By: Mark Huffman
December 19, 2013
Storefront payday loan companies seem to be everywhere, especially in areas where lower-income consumers live, work and shop. They're especially busy this time of year.
Consumer advocates generally urge consumers to avoid them, warning that if you don't have money now and need a loan, what makes you think you're going to have the money in two weeks, when payment is due? When you can't pay, you have to take out another two-week loan, trapping the borrower in what consumer advocates call a "cycle of debt."
Adam Rust, of Durham, N.C.-based Reinvestment Partners, has studied the payday loan industry as a business. He recently authored a report that traces the source of the money that payday lenders lend. It comes in large part, he says, from the nation's largest banks, including Bank of America and Wells Fargo.
Connecting the dots
According to his report - Connecting the Dots: How Wall Street Brings Fringe Lending to Main Street - payday lenders borrow money from the biggest banks at a little over six percent interest and charge consumers often in excess of 500%.
"This report draws a clear line between regulated financial institutions that hold millions of Americans' deposits and the fringe lenders that routinely threaten their bank accounts," Rust said. This chart, from Rust's report, shows the relationship between Wells Fargo and selected lenders.
To uncover his evidence Rust has followed publicly traded payday lenders just like any Wall Street analyst. He listens in to quarterly conference calls and studies documents the companies are required to file with the Securities and Exchange Commission (SEC).
$5.5 billion in loans
His research identified $5.5 billion in lines of credit and term loans issued by the banks. He says the filings show major banks are making loans to virtually every one of the country's largest payday and car title lenders, rent-to-own companies, buy-here pay-here car lenders, tax refund check providers, and pawn brokers.
Rust says nine of the 10 banks with the greatest levels of participation in fringe lending are national banks regulated by the Office of the Comptroller of the Currency (OCC), which periodically reviews the exposure held by their member institutions to products and practices that expose them to undue legal and reputational risk.
Being part of the payday lending food chain, Rust believes, is enough to damage a respected bank's reputation. Cutting off or reducing the supply of money flowing to these high-interest lenders, he believes, would deal a serious blow to the industry. How big a blow, he admits, is hard to know.
Probably a significant blow
"I think it would impact the scale of financing they would be able to tap," Rust said. "With a reduced supply of funds and different terms I think they would end up paying more for it."
The payday lenders, themselves, apparently believe it would be a significant blow if a major source of cheap funds suddenly dried up. As he has listened in to recent quarterly conference calls from what he calls "fringe" lenders, Rust says corporate executives have said things like losing access to financing "could adversely affect our operations," "would have a materially adverse effect on the company," and "adversely affect our ability to achieve our planned growth and operating results."
Rust would like to see pressure placed on banks to get out of financing these storefront operators. He points out the total amount loaned to these lenders makes up a tiny portion of the banks' total loan portfolios.
Payday lenders don't operate in all states. Some states have passed laws capping interest rates at 36% APR. The effective interest rate on a typical payday loan is deep into triple digit territory. Couldn't payday lenders charge less and still make money?
"I think the evidence out there suggests that's pretty hard," Rust said. "The business model is troubled because the payday lenders have to work under the assumption they're going to have significant loan losses. They're setting aside lots of money with the expectation that an awful lot of these loans are going to go bad."
Rust says he would like to see the OCC force the banking institutions they regulate to divest from companies making short-term, high cost consumer loans.