Small Banks Become Collateral Damage in CFPB's Payday Plan

Community bankers are unexpectedly caught up in the Consumer Financial Protection Bureau's proposal to rein in payday lending, with some saying the plan would jeopardize their ability to provide cash-strapped customers with small-dollar loans.

Roughly 75% of community banks currently offer small-dollar loans to customers, though many do not actively advertise them. Such loans typically make up less than 3% of a community bank's overall loan portfolio, according to the Independent Community Bankers of America.

On its face, the CFPB's plan could make offering such loans a compliance headache at the very least. But bankers said they plan to offer them regardless because their customers need them.

"We will find a way to offer the loans," says H. McCall Wilson, president and CEO of the $425 million-asset Bank of Fayette County in Piperton, Tenn. "This sounds tacky, but we're the answer to a prayer when these consumers need someone to help them."

Thomas Richards, president and chief executive of the $63 million-asset Owingsville Banking Co. in Kentucky, agreed.

"We will continue to make these loans," he said.

Community bankers are lumped in with payday and installment lenders in trying to figure out how to provide small-dollar loans that fit within the CFPB's complex, 1,341-page proposal.

The CFPB's plan would cover short-term payday loans, auto title loans, deposit advance products, certain (but not all) installment loans and open-end lines of credit. (Overdraft services on deposit accounts are excluded from the proposal.)

Under the plan, all lenders have the option to determine if a borrower has the ability to repay a loan, with fees and finance charges, and still meet basic living expenses. For many community bankers, however, the income verification and record keeping requirements are too stringent to be workable.

Lenders that offer short-term loans of up to $500 with terms of less than 45 days can choose an alternative, principal payoff option. But lenders would be barred from taking an auto title as collateral — another potential deal-killer for community bankers.

"We try to get a piece of collateral, even if it's a 1992 Corolla," Richards said. "We'll take anything over being unsecured."

For longer-term loans, typically a sweet spot for community banks, lenders have two alternatives if they do not verify a borrower's ability to repay. They can meet the parameters of the National Credit Union Administration's "payday alternative loans" program, where the interest rate is capped at 28% and the application fee is $20 or less.

A third option would be to offer loans with an all-in cost of 36% or less, excluding a "reasonable" origination fee. The loan's term cannot exceed two years and the lender's projected default rate cannot exceed 5%, or the lender would have to refund the origination fees.

Joe Gormley, an assistant vice president and regulatory counsel for the ICBA, said "the totality" of the restrictions will mean most community bankers are "going to get out" of small-dollar loans.

"The bankers we've talked to don't see a way to serve the market with these restrictions," Gormley said. "It would be a real shame if community banks are forced to stop making these types of loans."

The CFPB is soliciting public comment on its proposal through Sept. 14.

Joe Rodriguez, of counsel at Morrison & Foerster and a former Southeast regional counsel at the CFPB, said he thinks banks, credit unions and fintech firms will structure loans under the NCUA credit union model because of the potential to charge annual percentage rates above 100%, which would make the loans profitable.

"This is where many institutions will operate if they are extending short-term credit, because there is flexibility in structuring the loans, and in certain cases, the APR can be over 100%," Rodriguez said. "Many more borrowers would be able to qualify than under the 36% APR option the rule otherwise allows, and they'd get better terms than from a payday operation. So from the CFPB's perspective an APR of 100% is better than 400%."

Richards at Owingsville Banking is considering the credit union option, also known as PALs. He is also weighing extending all of the bank's short-term loans to a longer term of at least a year. Since 2013, Owingsville has made 1,563 small-dollar loans. The average loan was for $2,825 over 19 months, with an interest rate of 12%. The bank's chargeoff rate was a paltry 0.9%.

Richards argues that bankers overseen by the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency should be exempt from the CFPB's plan.

"The name of the regulation is payday lending, so why in the world are they dragging banks and credit unions into it?" Richards asked. "Banks and credit unions are not taking advantage of their own customers. They should apply the plan to nonbank entities that are making these abusive loans."

The CFPB designed its proposal, in part, to reduce loan rollovers that trap consumers into debt. (A CFPB study found that 80% of payday loans are rolled over or renewed, and nearly 80% of borrowers do not pay down principal when they roll over a loan.) The plan also aims to restrict lenders from directly withdrawing payments from borrowers' bank accounts, which can lead to repeat fees.

But there are other restrictions, such as giving consumers written notice before attempting to debit a checking account to collect payment, that bankers object to because they would increase costs.

Not every small-dollar loan is profitable. Wilson at Bank of Fayette County recalled lending $220 in 2014 to a customer who needed to get her teeth fixed. She paid the loan back in four months. The bank earned $7 plus a $50 fee, even though processing costs were $100.

"I agree it's an incredibly expensive product," Wilson said. "A small-dollar loan should be simple, easy to make, easy to understand and tailored to the borrower. It shouldn't require 1,500 pages of regulations."