BILL ANALYSIS SENATE COMMITTEE ON BANKING, FINANCE, AND INSURANCE Senator Ronald Calderon, Chair SB 1146 (Florez) Hearing Date: April 7, 2010 As Amended: March 22, 2010 Fiscal: Yes Urgency: No SUMMARY Would authorize the creation of a four-year, statewide pilot program under the California Finance Lenders Law (CFLL), to increase the availability of affordable, low dollar value loans. Would authorize licensed finance lenders accepted by the Commissioner of Corporations for admission into the pilot program to charge higher rates and fees than currently allowed under the CFLL and to use the services of one or more finders, as defined. DIGEST Existing law 1. Provides for the California Finance Lenders Law (CFLL), administered by the Department of Corporations (DOC), which authorizes the licensure of finance lenders, who may make secured and unsecured consumer and commercial loans (Financial Code Sections 22000 et seq.). The following are the key rules applied to consumer loans made pursuant to the CFLL: a. CFLL licensees who make consumer loans under $2,500 are capped at interest rates which range from 12% to 30% per year, depending on the unpaid balance of the loan (Sections 22303 and 22304). Administrative fees are capped at the lesser of 5% of the principal amount of the loan or $50 (Section 22305); b. In addition to the requirements in "a" above, CFLL licensees who make consumer loans under $5,000 are prohibited from imposing compound interest or charges (Section 22309); are limited in the amount of delinquency fees they may impose (Section 22320.5; delinquency fees are capped at a maximum of $10 on loans 10 days or more delinquent and $15 on loans 15 days or more delinquent); are required to prominently display SB 1146 (Florez), Page 2 their schedule of charges to borrowers (Section 22325); are prohibited from splitting loans with other licensees (Section 22327); are prohibited from requiring real property collateral (Section 22330), and are limited to a maximum loan term of 60 months plus 15 days (Section 22334); c. In addition to the requirements in "a" and "b" above, CFLL licensees who make consumer loans under $10,000 are limited in their ability to conduct other business activities on the premises where they make loans (Section 22154); must require loan payments to be paid in equal, periodic installments (Section 22307); and must meet certain standards before they may sell various types of insurance to the borrower (Sections 22313 and 22314); d. Generally speaking, the terms of loans of $10,000 or above are not restricted under the CFLL; 2. Authorizes the licensure of finance brokers under the CFLL, and defines a finance broker as any person who is engaged in the business of negotiating or performing any act as a broker in connection with loans made by a finance lender (Section 22004); 3. Prohibits a CFLL licensee from using advertising copy after its use has been disapproved by the Commissioner of Corporations (Commissioner), and the Commissioner has notified the licensee in writing of the disapproval; 4. Authorizes the Commissioner to require CFLL licensees to maintain a file of all advertising copy for a period of 90 days from the date of its first use and to make that file available to the Commissioner, upon request. This bill 1. Would authorize a four-year, statewide pilot program under the CFLL, under which licensees approved by the Commissioner for entry into the program could do all of the following: a. Offer a new type of consumer loan under the CFLL, with a new (higher) rate schedule, a new (higher) set of allowable delinquency fees, new (lower) costs to file a claim against a borrower in small claims court, and a new series of conditions on the licensee, as follows: i. The interest rate of each loan would be SB 1146 (Florez), Page 3 capped at 3% per month, simple interest, on the unpaid principal balance; ii. Origination fees would be capped at the lesser of 5% of the principal amount of the loan or $75; iii. Delinquency fees would be capped at an amount not to exceed one of the following amounts: $20 for a delinquency of seven days or more, and $25 for a delinquency of fourteen days or more; iv. The cost for a pilot project participant to file a small claims action to enforce a pilot project loan contract would be $25 (rather than a maximum of $100 per action, depending on the size of the loan and the number of actions filed during the prior twelve months); v. The loan would have to have a term of at least 90 days, and a principal amount between $250 and $2,499 upon origination; vi. The licensee would have to disclose the annual percentage rate of the loan, the periodic payment amount, and the total finance charge to the borrower at the time of application; vii. The licensee would also have to inform the consumer that he or she could rescind the loan by returning the loan principal by the end of the business day following the day on which the loan was consummated; viii. Before disbursing the loan proceeds, the licensee would have to either offer a credit education program or seminar to the borrower or invite the borrower to a credit education program or seminar offered by an independent third party. The education program or seminar would have to have been previously approved by the Commissioner. The borrower would not be required to attend these education programs or seminars; ix. The licensee would have to report each borrower's payment performance to at least one of SB 1146 (Florez), Page 4 the three major credit bureaus in the U.S.; x. The licensee would have to underwrite the loan, and could not make the loan, if it determined that a borrower's total monthly debt service payments, across all outstanding forms of credit known to the licensee, and including the loan, exceeded 50% of the borrower's gross monthly income at the time of loan origination; b. Utilize the services of one or more finders, as specified; i. A finder would be defined for purposes of the bill as a person who brings a licensee and a prospective borrower together for the purpose of negotiating a loan contract; ii. Finders would be authorized to engage in one or more of a list of eight tasks, which are enumerated in the bill, and which generally relate to disseminating loan-related advertising and informational materials, collecting information from prospective borrowers, filling out loan applications for prospective borrowers, arranging for and facilitating credit checks on prospective borrowers, and serving as intermediaries between prospective borrowers and CFLL licensees; 2. Would prohibit finders from doing any of the following: a. Providing counseling or advice to a borrower or prospective borrower; b. Providing loan-related marketing material that had not been previously approved by a CFLL licensee to a borrower or prospective borrower; c. Interpreting or explaining the relevance, significance, or effect of the marketing materials or loan documents the finder provides to a borrower or a prospective borrower; 3. Would provide that a finder meets the definition of a broker under the CFLL, if it does any of the following: SB 1146 (Florez), Page 5 a. Negotiates the price, length, or any other loan term with a prospective borrower; b. Advises a prospective borrower or licensee regarding any loan term; c. Offers information about the same borrower to more than one licensee, unless the borrower has been formally rejected in writing by one of the licensees, before the borrower's information is provided to the other licensee; 4. Would prohibit licensees from passing on any finder's fees to borrowers; 5. Would require all arrangements between a licensee and a finder to be set forth in a written agreement between the parties, and would require each written agreement to contain a provision establishing that the finder agrees to comply with all regulations established by the Commissioner regarding the activities of finders, and agrees to give the Commissioner access to all of the finder's books and records that pertain to the finder's operations under its agreement with the licensee; 6. Would require a licensee that utilizes the services of a finder to provide specified information about the finder to the Commissioner within 10 days of entering into a contract with that finder. Licensees would also have to pay an annual finder registration fee to the Commissioner and submit an annual report to the Commissioner, which includes information pertaining to the finder and the licensee's relationship and business arrangements with the finder; 7. Would authorize the Commissioner to examine the operations of each licensee and each finder, attribute the costs of those examinations to the licensee, and attribute any violation of the CFLL by a finder or a finder's employee to the CFLL with whom the finder entered into an agreement; 8. Would require the Commissioner to submit a report to the Legislature on or before January 1, 2014, in which he summarizes utilization of the pilot program by CFLL licensees and makes recommendations regarding whether the program should be continued; 9. Would increase the length of time that the Commissioner may SB 1146 (Florez), Page 6 require a CFLL licensee to retain advertising copy from 90 days to two years; 10. Would authorize the Commissioner to direct any CFLL licensee to submit advertising copy for review prior to its use. SB 1146 (Florez), Page 7 COMMENTS 1. Purpose of the bill To help underbanked Californians obtain affordable loans and build credit, with the aim of helping them enter the financial mainstream. 2. Background This bill is the brainchild of James Gutierrez, President and CEO of a Mountain View, California-based company called Progreso Financiero, or Progress Financial. Initially hatched by Gutierrez as a research project at Stanford's Graduate School of Business, Progreso Financiero was founded by Gutierrez in 2005, with the aim of offering underbanked Latinos a responsible alternative to payday loans. Using a CFLL license, Progreso Financiero currently offers short-term, unsecured loans of $250 to $2,500, to Latino borrowers who lack credit scores. Loans are made through 27 retail locations in California, all of which are inside ethnic supermarkets and ethnic pharmacies. To date, Progreso has made 40,000 loans totaling $36 million. The company is currently making slightly over 3,000 loans per month. Consistent with its authority under the CFLL, Progreso charges borrowers average annual percentage rates of 36% (a number calculated by adding Progreso's 26% annual interest rate to origination fees allowable under the CFLL). Progreso offers lower rates to borrowers on subsequent loans. The typical loan obtained by a Progreso Financiero borrower is a fully-amortizing installment loan of $900, and a nine month duration. One of the key components of Progreso Financiero's business model is the practice of reporting borrower payments to a major credit bureau, to help its customers establish a credit history. In discussions with Committee staff, Progreso states that a customer who lacks a credit score before obtaining a Progreso loan can establish a FICO score of up to 638, after successfully paying off two Progreso loans without experiencing a delinquency, and up to 660 after successfully paying off three Progreso loans without a delinquency. Although its current products are limited to relatively low dollar value, unsecured installment loans, Progreso has plans to expand into additional financial markets. According to information provided by the company, it plans SB 1146 (Florez), Page 8 to offer FDIC-insured, reloadable debit cards during the second quarter of 2010, savings options and life insurance policies by the end of 2010, and, eventually, investment accounts. These new product rollouts are intended to allow Progreso to branch out beyond helping build its customers' credit histories, and into transactional security, asset-building, and personal security for borrowers. To date, Progreso has secured its funding from venture capital firms. It is not yet profitable, but hopes to become profitable before the end of 2010. 3. What is being proposed, and why? As noted above, Progreso's loans are currently offered at average annual percentage rates of 36%. The rate structure proposed in this bill would allow loans to be made at higher annual percentage rates, ranging from 39% (for high dollar value loans amortized over 24 months) to 67% (for low dollar value loans amortized over three months). Many of the requirements in SB 1146 are based on Progreso's business model and its desire to begin using retail employees of department stores to help it market its loans. Progreso already underwrites loans, and will not lend to a borrower if their overall debt to income ratio, including the Progreso loan, will exceed 50%. The company schedules loan payments to coincide with borrowers' paychecks, provides customers with a full payment schedule at loan origination showing the dates and amounts of all payments, provides credit education to borrowers at the time of loan origination, and reports all loan payments made by borrowers to Experian. Progreso also makes all of its loan agreements and credit education materials available in Spanish, the first language of most of its borrowers. Currently, Progreso uses word-of-mouth and booths inside supermarkets to attract potential customers, and is testing direct mail. The company does not advertise via print, broadcast, or electronic media. To date, DOC has not allowed Progreso to use unlicensed finders, to help it acquire customers. However, as envisioned by Mr. Gutierrez, and as proposed in this bill, Progreso would use finders that act in much the same way a retail clerk acts at a department store, when he or she offers a customer the opportunity to apply for a store-branded credit card. SB 1146 (Florez), Page 9 Instead of offering a customer the opportunity to apply for a store-branded credit card, the retail clerk could offer the customer an opportunity to apply for a Progreso Financiero loan. If a customer chooses to apply, the clerk would collect preliminary information from the potential borrower at the point of sale, and input that information into a Progreso prequalification program. If Progreso's prequalification program rejects the potential borrower, the clerk would inform the customer of their rejection. If Progreso's prequalification program suggests that the customer could qualify to become a Progreso borrower, the clerk would collect additional, more detailed information from the customer. Customers would then be asked to provide personal identification, proof of address, and a paycheck stub, all of which the retail clerk could verify at the time of loan application, or subsequently, if the borrower had to gather the information from home before returning. Mr. Gutierrez sees the use of finders as a way to lower his costs of customer acquisition. The lower his customer acquisition costs, the easier time he will have achieving and sustaining profitability. He cites customer acquisition as the largest cost of maintaining a low dollar value loan program. 4. Support Progreso Financiero is seeking the changes in SB 1146, in order to help it grow its own business and to help attract other, similar businesses into the low dollar loan market. Mr. Gutierrez sees the loans his company offers as a responsible alternative to payday loans for individuals who have not entered the financial mainstream. In support of his lending model, Mr. Gutierrez notes that Progreso's current loan terms are consistent with the Guidelines for Affordable Small-Dollar Loans, issued by the Federal Deposit Insurance Corporation (FDIC) as part of its two-year pilot project to encourage small dollar loans by banks. The company is also a Community Development Financial Institution, certified by the U.S. Treasury. Furthermore, in recognition of his efforts to promote access to affordable credit in minority communities, Mr. Gutierrez has been asked by FDIC Chair Sheila Bair to participate on her Small Dollar Loan Advisory Committee, and is frequently invited to speak at conferences geared toward banking the unbanked and financially empowering the underbanked. SB 1146 (Florez), Page 10 5. Opposition The Center for Responsible Lending (CRL), California Reinvestment Coalition, and Consumers Union are all opposed to the bill, unless it is amended. Although the organizations strongly support the goal of having a wider availability of affordable and responsible small dollar value loan products in the marketplace, the organizations are concerned that SB 1146 would authorize substantial expansions in fees and marketing channels for finance lenders, without providing enough checks against abuse. The three consumer advocacy organizations are requesting the following six amendments, some of which they would like to apply to all consumer loans made under the CFLL, and some of which are focused only on the pilot program being proposed by SB 1146. The amendments these organizations are seeking include the following: 1) Amend the CFLL to adopt a tiered interest rate structure, where interest rates decline as the loan balance grows. The organizations advocate adopting the rate structure used in North Carolina, which allows for a maximum interest rate of 30% on the first $1,000 borrowed and a maximum interest rate of 18% on loan amounts above $1,000. By amending the entire CFLL, rather than just the pilot program proposed in SB 1146, this amendment would impose maximum interest rates on CFLL loans above $2,500, where interest rate caps do not currently exist. 2) Limit pilot program origination fees to one full fee per borrower, per year, per lender, regardless of whether the lender is originating a new loan or refinancing an existing loan for the borrower. CRL would propose that a credit report fee of up to $10 per loan could be charged for each new pilot project loan for which a credit report is obtained. 3) Allow pilot program lenders to charge one late fee per loan, equal to the lesser of 10 percent of the late payment or $20 per payment cycle. 4) Require declining interest rates to be provided under the pilot project, to repeat borrowers, who pay off their pilot project loans in a timely fashion. 5) Institute a tiered minimum loan term for all CFLL loans, with a minimum of 90 days for loans of up to $500, 120 days SB 1146 (Florez), Page 11 for loans between $500 and $1,500, six months for loans between $1,500 and $2,500, and one year for loans above $2,500. 6) Prohibit the use of finders. Continue, instead, to allow CFLL-licensed brokers to generate leads for CFLL lenders. In advocating against the use of finders, the consumer groups express concern that finders could aggressively market their products to people who may not be shopping for a loan. The consumer groups are also concerned that DOC will lack the capacity to monitor, regulate, and enforce infractions committed by large chain retailers, particularly those with high staff turnover. In particular, the groups are unclear how DOC would monitor the prohibition against finders providing advice or counseling to prospective borrowers, or against marketing of products from multiple licensees. Regarding the use of finders, Consumers Union states, "We believe that good financial products worth having sell themselves. They don't need to be aggressively marketed to consumers by paying commissions to those whose primary interest is in generating a commission by completing another sale?Over the last decade and a half, we have witnessed the serious financial consequences experienced by consumers when commission-based salespersons sell them higher-cost products that create more debt. Rather than building wealth, they plunge consumers deeper into a cycle of debt." CRL is also seeking an amendment to require underwriting of all loans made under the CFLL. 6. Questions a. If Progreso is likely to achieve profitability later this year under its current fee schedule, should the company be allowed to charge higher interest rates, origination fees, and delinquency fees than allowed under current law? b. Will other companies use the availability of the proposed pilot project to enter the small dollar loan market, or will this bill benefit only one company? c. California licensed finance lenders made SB 1146 (Florez), Page 12 approximately 97,000 loans with principal amounts under $2,500 during 2008 (the most recent year for which loan level data are available). They made these loans under the current rate and fee schedule. Will some of the lenders who made these loans begin charging higher rates and fees, if this bill becomes law? Or will the bill attract new lenders, who did not previously lend under the authority of the CFLL? d. How much will it cost for DOC to administer the pilot program? Will the fees that DOC charges pilot program applicants and participants to offset its administrative costs be high enough to discourage companies from applying to participate in the pilot program? SB 1146 (Florez), Page 13 7. Suggested Amendments a. Page 8, line 11, correct an unintentional drafting error by striking "do not" POSITIONS Support Progreso Financiero (sponsor) Oppose California Reinvestment Coalition Center for Responsible Lending Consumers Union Consultant: Eileen Newhall (916) 651-4102