How a scorned industry plans to keep the 400% loan around

Posted6/19/2016 7:16 AM
  • Larger payday lenders have already concluded they will be able to withstand a recent regulatory onslaught -- and keep alive the most controversial loan in the United States: one with an annualized interest rate of 390 percent or more.

    Larger payday lenders have already concluded they will be able to withstand a recent regulatory onslaught -- and keep alive the most controversial loan in the United States: one with an annualized interest rate of 390 percent or more.

When federal regulators recently took their first ever step to protect consumers who use payday lenders, many experts described the move as a fatal blow to the industry. The payday trade association said "thousands of lenders" would be forced to "shutter their doors."

But larger payday lenders have already concluded they will be able to withstand the regulatory onslaught -- and keep alive the most controversial loan in the United States: one with an annualized interest rate of 390 percent or more.

"It's certainly our intention to survive," said Patrick O'Shaughnessy, chief executive of Advance America, at a Springfield, Virginia, branch this week.

The Consumer Financial Protection Bureau proposed tough new rules last week to end what it calls "payday debt traps" that embroil consumers in an escalating cycle of high-priced loans. The CFPB, which projects that the proposed rules could shrink payday loan volume by as much as two-thirds, attempts to limit the type of serial borrowing that accounts for most payday transactions and the bulk of the industry's profits. It does not limit interest rates.

Interviews with executives from several payday lenders provide a window into how one of the most scorned industries in the United States will try to contend with the regulatory attack. In the past, payday lenders have shown a chameleon-like ability to adapt under threat. In Ohio, for instance, a 2008 law placed a rigid cap on short-term loans; payday lenders entered into the "mortgage" business, offering similar loans under similar terms.

Ultimately, payday lenders say they are almost certain to take legal action against the CFPB to block the proposed rules, which experts say are likely to resemble the final product. But even if they lose, some of the biggest firms are already eyeing ways to make up for what all sides agree would be a massive plunge in business, by shifting to longer-term loans with similarly high interest rates or by plucking away business from smaller competitors.

The regulators and companies are battling over an area of the economy that aims to both serve and profit from lower- and middle-income borrowers in need. Payday and other high-interest-rate loans have previously been regulated only by states, and unevenly at that. (Fourteen states, as well as the District of Columbia, place a de facto ban on the practice with interest rate cap.) The proposed rules from the CFPB come as part of a broader effort in the wake of the Great Recession to curb abusive practices, all while raising the question of whether borrowers at the bottom of the economy have a right to access -- or be protected from -- risky loans.

According to government data, the median borrower has an income of roughly $22,500. They often take out a loan to deal with an unforeseen expense -- a flat tire or a medical bill -- or because take-home pay dips after a week with fewer hours.

With its proposal, the agency calls to limit borrowers to three consecutive payday loans and six in a year. In 2011, the last year Advance America was owned by shareholders and released earnings data, the company's average borrower took out eight loans in a year.

Some experts on payday lending say companies would have to raise fees as a response to the shrinking number of loans -- as well as new underwriting duties.

"The more you cap that repeat business, the more the cost of that first loan has to go up," said Howard Beales, a professor at George Washington University who has recently done paid research on behalf of the industry.

"The business isn't going to make money by giving one or two loans per year to a person," added Stephen Martino, the manager from 2007 to 2011 of an Advance America store in Pawtucket, Rhode Island. "They're going to make money with the person who is going to take out X number of loans for years on end."

But Jamie Fulmer, Advance America's senior vice president for public affairs, said pushing up interest rates could be difficult. Companies are already up against interest rate caps in most states where they operate.

-- -- --

With both payday and installment loans, borrowers provide the lenders with either a postdated check or access to their bank account -- an assurance that they can collect what is owed. But the business model for the loans is different.

Payday loans span two weeks, and a borrower might pay $15 in fees for a $100 loan; the fees escalate, and the loan becomes more profitable for the lender, only when the loan is rolled over many times. With installment loans, though, the fees are much higher -- and repeat lending isn't necessary. A borrower might pay $200 in financing charges for a $100 installment loan, with the repayment spread over months or several years.

The CFPB's proposal addresses both payday and installment loans, but for installment loans, the rules merely limit who is eligible, trimming the pool of customers. The business model for payday loans, on the other hand, will be "obliterated," said Darrin Andersen, the chief executive of QC Holdings, the company that operates Quik Cash, a major payday lender.

Andersen said his company is "preparing to weather the storm" by shifting more heavily to installment loans. Right now, Andersen said, payday loans comprise about 60 percent of Quik Cash's total. That share could soon fall to 20 percent, he said.

"We've been entirely focused on payday for most of our life cycle" as a company, Andersen said.

Not all payday borrowers want installment loans, he said, because they are guaranteed "to be in debt for a longer period of time." But they, too, can provide an influx of money for emergencies.

Though consumer groups have generally applauded the CFPB's approach to the payday industry, the Pew Charitable Trusts has been critical about the dangers of a potential shift toward installment loans.

"Lenders can be as profitable under an installment model," said Alex Horowitz, an officer at the Pew Charitable Trusts who studies short-term lending.

In Texas, for instance, Advance America offers a $500 installment loan with $1,341.84 in financing fees. The annualized interest rate is 574.52 percent.

That loan remains legal under the CFPB's proposal.

-- -- --

Lenders have at least one thing going in their favor: A lot of credit-strapped Americans are desperate for money in a pinch. According to recent data from the Federal Reserve, 46 percent of American households say they would have trouble handling an emergency costing $400.

"The demand will always be there," O'Shaughnessy said.

When O'Shaughnessy, during a trip through the District, stopped earlier this week at a strip mall store in Springfield, Va., he found himself in a branch that looked much like the other 2,200 Advance Americas -- with green and yellow trim, mahogany chairs and a lineup of employees whose positioning was designed to mimic bank tellers.

"Money problems? No problem," said a sign on the door.

During O'Shaughnessy's visit, a flow of customers came through.

One man joked about borrowing $25,000.

One woman with a cane shuffled to a section advertising auto title loans.

Analdo Pacheko, 28, who works at a moving company warehouse, took out a $350 loan -- with more than $75 fees -- to make a rent payment. The fees were nasty, he said, "but I didn't want to go homeless."

O'Shaughnessy, who made $3 million in salary and stock options in 2011, the last year for which data is publicly available, talked at length about Advance America's customers. He said the CFPB wasn't looking out for their best interests, and was instead acting paternalistically, as if assuming payday borrowers weren't savvy.

Some payday lending companies might go out of business. Some customers might not be able to get loans. Perhaps they'd go to churches or food pantries, but perhaps, too, they'd also drift toward loan sharks or offshore companies.

It's not necessarily good for customers, eliminating more choice," O'Shaughnessy said. "But you could see a situation where over a long period of time the supply dries up and there's a few survivors."

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