s proposals are sweeping in terms of the products they cover and the limitations they impose.  In addition to payday loans, they cover auto title loans, deposit advance products, and certain “high cost” installment and open-end loans.  In this blog post, we provide a detailed summary of the proposals.  We will be sharing industry’s reaction to the proposals as well as our thoughts in additional blog posts.

When developing rules that may have a significant economic impact on a substantial number of small businesses, the CFPB is required by the Small Business Regulatory Enforcement Fairness Act to convene a panel to obtain input from a group of small business representatives selected by the CFPB in consultation with the Small Business Administration.  The outline of the CFPB’s proposals, together with a list of questions on which the CFPB seeks input, will be sent to the representatives before they meet with the panel.  Within 60 days of convening, the panel must issue a report that includes the input received from the representatives and the panel’s findings on the proposals’ potential economic impact on small business.

The contemplated proposals would cover (a) short-term credit products with contractual terms of 45 days or less, and (b) longer-term credit products with an “all-in APR” greater than 36 percent where the lender obtains either (i) access to repayment through a consumer’s account or paycheck, or (ii) a non-purchase money security interest in the consumer’s vehicle.  Covered short-term credit products would include closed-end loans with a single payment, open-end credit lines where the credit plan terminates or is repayable in full within 45 days, and multi-payment loans where the loan is due in full within 45 days.

Account access triggering coverage for longer-term loans would include a post-dated check, an ACH authorization, a remotely created check (RCC) authorization, an authorization to debit a prepaid card account, a right of setoff or to sweep funds from a consumer’s account, and payroll deductions.  A lender would be deemed to have account access if it obtains access before the first loan payment, contractually requires account access, or offers rate discounts or other incentives for account access.  The “all-in APR” for longer-term credit products would include interest, fees and the cost of ancillary products such as credit insurance, memberships and other products sold with the credit.  (The CFPB states in the outline that, as part of this rulemaking, it is not considering proposals to regulate certain loan categories, including bona-fide non-recourse pawn loans with a contractual term of 45 days or less where the lender takes possession of the collateral, credit card accounts, real estate-secured loans, and student loans.  It does not indicate whether the proposal covers non-loan credit products, such as credit sale agreements.)

The contemplated proposals would give lenders alternative requirements to follow when making covered loans, which vary depending on whether the lender is making a short-term or longer-term loan.  In its press release, the CFPB refers to these alternatives as “debt trap prevention requirements” and “debt trap protection requirements.”  The “prevention” option essentially requires a reasonable, good faith determination that the consumer has adequate residual income to handle debt obligations over the period of a longer-term loan or 60 days beyond the maturity date of a short-term loans.  The “protection” option requires income verification (but not assessment of major financial obligations or borrowings), coupled with compliance with specified structural limitations.

For covered short-term loans (and longer-term loans with a balloon payment more than twice the level of any prior installment), lenders would have to choose between:

Prevention option.  A lender would have to determine the consumer’s ability to repay before making a short-term loan.  For each loan, a lender would have to obtain and verify the consumer’s income, major financial obligations, and borrowing history (with the lender and its affiliates and with other lenders.)  A lender would generally have to adhere to a 60-day cooling off period between loans (including a loan made by another lender).  To make a second or third loan within the two-month window, a lender would need to have verified evidence of a change in the consumer’s circumstances indicating that the consumer has the ability to repay the new loan.  After three sequential loans, no lender could make a new short-term loan to the consumer for 60 days.  (For open-end credit lines that terminate within 45 days or are fully repayable within 45 days, the CFPB would require the lender, for purposes of determining the consumer’s ability to repay, to assume that a consumer fully utilizes the credit upon origination and makes only the minimum required payments until the end of the contract period, at which point the consumer is assumed to fully repay the loan by the payment date specified in the contract through a single payment in the amount of the remaining balance and any remaining finance charges.  A similar requirement would apply to ability to repay determinations for covered longer-term loans structured as open-end loans with the additional requirement that if no termination date is specified, the lender must assume full payment by the end of six months from origination.)

Protection option.  Alternatively, a lender could make a short-term loan without determining the consumer’s ability to repay if the loan (a) has an amount financed of $500 or less, (b) has a contractual term not longer than 45 days and no more than one finance charge for this period, (c) is not secured by the consumer’s vehicle, and (d) is structured to taper off the debt.

The CFPB is considering two tapering options.  One option would require the lender to reduce the principal for three successive loans to create an amortizing sequence that would mitigate the risk of the borrower facing an unaffordable lump-sum payment when the third loan is due.  The second option would require the lender, if the consumer is unable to repay the third loan, to provide a no-cost extension that allows the consumer to repay the third loan in at least four installments without additional interest or fees.  The lender would also be prohibited from extending any additional credit to the consumer for 60 days.

Although a lender seeking to utilize the protection option would not be required to make an ability to repay determination, it would still need to apply various screening criteria, including verifying the consumer’s income and borrowing history and reporting the loan to all commercially available reporting systems.  In addition, the consumer could not have any other outstanding covered loans with any lender, rollovers would be capped at two followed by a mandatory 60-day cooling-off period for additional loans of any kind from the lender or its affiliate, the loan could not result in the consumer’s receipt of more than six covered short-term loans from any lender in a rolling 12-month period, and after the loan term ends, the consumer cannot have been in debt for more than 90 days in the aggregate during a rolling 12-month period.

For covered longer-term loans, lenders would have to choose between:

Prevention option.  Before making a fully amortizing covered longer-term loan, a lender would have to make essentially the same ability to repay determination that would be required for short-term loans, over the term of the longer-term loan.  In addition, an ability to repay determination would be required for an extension of a covered longer-term loan, including refinances that result in a new covered longer-term loan.  To extend the term of a covered longer-term loan or refinance a loan that results in a new covered longer-term loan (including the refinance of a loan from the same lender or its affiliate that is not a covered loan), if certain conditions exist that indicate the consumer was having difficulty repaying the pre-existing loan (such as a default on the existing loan), the lender would also need verified evidence that there had been a change in circumstances that indicates the consumer has the ability to repay the extended or new loan.  Covered longer-term loans with balloon payments are treated the same as short-term loans.

Protection option.  The CFPB is considering two alternative approaches for a lender to make a longer-term loan without determining the consumer’s ability to repay.  Under either approach, the loan term must range from a minimum of 45 days to a maximum of six months and fully amortize with at least two payments.

  • The first approach is based on the National Credit Union Administration’s program for payday alternative loans, with additional requirements imposed by the CFPB. The NCUA program would limit the loan’s terms to (a) a principal amount of not less than $200 and not more than $1,000, and (b) an annualized interest rate of not more than 28% and an application fee of not more than $20, reflecting the actual cost of processing the application.  Under the NCUA’s screening requirements, the lender would have to use minimum underwriting standards and verify the consumer’s income.  The CFPB would also require the lender to verify the consumer’s borrowing history and report use of the loan to all applicable commercially available reporting systems and would prohibit the lender from making the loan if the consumer has any other outstanding covered loan or the loan would result in the consumer having more than two such loans during a rolling six-month period.  Under this alternative, a lender that holds a consumer’s deposit account would not be allowed to fully sweep the account to a negative balance, set off from the consumer’s account to collect on the loan in the event of delinquency, or close the account in the event of delinquency or default.
  • The second approach limits each periodic payment to 5 percent of the consumer’s expected gross income over the payment period.  No prepayment fee could be charged.  The lender would also have to verify the consumer’s income and borrowing history and report use of the loan to all applicable commercially available reporting systems.  In addition, the consumer must not have any other outstanding covered loans or have defaulted on a covered loan within the past 12 months and the loan cannot result in the consumer being in debt on more than two such loans within a rolling 12-month period.

Restrictions on  collection practices.  For all covered short-term and longer-term loans, lenders would be subject to the following restrictions:

  • Advance notice of account access.  A lender would be required to provide three business days advance notice before attempting to collect payment through any method accessing an account, including ACH entries, post-dated signature checks, RCCs, and payments run through the debit networks.  The notice would have to include information such as the date of the payment request, payment channel, payment amount (broken down by principal, interest and fees), and remaining loan balance.  Notice by email would generally be permitted.
  • Limit on collection attempts.  If two consecutive attempts to collect money from a consumer’s account made through any channel are returned for insufficient funds, the lender would not be allowed to make any further attempts to collect from the account unless the consumer provided a new authorization.

Yesterday, the CFPB announced a consent order with First Investors Financial Services Group, Inc., an auto finance company that both makes loans to consumers and purchases retail installment sale contracts from auto dealers. Under the terms of the consent order, First Investors agreed to pay a $2.75 million civil penalty relating to allegations that it knowingly failed to fix flaws in a computerized credit reporting system it had purchased from a third-party vendor. Although First Investors notified the vendor of the problem, the CFPB took issue with First Investors continuing to use that system without any fix being put in place by the vendor.

Importantly, this consent order suggests that the CFPB does not place much significance on whether it can show any resulting consumer injury in determining that a practice warrants a significant civil penalty. Notably, although “the severity of the risks to or losses of the consumer” is one of the mitigating factors to be taken into account in determining the amount of a civil penalty under Dodd-Frank, there is no mention of any actual consumer injury in the CFPB’s consent order, press release, or related prepared remarks. Instead, the CFPB stated only that First Investors “potentially harmed tens of thousands of its customers” and that in “strategically target[ing]” subprime consumers and then “knowingly” sending incorrect information to the credit reporting agencies, First Investors “put consumers with credit profiles that were already impaired into an even more perilous position.”

As such, the CFPB seems to say that the mere existence of a practice that it believes poses significant risks to consumers is sufficient to warrant a civil penalty in the millions. This means that companies cannot take comfort in the fact that a practice the CFPB may deem problematic resulted in only potential, not actual, consumer harm. The potential for consumer injury appears to be as unacceptable to the CFPB as injury in fact.

This consent order also reminds us of the need to monitor and exercise significant oversight of any vendors involved in providing financial products and services to consumers at all levels – origination, servicing, marketing, collections, and so on. Here, although First Investors did notify its vendor of the flaws in the credit reporting system, the CFPB determined that First Investors “knew there was a problem with its computer system but did not make sufficient efforts to fix the errors.” The CFPB further remarked that “[c]ompanies cannot pass the buck by blaming a computer system or vendor for their mistakes. . . . Using a flawed computer system purchased from an outside vendor does not get you off the hook for meeting your own obligations.” The message is clear. The CFPB wants to see companies demanding results from their vendors when issues arise, or suspend their impacted operations until those issues are addressed.

The CFPB also sent an unequivocal warning yesterday to furnishers that they must take “all necessary steps to ensure they are complying with federal laws.” These steps include: (1) monitoring consumer disputes for patterns or indications of systemic inaccuracies; (2) promptly modifying or deleting inaccurate information when it comes to the furnisher’s attention; and (3) making sure that any products or vendors furnishers use to assist in furnishing information do so in an accurate and legal manner. This warning is consistent with advice we already provide to our clients in connection with their efforts to prepare for a potential CFPB examination or enforcement action. The CFPB is unlikely to be sympathetic to any companies that do not take note of this warning with respect to their vendor relationships.

Finally, this consent order also has a number of direct impacts on the auto finance industry, an area in which we anticipate seeing additional enforcement and rulemaking activities by the CFPB in the near future. Ballard Spahr is hosting a four-part auto finance webinar series this fall and invites you to attend to further explore the current issues and trends in this area. We will begin the series on September 9, How the CFPB’s Larger Participant Rule for the Auto Finance Market Will Change the Game for Nonbank Auto Finance Companies, and follow it with a Fair Credit in the Auto Finance Industry presentation on September 30. On October 16 we will present The Application of UDAAP Proscriptions to Auto Finance and Leasing. The series will conclude on November 5 with a presentation on Regulatory Scrutiny of Ancillary Products in Auto Finance and Leasing. All of these programs will take place from noon – 1 p.m. Eastern on these dates. To register for any of these programs, simply click on the name of the event you’d like to attend and complete the registration form.