By: Carter Dougherty
May 29, 2013
For three years, payday lenders have been bracing for dedicated scrutiny from a U.S. agency for the first time. One way they're getting ready: switching to loans designed to fall outside the regulator's grasp.
Companies including Cash America International Inc. (CSH) and Advance America Cash Advance Centers Inc. (AEA) are increasingly selling longer-term installment loans to avoid rules the Consumer Financial Protection Bureau may impose on their shorter-term products.
While consumer groups say installment loans carry the same risks and high annual interest rates that drew regulatory attention to payday lending, companies making the switch have won kudos from shareholders. They've also taken encouragement from statements made by agency officials.
"You're diversifying the revenue sources while also shedding regulatory risk," said John Hecht, an analyst with Stephens Inc., a Little Rock, Arkansas-based investment bank.
The move by payday lenders puts them in competition with firms that have long focused on installment loans, including Citigroup Inc. (C) unit OneMain Financial; World Acceptance Corp. (WRLD) and Regional Management Corp., both based in Greenville, South Carolina; and Springleaf Financial Corp. (AGC1) of Evansville, Indiana, Hecht said.
Formed under the 2010 Dodd-Frank law, the consumer bureau consolidates and expands U.S. oversight of consumer finance. It supervises banks with assets over $10 billion, including JPMorgan Chase & Co. and Wells Fargo & Co., and regulates products from non-banks including payday lenders.
Typical payday loans can be for as little as $100 and for terms as short as two weeks. They are meant to tide the borrower over with cash until the next paycheck. The loans are secured by a single post-dated check. Online payday loans require borrowers to authorize a direct debit from a bank account.
After factoring in fees which can be $20 per $100 borrowed, interest rates on a payday loan can reach 521 percent on an annual basis, the bureau has said.
In contrast, installment loans are paid off under a fixed schedule in periods ranging from 90 days to 18 months. Unlike payday loans, borrowers are generally subject to credit checks and income verification.
A yearlong consumer bureau study concluded that payday borrowers can get ensnared in "debt traps" as they take out new loans to cover previous ones. The study found that 48 percent of those borrowing from storefront firms had more than 10 transactions with payday lenders in a 12-month period.
Payday industry lobbyists said the study overstated the incidence of repeat loans. Still, the agency said April 24 it would consider imposing waiting periods between loans.
Consumer advocates have taken a dim view of some installment lending as well. Annual percentage rates can also reach triple digits when fees are factored in, according to the Consumer Federation of America. Customers can fall into the same traps as they can with traditional payday loans, said Tom Feltner, the group's director of financial services.
"Consumer-protection criteria need to apply to short-term loans whether they are 14 days or 180 days," said Feltner, whose group has urged the consumer bureau to broaden its focus.
In states that don't authorize the installment loans they want to make, including Washington, New Hampshire and New York, payday lenders are seeking to change the laws, said Uriah King, vice president of state policy at the Center for Responsible Lending, a Durham, North Carolina-based advocacy group.
"Despite their claims, this has nothing to do with offering a better product for struggling families but rather thwarting state and federal policies intended to address the now well-documented debt trap of predatory payday lending," King said in an e-mail.
Payday lenders say they are making a pragmatic change in business strategy.
Standard & Poor's, the bond rating company, said U.S. rules could lead to lower ratings for firms that remain specialized in payday loans, meaning it would be more expensive for them to raise money.
"The companies that continue to pursue geographic and product diversification will, in our view, be in a better position to navigate regulatory channels," Igor Koyfman, an S&P credit analyst, said in a May 20 statement.
Jeremy Rosenblum, an attorney with Ballard Spahr LLP in Philadelphia who represents payday lenders, said he advises clients to develop new products in advance of any rules.
"If you're serving this market, you have to be considering alternative strategies if the CFPB does come up with regulations," Rosenblum said in an interview.
Cash America said its move into installment lending came in response to customers who couldn't get the loans at traditional banks. The Fort Worth, Texas-based firm reported earnings of $42.3 million from installment loans in the quarter ending Dec. 31, nearly double the $22.3 million it earned a year earlier.
"We do believe a substantial portion of our installment loan growth has been generated by new customers who are finding fewer and fewer affordable opportunities for consumer credit in the marketplace," Chief Executive Officer Daniel Feehan told analysts on April 13.
Lenders also have pointed to approving statements from consumer bureau officials about installment loans.
Richard Cordray, the consumer bureau's director, said in an April 10 speech at the American Financial Services Association in Las Vegas that installment lending is an important service for consumers who need short-term credit, according to Bill Himpler, the group's executive vice president.
On May 14, Rohit Dewan, a financial analyst in the consumer bureau's Office of Installment and Liquidity Lending, said on a conference call with analysts that an installment loan "seems like a safer product" than a payday loan.
Thomas Bessant, chief financial officer of Cash America, said that's one reason "the subprime category of installment products" has become a new focus for the firm.
"The good news, from a regulatory perspective, is there is a perception that it's more appealing to the customer and it's a more favorable product to the customer," Bessant said in a Nov. 27 conference call with analysts.
Asked about the consumer bureau's position on installment loans, spokeswoman Moira Vahey said, "If small-dollar lenders are engaged in unfair, deceptive or abusive practices, the bureau will hold those institutions accountable, no matter how their products are structured."
Spartanburg, South Carolina-based Advance America, a unit of Grupo Elektra SAB (ELEKTRA), has also increased its offerings of installment loans in recent years, Jamie Fulmer, senior vice president for public affairs, wrote in an e-mail. It started with offerings in Illinois in 2008, Colorado in 2010, Missouri in 2012 and Delaware and Wisconsin this year, he said.
"We are always looking for ways to meet the needs of our customers with new products," Fulmer wrote.
EZCorp Inc. (EZPW), an Austin, Texas-based company whose products include pawn and payday loans, is also transitioning toward other businesses. Two years ago, its loan balances were 85 to 90 percent payday loans, and now it is "right just under 50 percent," Paul Rothamel, its chief executive officer, told analysts on Jan. 22.
Marcy Bowers, director of the Statewide Poverty Action Network, a Seattle-based advocacy group, said a legislative debate in the state of Washington highlights how installment loans can be just as costly to consumers as payday loans.
State lawmakers are debating proposals backed by MoneyTree Inc., a Seattle-based payday lender, to authorize installment loans for as much as $2,000 at a 36 percent annual interest rate. The legislation also would permit origination fees and monthly maintenance fees that could push the effective annual rate above 200 percent, according to a calculation by the state Department of Financial Institutions.
Dennis Bassford, CEO of MoneyTree, didn't respond to calls seeking comment.
Under a law that took effect in 2010, borrowers in Washington are limited to eight payday loans in any 12-month period, and the state maintains a database that allows lenders to track adherence to the rule.
"Washington was one of the first states to limit the number of loans, so it shouldn't be surprising that the lenders are looking for ways around the payday law," she said.
Rosenblum, the lawyer for payday lenders, cautions his clients that moving into installment loans may not protect them from federal rules. In its guidelines for examining payday lenders, the bureau didn't explicitly define a payday loan, and could still decide to oversee to installment products, he said.
The switchover "isn't a perfect solution," Rosenblum said. "But it may be a partial solution to the problem of regulation."