Bank Lawyer's Blog

The Devil You Know

Writing in the latest issue of The Atlantic, Bethany McLean gives a fairly balanced treatment of the oft-whipped payday lending business, and asks the very intelligent question, "If you get rid of it, will anything better replace it?"

After noting that payday lenders serve almost 15% of American households, and that the typical customer is a white woman age 25 to 44, she also points the problems faced by those typical customers, many of whom live paycheck to paycheck, as a result of the typical payday loan.

The entire amount—the fee plus the sum that was borrowed—is generally due all at once, at the end of the term. (Borrowers give the lender access to their bank account when they take out the loan.) But because many borrowers can’t pay it all back at once, they roll the loan into a new one, and end up in what the industry’s many critics call a debt trap, with gargantuan fees piling up.

McLean states "a key truth" about all small, short-term loans: "they are expensive for lenders to make." Payday loan borrowers are not "price sensitive" because "[t]he typical payday-loan consumer is too desperate, too unsophisticated, or too exhausted from being treated with disrespect by traditional lenders to engage in price shopping." With price competition being "inelastic" and with fees being so high, you would expect to see the business "awash in profits," yet studies of the industry show that the profit margin is less than 10%, which is less than one-third of the profit margin of the consumer-financial-services industry as whole. This is because default rates are high. The people who pay high fees for short-term loans don't have access to other alternative sources of credit because they are lousy credit risks, and on a $300 loan, payday lenders can't afford to underwrite them as they do more "conventional loans. An even bigger drag on profitability is overhead. Lots of storefronts, high employee turnover rates, and overall lousy efficiency.

The CFPB's proposed rules for the business would require underwriting to ensure sufficient verified income to ensure repayment (as well as living expenses) without either default or repeated re-borrowing. The latter is the aspect of payday lending that most disturbs its critics, who feel that payday lenders "trap" borrowers in never-ending cycles of re-borrowing. However, McLean supports the payday lending industry's supporters' contention that these requirements would put all payday lenders out of business, and she asks whether or not that's a good thing.

Emergency credit can be a lifeline, after all. And while stories about the payday-lending industry’s individual victims are horrible, the research on its effect at a more macro level is limited and highly ambiguous. One study shows that payday lending makes local communities more resilient; another says it increases personal bankruptcies; and so on.

[...]

If most payday-lending customers ultimately need to fall back on financial support from family members, or on bankruptcy, then perhaps the industry should be eliminated, because it merely makes the inevitable more painful. Yet some consumers do use payday loans just as the industry markets them—as a short-term emergency source of cash, one that won’t be there if the payday-lending industry goes away. The argument that payday lending shouldn’t exist would be easy if there were widespread, affordable sources of small-dollar loans. But thus far, there are not.

She discusses the desire of consumer advocates like Sheila Bair and Richard Cordray to strong-arm banks and credit unions into the business, at much lower rates. On the other hand, she rightly observes that Bair's foray in 2007-2008 to entice banks into the mix was a crashing failure because, as even dim bulbs like this blogger noted at the time, you can't make any money on them at 36% (the consumer advocate's favorite annual percentage rate cap). McLean also notes the perversity of the subsequent FDIC and OCC guidelines about the risks of small-dollar lending that drove Wells Fargo and U.S. Bankcorp to drop the business entirely. Even credit unions, which (need we point this out?) DON'T PAY TAXES, can't figure out a way to make payday lending work for them, at least not on a scale that will replace the current payday-loan-office-on-every-corner industry model and service the targeted market.

Although McLean suggests that Colorado has done some "out-of-the-box" thinking about payday lending (thinking apparently done prior to the legalization of recreational marijuana use), it's not likely to satisfy the industry's critics (like Cordray & Co.) because it actually leaves the industry in place. Sure, it's a much smaller industry, one that charges 42% less in fees, and one whose loans default less frequently, but it still actually exists, making all those icky payday loans to people that The Care Bair and King Richard need to protect from themselves because they're all just too dense to do it alone. True believers will never rest until Michael Corleone and his crew step back into the role they were born to play: real-life loan sharks and knee-cappers. If that happens, McLean will not be rooting from the sidelines.

Outrage is easy, and outrage is warranted—but maybe payday lenders shouldn’t be its main target. The problem isn’t just that people who desperately need a $350 loan can’t get it at an affordable rate, but that a growing number of people need that loan in the first place.

That last sentence is especially cogent, but a topic for another day, and a different blog.

Residential Mortgage Lending: The Bloom Is Off The Rose For More Than Just The Big Banks

My friend, Colorado community and mortgage banker Pat Dalrymple's, latest "Banker's Hours" column in the PostIndependent Citizen Telegram again struck a chord with me. With permission, here it is, in case it also hits home with you:

We hear that the TBTF (Too Big to Fail) banks are getting out of the mortgage business. Can this really be true? Weren’t they reputed to be the culprits in the recent Great Recession that was reportedly triggered by all of the toxic mortgages they originated?

Well, they haven’t left the building entirely, but they’re not in residence like they once were. Here are some fairly dramatic stats:

Wells-Fargo, the nation’s No. 1 mortgage originator, funded $125 billion in mortgage loans during the fourth quarter of 2012. During the same period in 2015, that number was down to $47 billion.

Chase, the second ranking lender, did $51 billion in the last three months of 2012. In 2015, that number had shrunk to just under $23 billion. These are dramatic swings in banking, and show major ramp down of what was once a core business.

And it’s not just the big guys that are backing away from the iconic American Dream of financing home ownership. In 2007 banks made 74 percent of home loans in the country. By 2014, their share had dropped to 52 percent. At the same time, the share of nonbanks, which includes online lenders like Quicken Loans, had increased from 23 percent to 43 percent.

What’s happened? Just business; mortgage lending isn’t as profitable for banks as it once was. Interest margins on home loans held in portfolio are thinner than other lending lines. Since the Great Meltdown, the private bond market has virtually dried up for mortgage-backed securities. The cost of originating mortgages has skyrocketed, and regulatory risk has become, in the eyes of some former mortgage lenders, intolerable.

The increased cost of doing business is graphically demonstrated by the fourth quarter of 2015: Net gain on mortgages originated was down 60 percent, from $1,238 per loan to just $493. This is because lenders spent billions on re-tooling for the new RESPA-Truth in Lending disclosure protocol mandated by the Consumer Financial Protection Bureau that came online in October of last year.

As for regulatory risk, we’ve all heard of the multi-billion-dollar fines levied against the big banks for their role in originating and packaging the famous rotten mortgages that were at the root of the financial crisis. But the risk for banks is ongoing.

For example, PHH — a nonbank mortgage originator, seventh largest in the country last year at $37.57 billion — was just hit with a $109 million fine, which is certainly an attention getter. But the way it happened has lenders shaking in their Guccis. It was alleged that PHH had illegally taken kickbacks from mortgage insurers through customer referrals. The case went to an administrative law judge, who suggested a fine of $6 million.

To appreciate this story, we need to understand what an administrative law judge is. This person is trained in the law, but isn’t a real judge, as in a courtroom. Rather, he or she is employed by the agency bringing the charge. People who have been subjected to this process have likened it to walking into the Godfather’s study, who says, “Don’t worry about a thing, Joey, my consigliere here will give you a fair and impartial hearing.”

In the PHH case, the capo of the CFPB interpreted the law differently than it had been heretofore applied, so he must have said, “Geno, you were too soft on them.” He decided that the violations went back much further than the tame judge deemed, way back even before the CFPB was created, and increased the fine up to the $109 million.

Think the Mob has a long memory?

All of these factors are making big lenders think twice about being in the business. It may be the slack will be picked up by small banks, credit unions and online lenders. The jury’s out on that question.

FDIC: Bring Me Your Tired, Your Poor, Your Huddled De Novos, Yearing To Be Free

Last week, FDIC Chairman Martin Greunberg announced that the FDIC was rescinding a policy that it instituted during the depths of the last recession, of requiring heightened scrutiny of de novo banks during their first eight years of existence, and was returning to the policy of the "good old days," when new banks suffered life under an regulatory electron microscope for only three years. Gruenberg claims that "the FDIC welcomes applications for deposit insurance, and we clearly have a role to play in facilitating the establishment of new institutions." He also claimed that the reason that de novo applications have slowed to "a trickle" since the start of the Great Recession is because of economic factors, not a real or imagined FDIC moratorium on insurance of accounts for de novo banks.

I should note that establishing even a small community bank is a challenging endeavor. Developing a sound business plan, raising the needed financial resources and recruiting competent leadership and staff takes work and we want to ensure that every new institution that is established is in a position to succeed.

But we are very committed to working with and providing support to any group with an interest in starting a community bank. To that end, we are developing a handbook to guide applicants through the review process.

There is ample room for new community banks with sound funding and well conceived business plans to serve their local markets. It is essential that they have a clear path to approval.

This all sounds well and good on the surface. However, I'm with attorney Charles Horn who, writing in the National Law Journal, indicates that he is, like me, from Missouri on this matter.

That said, the dearth in new deposit insurance approvals in recent years has, to some extent, become a self-fulfilling prophecy in that a perceived FDIC reluctance to approve new deposit insurance applications has helped suppress industry interest in establishing new banks. Chairman Gruenberg is correct, in part, in attributing the decline in deposit insurance applications to post-financial crisis economic conditions. At the same time, experience has shown us that persons wanting to organize a new insured depository institution have been discouraged by the FDIC’s failure to approve more than a small handful of new deposit insurance applications in the past few years (none so far in 2016, two in 2015, none in 2014, three in 2011, and two in 2010, according to the FDIC’s website).

While we state the obvious in saying that the best way for the FDIC to encourage the formation of new banks is to approve more deposit insurance applications, the point here is that it is actions—not words—that will speak the loudest on this subject.

There is no question that these are still difficult times to make money in the community banking business, no matter how much lipstick Gruenberg paints on the lips of the community banking business in the course of his address (and he lathers it on in rosy red hues in the linked article). A good portion of that difficulty is due to the small interest rate spreads and low interest rates imposed by the Federal Reserve's policies over the past nine years, which, as of today, seem rooted in place. Nevertheless, as the Federal Reserve's own economists have noted, the dearth of de novos is also due to the regulatory burdens placed on the small banks by the FDIC, FRB, and OCC. Greunberg does state that a "gentler approach" and "tiered regulation" are on the way. If true, this relief will be welcome.

We'll have to wait and see whether this promise of more de novos is true or false. As we noted just a few months ago, even those applicants who have weathered the storm and made it over the finish line have painted a grim picture of the time and expense required, as well as of much higher capital requirements (which means reduced return on equity). If organizers expect to pay consultants and attorneys hundreds of thousands of dollars to assist them in raising capital, creating extensive business plans, and preparing detailed applications for insurance of accounts, I think that they want to feel more confident that they will have a decent shot at approval.

As Horn observes, in this area, actions will speak louder than words.