KeyBank's Small Loan Formula Avoids Payday Problems

Small dollar, high cost, short term credit has long been controversial, regardless of whether it's a payday loan at a check cashing shop or a deposit advance at a bank. For traditional lenders, the offerings may not need to be a source of strife.

Experiments in basic financial innovation over the last few years suggest that banks can create profitable products that please consumer advocates and fill low-to-middle income borrowers' need for quick credit. Regulators aren't demanding such a switch yet, but institutions like KeyCorp are still showing the way.

An FDIC small dollar loan pilot program concluded in 2009 suggested that 90-day, 36% APR loans could be viable; more recently Key experimented with an unsecured credit line that permits borrowers to repay loans of up to $1,500 over as much as 60 months.

"We're pleased not only with the clients we're able to serve, but also with how responsibly clients have used the product," says Cindy Balser, the consumer banking executive who designed the product.

The bank's offering, called the KeyBasic Credit Line, was initially conceived of as a variant on the deposit advance products already offered by many banks. But Balser and other Key executives shared consumer advocates' concern that borrowers often become trapped in such products.

Because advance loans require repayment at the time of the borrower's next deposit, they're difficult for cash-strapped borrowers to repay without lining up yet another loan. A study by the Center for Responsible Lending utilizing actual bank customer data gathered by Lightspeed Research found that the average deposit advance customer took out 16 loans a year, making the product in practical terms an exorbitantly expensive form of revolving credit.

Some banks have addressed this problem by capping the number of consecutive loans a customer may take out. But Key didn't see that as a solution. In June of 2010, Key community banking executive Michael Griffin told a SourceMedia conference that the bank was looking at a deposit advance product with a longer repayment period and features such as repayment forbearance if a customer's account contained less than $100. Shortly after, however, the bank threw in the towel on the entire deposit advance model.

"When the rubber met the road, it wasn't good for us, and it wasn't good for our customers," Balser said. "So we looked at what else we could do."

The alternate approach Key settled on involves offering an unsecured credit line to all of its checking account customers.

Like many banks, Key already underwrites personal loans between $1,000 and $10,000 to good customers, with the current cost for a New York borrower as around 15.99% plus a $25 annual fee and a $10 charge for drawing on the line. (Key declined to discuss its exact pricing, but confirmed that numbers recently obtained from its customer service operators were approximate.) Borrowers must pay back the loan over five years, though they can opt to close it out sooner.

If Key can't qualify a borrower for that line of credit, it offers its KeyBasic option. The loan's more pricey — for a New York account, the recent quote was 19.99% plus same annual and drawdown fees — but largely similar in most other respects. If a customer wants, he can deposit the balance of credit line in his checking account — or use it as a form of overdraft, with a $10 fee for the transfer. Under all circumstances, loans can be paid back over five years, avoiding the problems associated with a balloon payment.

The product's pricing and terms address concerns raised by regulators and consumer advocates. Barry Wides, the Office of the Comptroller of the Currency's head of community affairs, identified it at a Senate hearing as a good example of serving lower income customers.

"We think the Key product shows that banks can offer much more affordable products that meet the same needs as direct deposit advance," says the Center for Responsible Lending's Mike Calhoun.

The KeyBasic line comes with another virtue as well: it's profitable for the bank. While the bank declined to offer specifics on revenue from the product, "we need to get a return on every product we put into the market," says Griffin.

While the product's been around for less than a year, Key says its early experience is that customers tend to pay off the loan quickly. Few borrowers appear to actually be taking the bank up on its five year amortization plan; it just allows them to make a balloon payment on their own schedule.

"While theoretically people could go for [five years], it's really about saying that we're not going to take a huge chunk of somebody's pay to force them to pay it," Griffin says.

For banks that are still reliant on income from $35 overdraft fees, it seems logical that offering a product that cushions the fallout from cash crunches would cannibalize the bank's profits. Griffin says he doesn't expect any significant revenue fallout elsewhere in Key, although he says the bank hasn't yet gathered enough data to be sure.

While alternatives to traditional deposit advance products have been demonstrated to work, there's no sign that regulators will demand that banks adopt them.

If regulatory trends shift in that direction, or other institutions voluntarily decide they want to offer a more consumer-friendly product, they could likely replicate Key's approach. (The FDIC reached a similar conclusion about the model small dollar loans it encouraged in its pilot program.)

But keep something in mind, Balser says: "It's taken us a whole lot of work to get us to this point."