CFPB Report Points to Payday Lending Clampdown

NEW YORK (TheStreet) -- Now that banks are pretty much bailing out of the payday lending business, federal regulators are getting ready to set new rules for non-bank payday lenders.

The Federal Deposit Insurance Corp. and the Office of the Comptroller of the currency set new rules last year for payday loans -- called "deposit advance products" by banks and bank regulators -- last year, and the largest banks in the business, including Wells Fargo (WFC), Fifth Third Bancorp (FITB) of Cincinnati and Regions Financial (RF) of Birmingham, Ala., have either exited the business or announced plans to do so.

Banks of course have an advantage in the business over non-bank payday lenders because the bank's customers have deposit accounts, and the bank can quickly review a customer's history of direct deposits when making a loan decision. But the banks have shied away from the business because of the new rules. These include a "cooling off period," limiting customers to one payday loan a month, as well as a requirement for the bank to assess a deposit advance loan customer's eligibility for the loans every six months, including a detailed analysis of checking-account inflows and outflows, factoring in overdrafts and drafts from savings account.

OK, so that takes care of the banks. They are pretty much out of the payday lending business, unless they want to set up elaborate underwriting systems for these customers.

The Consumer Financial Protection Bureau -- created when the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010 -- has said it would address payday lending later this year, and new rules will likely require much more thorough and clear disclosure of just how much payday loans can cost consumers. And the CFPB's rules will cover all payday lenders, including the ones that aren't banks.

The CFPB on Tuesday released a report called CFPB Data Point: Payday Lending, which includes plenty of data supporting the case for much better disclosure -- at least -- to consumers.

According to the report, 80% of payday loans are rolled over or are followed by another loan within two weeks. Here are two other statistics from the report that look particularly ugly, when considering that the payday loans typically feature triple-digit annualized interest rates: "15% of new loans are followed by a loan sequence at least 10 loans long. Half of all loans are in a sequence at least 10 loans long."

According to the CFPB, when a payday loan customer begins a series of rolled-over loans, the loan balance doesn't go down, and it might go up. And increases in principal balance lead to a higher likelihood of default.

Fans of movies and TV shows portraying organized crime have probably become familiar with the concept of adding unpaid interest to the principal, as customers of loan sharks fall further and further into debt, with dangerous consequences.

For the CFPB, this lack of "amortization" is a big deal, and is probably going to be addressed when the agency sets rules for payday lenders later this year.

In addition to requiring amortization for a rolled-over loan, the CFPB appears likely to set a limit on how many times a payday loan can be rolled over, while also requiring a "cooling off" period in certain circumstances.

Payday lenders will certainly be required to spell out clearly, in writing, just how high a customer's annual interest rate is before they take out a loan.

The CFPB will not regulate the interest rates on payday loans, because it lacks the power to do so, but it will be able to place limits on loan fees.

Back in January, Rafferty Capital Markets analyst Richard Bove wrote in a client note that the new rules pushing banks out of the payday lending business were likely to push customers to non-bank lenders, which would charge much higher interest rates. It will be interesting to see just how tough the CFPB is on the non-bank payday lenders, and whether any of them will also be pushed out of the business.

That would leave borrowers who still wanted to take out these loans in a very difficult position.

Senator Elizabeth Warren (D., Mass) in a Huffington Post op-ed early last month offered her support to a possible partnership between the U.S. Postal Service and banks, to begin offering various financial services to under-banked households.

The USPS Office of the Inspector General has been exploring the possibility of offering bill paying, check cashing and small loans to customers, which according to Warren could save consumers in areas with fee bank branches billions of dollars in fees each year.

In the meantime, payday loan customers are likely to go on doing what they have been doing, but the CFBP's new disclosures will at least make it clear to them how much they are paying to borrow, and may even force some changes in expensive habits.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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