Last week the Consumer Finance Protection Bureau ("CFPB") released its long-awaited proposed rulemaking to regulate payday, auto title and certain high-cost installment loans ("covered loans"). The stated purpose of the rulemaking is to protect consumers living paycheck to paycheck from the so-called "debt spiral" of serial borrowing and multiple loan origination and overdraft fees occasioned by chronic liquidity needs. Given that the proposed rule spans 1,334 densely filled pages, it will take some time to digest the broad requirements and potential impact. Thus far, however, opinions on whether the proposed rulemaking is likely to achieve its stated goals and the impact it may have on particular businesses or borrowers seem to depend on perspective. For some, the proposed rule is an example of overreaching by the CFPB that threatens their business and really "miss[es] the mark," as Richard Hunt, President and CEO of the Consumer Bankers Association, noted last week. For others, the rulemaking would appear to have a marginal impact, if any. And some FinTech companies view the proposed rule as an opportunity for market disruption and new entrants.
Summary of the CFPB's Proposed Payday Loan Rules
The CFPB's proposal would impose a series of regulations on two categories of loans: (1) those with a term of 45 days or less and (2) those that have a term of greater than 45 days provided that: (i) they have a total cost of credit of greater than 36 percent and (ii) are either repaid directly from the borrower's bank accounts or income or are secured by the borrower's vehicle. (See Proposed Rule at § 1041.3.)
For both categories of covered loans, the proposed rule would:
- require lenders to make a reasonable determination that the borrower has the ability to repay the loan (absent the exceptions discussed below) (Proposed Rule at §§ 1041.5 and 1041.9);
- limit a lender's ability to collect on covered loans via direct withdrawal from a borrower's bank accounts (Proposed Rule at §§ 1041.14 and 1041.15); and
- require lenders to furnish information concerning origination practices to registered information systems (Proposed Rule at §§ 1041.16 and 1041.17).
With respect to those covered loans with terms of less than 45 days, the proposed rule would permit a lender to forego an ability-to-repay determination in very limited circumstances. In particular, a lender could, without determining ability to repay, make a maximum of three sequential loans to a borrower with the first loan having a principal amount of not more than $500, the second loan having a principal amount that is at least one-third smaller than the first, and the third loan having a principal amount at least two-thirds smaller than the first loan. (Proposed Rule at § 1041.7(b)(1).) The proposed rule, however, precludes the use of this exemption if making the loan would result in the consumer having more than six covered short-term loans during a consecutive 12-month period or being in debt for more than 90 days on covered short-term loans during a consecutive 12-month period. (Proposed Rule at § 1041.7(c)(4).)
The proposed rule provides a slightly different option for avoiding an ability-to-repay determination as to loans with greater than 45-day terms. For covered longer-term credit, a lender can avoid an ability-to-repay determination under two different scenarios. First, the lender could provide borrowers with generally the same protections offered under the National Credit Union Administration program for "payday alternative loans," and employ a 28 percent interest rate cap on the loans and an application fee of no more than $20. ("PAL Approach"). (Proposed Rule at § 1041.11) Alternatively, the lender could make a longer-term loan, provided the amount the consumer is required to repay each month is no more than 5 percent of the consumer's gross monthly income and the lender does not make more than two of these loans within a 12-month period ("Portfolio Approach"). (Proposed Rule at § 1041.12)
A lender's failure to adhere to any of the foregoing requirements would be considered an abusive and unfair practice subject to a CFPB enforcement action.
Potential Impact on Current Providers of Short-Term Consumer Loans
The most significant impact of the proposed regulations on current payday lenders appears to be the limitations it would impose on the frequency of both short and longer-term loans as well as the proposed caps on certain origination fees. The Community Financial Services Association of America, a trade group for the payday lending industry, issued a statement last week saying that "by the [CFPB's] own estimates this rule will eliminate 84 percent of loan volume thereby creating financial havoc in communities across the country." Whether these estimates prove accurate remains to be seen. What seems clear, however, is that the proposed lending restrictions are likely to result in at least some reduced loan volume.
Second, even if the proposed rulemaking does not significantly reduce loan volume, the requirements to determine a borrower's ability-to-repay will likely increase origination costs for those payday lenders who do not presently employ traditional underwriting practices. For those lenders, the increased costs, paperwork and procedures could fundamentally alter their business model and/or profitability. As for lenders who currently employ traditional underwriting practices, the impact of this portion of the proposed rulemaking would appear to be far less significant. At present, the proposed requirements imposed for determining ability to pay include:
- verifying the borrower's net income;
- verifying the borrower's debt obligations using a credit report from a "registered information system";
- verifying the borrower's housing costs;
- forecasting a reasonable amount for the borrower's basic living expenses;
- projecting the borrower's net income, debt obligations and housing costs for the period of time covered by the loan; and
- projecting the borrower's ability to repay the loan based on the above projections.
(Proposed Rule at § 1041.5). All of the foregoing are fairly standard aspects of a traditional loan underwriting process.
A final important impact of the proposed regulations on lenders is the restriction placed on loan collection methods. For all covered short-term and longer-term credit, the rule would make a lender subject to the following collection restrictions:
- Generally, a lender has to give the consumer at least three business days' advance notice before attempting to collect payment by direct access to a consumer's checking, savings or prepaid account.
- If two consecutive attempts to collect money from a consumer's account made through any channel are returned for insufficient funds, the lender could not make any further attempts to collect from the account unless the consumer provided a new authorization.
The extent to which these new regulations would reduce loan volume and/or increase costs for current payday lenders will undoubtedly be the subject of much debate during the comment period, with divergent estimates based on differing assumptions.
Potential Impact on Established Banking Institutions and New Market Entrants
For some banks and credit unions, the biggest disappointment of the CFPB's proposed rulemaking appears to be the removal of the so-called "payment-to-income test" that had been included in prior outlines of the proposed rule released by the CFPB. The payment-to-income test would have allowed lenders to issue loans, without performing ability-to-repay determinations, so long as repayment was limited to 5 percent of a consumer's income. At least a few banks and credit unions had reportedly been designing products based on that exemption. The loss of the exclusion may mean that these credit unions and banks forego entering the short-term consumer space because the origination and collection costs are prohibitive.
Certain online lenders and FinTech companies (marketplace lenders), by contrast, appear to believe that the proposed rulemaking will provide them with greater opportunities to fill the void left by brick-and-mortar lenders. These new market entrants contend that providing cheaper borrowing options for consumers may be accomplished profitably through the use of more and better technology. For example, LendUp, a startup backed by Google Ventures, supports the proposed new rule. LendUp CEO and co-founder Sasha Orloff said, "As a mission-driven startup committed to redefining the way underbanked consumers access financial services, LendUp shares the CFPB's goal of reforming the deeply troubled payday lending market." LendUp, like some others, apparently believes that the proposed rulemaking may provide it, and other FinTech companies, with a competitive advantage based on its enhanced technology.
Marketplace lenders generally lend for periods greater than 45 days; some lend at APRs in excess of 36 percent, and most lend on an unsecured basis. If those lenders do not require direct access to a borrower's bank account or income, the CFPB rule, as proposed, would not apply. If direct repayment is required from the borrower's bank account or income, the CFPB rule, as proposed, would apply. The question then would be whether the lender's credit determination—its ability-to-repay analysis—is consistent with the analysis prescribed by the proposed rule (or with the 5 percent of monthly gross income/ maximum two loans per 12 months limitation). If not, a comment letter and other advocacy may be appropriate to explain why the marketplace lender's methodology is at least as sufficient to evaluate ability to repay as the analysis prescribed by the proposed rule.
Potential Impact on Consumers
Perhaps the most interesting aspect of the CFPB's proposed rulemaking has been the divergent views of the impact on consumers. Certain consumer protection groups, like the Consumer Federation of America, support the proposed rulemaking and believe it represents an attempt to protect borrowers. Other groups seem to believe that although it is a good start it does not go far enough and leaves loopholes that need to be closed. While still other consumer groups believe it goes too far and that it will result in diminished liquidity options for the most underserved, driving them to loan sharks, pawn shops or other less desirable alternatives to meet their liquidity needs.
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In light of these competing interests and divergent views, we expect a myriad of comments to be submitted between now and the end of the comment period on September 14, 2016.