BILL ANALYSIS Ó
SB 318
Page 1
Date of Hearing: May 7, 2013
ASSEMBLY COMMITTEE ON BANKING AND FINANCE
Roger Dickinson, Chair
SB 318 (Hill, Steinberg, and Correa) - As Amended: June 17,
2013
SENATE VOTE : 36-1
SUBJECT : Consumer loans: Pilot Program for Increased Access to
Responsible Small Dollar Loans.
SUMMARY : Establishes, until January 1, 2018 the Pilot Program
for Increased Access to Responsible Small dollar Loans (program)
under the California Finance Lenders Law (CFLL). Specifically,
this bill :
1)Provides that an existing California Finance Lender (CFL)
licensee in good standing that wishes to participate in the
program shall file an application with the Department of
Business Oversight (DBO) in a manner prescribed by the Deputy
Commissioner and shall pay a fee. Additionally provides that
an entity that is not licensed under the CFLL may file a duel
application.
2)Specifies that loans made pursuant to the program shall comply
with the following:
a) Interest on the loan shall accrue on a simple-interest
basis;
b) The licensee shall disclose to the consumer in type face
no smaller than 12-point font, at time of application for
the loan the following:
i) Amount borrowed;
ii) Total dollar cost of the loan to the consumer if
loan is paid back on time, including sum of the
administrative fee, principal amount borrowed, and
interest payments.
iii) Corresponding annual percentage rate (APR);
iv) Periodic payment amount;
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v) Delinquency fee schedule;
vi) A statement of the following, "Repaying you loan
early will lower your borrowing costs by reducing the
amount of interest you will pay. This loan has no
prepayment penalty." And,
vii) A statement that the borrower may rescind the loan
within one business day following the day the loan is
consummated and by returning any loan principal advanced.
viii) This disclosure may be provided via a mobile phone
application if the font size can be manually modified by
the borrower, and if the borrower is give the option to
print the disclosure in a type face of least 12-point
size or is provided a hardcopy by the licensee.
c) The loan shall have a minimum principal amount upon
origination of $300 and a term of not less than the
following:
i) Ninety days for loans whose principal balance upon
origination is less than $500
ii) One hundred twenty days for loans whose principal
balance upon origination is at least $500, but is less
than $1,500.
iii) One hundred eighty days for loans whose principal
balance upon origination is at least $1,500.
3)Allows the following interest rates and charges:
a) For a loan made pursuant to this section at an annual
simple interest rate not to exceed the lesser of 36.0
percent or the following:
i) 32.75 percent plus the United States prime lending
rate, as of the date of loan origination, on that portion
of the unpaid principal balance of the loan up to and
including, but not in excess of, one thousand dollars
($1,000). The interest rate calculated as of the date of
loan origination shall be fixed for the life of the loan.
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ii) 28.75 percent plus the United States prime lending
rate, as of the date of loan origination, on that portion
of the unpaid principal balance of the loan in excess of
one thousand dollars ($1,000), but less than two thousand
five hundred dollars ($2,500). The interest rate
calculated as of the date of loan origination shall be
fixed for the life of the loan.
b) The licensee may contract for and receive an
administrative fee of the following:
i) Seven percent of the principal amount, exclusive of
the administrative fee, or ninety dollars ($90),
whichever is less, on the first loan made to a borrower.
ii) Six percent of the principal amount, exclusive of
the administrative fee, or eighty dollars ($80),
whichever is less, on the second and subsequent loans
made to a borrower.
4)Prohibits a licensee from charging the same borrower an
administrative fee more than once in any four-month period.
5)Provides that an administrative fee shall not be contracted
for or received in connection with the financing of a loan
unless at least eight months have elapsed since the receipt of
a previous administrative fee paid by the borrower.
6)Allows a licensee to require a borrower to reimburse the
licensee from actual insufficient funds fees incurred by that
licensee due to actions of the borrower, as well as, receive a
delinquency fee in the following amounts:
a) For a period of delinquency of not less than seven days,
an amount not in excess of $14; or,
b) For a period of delinquency of not less than fourteen
days, an amount not in excess of $20.
7)Specifies that no more than one delinquency fee may be imposed
per delinquent payment or no more than two delinquency fees
may be imposed during any period of 30 consecutive days.
8)Prohibits the imposition of a delinquency fee that is 180 days
or more past due if that fee would result in the sum of the
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borrower's remaining unpaid principal balance, accrued
interest, and delinquency fees exceeding 180 percent of the
original principle amount of the borrower's loan.
9)Requires a licensee to attempt to collect a delinquent payment
for a period of at least 30 days before selling or assigning
that unpaid debt to an independent party for collection.
10)Specifies that prior to disbursement of loan proceeds, the
licensee shall either:
a) Offer a credit education program or seminar to the
borrower that has been previously approved by DBO; or
b) Invite the borrower to a credit education program or
seminar offered by an independent third party that has been
previously reviewed and approved by DBO.
11)Requires that a licensee must report each borrower's payment
performance to at least one consumer reporting agency (CRA)
upon acceptance as a data furnisher by the CRA.
12)Provides that a licensee that is accepted as a data furnisher
after admittance to the program must report all borrower
payment performance since its inception of lending under the
program, but no longer than six months after acceptance into
the program.
13)Allows the Deputy Commissioner to approve a licensee for the
program, prior to that licensee's acceptance as a data
furnisher by a CRA if the Deputy Commissioner has a reasonable
expectation, based on information supplied by the licensee,
that:
a) The licensee will be accepted once it achieves lending
volume required of data furnishers of its type; and
b) That lending volume will be achieved within the first
six months of the licensee commencing lending.
14) Provides the Deputy Commissioner with authority to withdraw
participation from the pilot program to a licensee that fails
to become a data furnisher within the first six months of
program participation.
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15)Specifies that a licensee shall provide each borrower with
the name of the CRA or agencies to which it will report the
borrower's payment history.
16)Mandates that each loan shall be underwritten to determine a
borrower's ability and willingness to repay the loan pursuant
to the loan terms, and shall not make a loan if it determines,
through its underwriting, that the borrower's total monthly
debt service payments, at the time of origination, including
the loan for which the borrower is being considered, and
across all outstanding forms of credit that can be
independently verified by the licensee, exceed 50 percent of
the borrower's gross monthly income.
17)Requires the licensee, in conducting underwriting, to seek
information and documentation, verified through at least one
CRA or other available electronic debt verification service,
pertaining to all of a borrower's outstanding debt
obligations, including loans that are self-reported by the
borrower but not available through independent verification.
18)Requires the licensee to request from the borrower and
include all information obtained from the borrower regarding
outstanding deferred deposit transactions in the calculation
of the borrower's outstanding debt obligations. A licensee
shall not be required to consider, for purposes of
debt-to-income ratio evaluation, loans from friends or family.
19)Provides that no licensee shall require, as condition of
providing the loan, that the borrower waive any right,
penalty, remedy, forum, or procedure provided for in any law
applicable to the loan.
20)States that the provisions of the program do not apply to any
loan with a bonafide principle amount of $2,500.
21)Prohibits:
a) any person, in connection with the making of a loan,
from offering, selling, or requiring "credit insurance";
b) a licensee from requiring, as a condition of the loan,
that the borrower waive any right, penalty, remedy, forum
or procedure provided for in any law applicable to the
loan, as specified; and
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c) a licensee from refusing to do business with, or
discriminating against a borrower or applicant on the basis
that the person refuses to waive any right, penalty,
remedy, forum, or procedure.
22)Allows a licensee to use the services of one or more finders,
as specified. Those finders may perform one or more of the
following services for a licensee at the finder's physical
location for business:
a) distributing written materials;
b) providing written factual information about the loan;
c) notifying a prospective borrower of the information
needed to complete an application;
d) entering information from a prospective borrower into a
database;
e) assembling credit applications and other materials;
f) contacting the licensee to determine the status of loan
application;
g) communicating a response regarding underwriting; and
h) obtaining the borrower's signature on documents.
23)Prohibits a finder from engaging in the following:
a) providing counseling advice;
b) providing unapproved loan-related marketing material;
and
c) interpreting or explaining marketing materials.
24)Specifies the activities that qualify a person as a broker
rather than a finder, and require a finder to comply with all
laws applicable to the licensee that impose requirements on
the licensee for information security safeguards.
25)Requires a finder to provide a specified statutory disclosure
upon receiving or processing an application for a Program loan
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and allow a finder to be compensated, as specified, by the
licensee pursuant to a written agreement. This bill would
prohibit a licensee from directly or indirectly passing on any
portion of the finder's fee to a borrower.
26)Mandates that a licensee to notify the Deputy Commissioner
within 15 days of entering into a contract with a finder, as
specified, pay an annual finder registration fee, and submit
an annual report to the Deputy Commissioner regarding the
finder, as specified. This bill would require all
arrangements between a licensee and a finder to be set forth
in a written agreement between the parties.
27)Allows the Deputy Commissioner to examine the operations of
each licensee and finder to ensure compliance, and permit the
Deputy Commissioner to take specified actions against a finder
upon a determination that a finder has acted in violation.
28)Require the Deputy Commissioner to examine each licensee at
least once every 24 months and provide that the cost of the
examination shall be paid to the Deputy Commissioner by the
licensee examined.
29)Requires, on or before January 1, 2016, and again, on or
before January 1, 2017, the Deputy Commissioner to post a
report on his or her Internet Web site summarizing utilization
of the Program, as specified. That report shall include,
among other things, the results of a random survey of
borrowers who have participated in the Program.
30)Clarifies under the CFLL that an extension of a loan subject
to the CFLL by a person that is unlicensed under the CFLL
voids the loan contract, and would prohibit any person from
collecting or receiving any principal, charges, or other
recompense in connection with the loan.
31)Sunsets the program on January 1, 2018.
EXISTING LAW
1)Provides for the CFLL administered by the Department of
Corporations (DOC), authorizes the licensure of finance
lenders, who may make secured and unsecured consumer and
commercial loans (Fin. Code Sec. 22000 et seq.).
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2)Specifies that CFLL licensees who make consumer loans under
$2,500 are capped at interest rates which range from 12
percent to 30 percent per year, depending on the unpaid
balance of the loan. (Fin. Code Secs. 22303, 22304.)
Administrative fees are capped at the lesser of 5 percent of
the principal amount of the loan or $50. (Fin. Code Sec.
22305.)
3)Authorizes, until January 1, 2015, the Pilot Program for
Affordable Credit-Building Opportunities (Pilot) that allow
licensees accepted into the program to offer small-dollar
consumer loans under the CFLL that are subject to the
following:
a) the loan has a minimum principal amount upon origination
of $250 and is not more than $2,500, as specified;
b) the interest rate does not exceed 30 percent for the
unpaid principal balance of the loan up to and including
$1,000, and, 26 percent for the unpaid balance of the loan
in excess of $1,000;
c) an administrative fee not in excess of either five
percent of the principal amount, or $65, whichever is less;
d) the loan term is: (1) 90 days for loans whose principal
balance upon origination is less than $500; (2) 120 days
for loans whose principal balance upon origination is at
least $500, but less than $1,500; and (3) 180 days for
loans whose principal balance upon origination is at least
$1,500;
e) the licensee must report each borrower's payment
performance to at least one of the national credit
reporting agencies; and
f) the licensee must underwrite each loan and shall not
make a loan if it determines that the borrower's total
monthly debt service payments exceed 50 percent of the
borrower's gross monthly income. (Fin. Code Sec. 22348 et
seq.)
4)Imposes various other restrictions on participants in the
above pilot program, including the use of finders, and
requires the Commissioner of the DOC to submit a report
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summarizing utilization of the pilot program, including
recommendations regarding whether the program should be
continued after January 1, 2015. (Fin. Code Sec. 22361.)
FISCAL EFFECT : Unknown
COMMENTS :
According to the author:
In 2010, SB 1146 was enacted to authorize a pilot program
intended to increase the availability of responsible small
dollar loans made in California. Since that legislation was
enacted, five lenders have applied to participate in the SB
1146 pilot program. Three of the applicants were accepted,
including Progreso (accepted to the pilot program in April
2011; made 118,000 loans under the pilot during 2012),
LendUp (accepted to the pilot program in November 2012 and
not yet lending under the pilot), and FairLoan Financial
(accepted to the pilot program in November 2012; has made
under 100 loans under the pilot program since acceptance).
Two of the applicants to the pilot program withdrew their
applications.
Despite the existence of the SB 1146 pilot, relatively few
installment loans are made in California, with principal
amounts under $2,500. This represents a challenge to the
significant population of people in California, who are
unable to access affordable credit through banks and credit
unions. Californians who lack credit scores or have very
thin credit files currently have very few options when they
need to borrow money. Credit cards are often unavailable to
this population, or, if available, bear very high interest
rates and fees. Californians with subprime credit scores
also have few options for affordable credit, and typically
access payday lenders or high-interest rate installment
lenders that lend in amounts above $2,500, when their
incomes fail to match their spending needs.
In 2010, the legislature passed and the Governor signed SB 1146
(Florez), Chapter 640, Statutes of 2010. The bill created the
Pilot Program for Affordable Credit-Building Opportunities to
increase the availability of affordable short-term credit and to
expand credit-building opportunities for individuals. According
to the June 18, 2010, Assembly Banking & Finance Committee
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analysis the author stated the following need for SB 1146
According to the author of SB 1146:
Enacted in the 1950's, based on statutes from the 1920's, the
CFL is archaic and needs reform. For example, its
restrictions on interest rates, fees, and marketing
partnerships for loans in the $250 to $2500 range effectively
discourages lenders from making loans that would otherwise be
a fair alternative to payday loans. As a result, today there
are very few fully amortizing, credit building loans in the
$250-$2500 range and even fewer providers. Instead, the vast
majority [of] CFL licensees only make loans above $2500,
precisely because there is no cap on interest rates for loans
over $2500. Lenders simply do not believe they can make a
profit below $2500, given current CFL law. Thus, if a lender
wants to make small loans, they become a pawn broker or payday
lender (who as an industry makes over 10 million loans to
California residents each year). The result: Californians
have only one option-pay-day loans-and no opportunity to build
or repair their credit. . . .
Californians need access to credit, now more than ever. But,
they also need alternatives that are safe and affordable,
provide credit education and help borrowers build credit. SB
1146 will hopefully allow consumers who need small loans an
alternative to a pay-day loan option, which likely causes more
of a financial burden when payments cannot be made.
SB 1146, sponsored by Progreso Financiero, established a pilot
program under the CFLL to fill the gap in loan products that
exist in the small dollar loan market. The pilot program
intends to fill this gap by allowing some flexibility on the
fees and interest rates associated with the loans, with an
enhanced underwriting process to determine borrower's repayment
ability, something often lacking for non-bank loans,
specifically payday loans. Additionally, the sponsor viewed the
pilot program as a way to help the unbanked and underbanked
build credit files in order to advance to more traditional lines
of credit by the requirement that loan performance be reported
to the credit reporting agencies. No other lending law requires
reporting of payment performance. The goal of the pilot program
is to make small dollar lending a profitable business so that
more options will become available, while creating lending
standards that will make it a responsible product under certain
conditions. A licensee under the pilot must also have a credit
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education program that the consumer will undergo prior to
disbursement of loan proceeds. Furthermore, the debt-to-income
ratio of a borrower cannot exceed 50%. Lenders in the small
dollar market may attempt to use third parties to find
customers. These third parties are known as finders. These
finders have a relationship with the lender as they might be
business entities such as a grocery store or other retail
establishment. The idea behind using finders is that it is a
cost effective way to reach customers with needed a physical
storefront for the lender. The pilot program contains very
specific mandates and restrictions on finders, including caps on
the payments that the lender may make to the finder. At the
committee's February 2012 hearing on this issue, testimony
provided by a pilot participant demonstrated that acquisition of
cost effective capital is a major obstacle in the small dollar
lending environment.
The driving force behind the pilot program is that many people
do not have access to mainstream credit options due to minimal
credit history. This history is often due to a lack of a
relationship with a financial institution through a checking or
savings account. Ironically, a consumer without a checking
account would not be able to get a payday loan as payday loans
are contingent upon the borrower having a checking account so in
some cases an unbanked borrower may not have many options at
all.
Since the 2010 legislation was enacted, five lenders have
applied to participate in the SB 1146 pilot program. Three of
the applicants were accepted, including Progreso (accepted to
the pilot program in April 2011; made 118,000 loans under the
pilot during 2012), LendUp (accepted to the pilot program in
November 2012 and not yet lending under the pilot), and FairLoan
Financial (accepted to the pilot program in November 2012; has
made under 100 loans under the pilot program since acceptance).
Two of the applicants to the pilot program withdrew their
applications.
Although aggregated annual data are not yet available for 2012,
DOC has indicated that only two CFLL lenders made the vast
majority of installment loans with principal amounts below
$2,500 during 2012 - Progreso Financiero and Adir Financial,
each of which made approximately 118,000 loans during 2012. As
noted above, Progreso is a pilot program participant that makes
loans of various sizes under the pilot. Its loans are currently
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available in 65 locations throughout California. Adir Financial
is not a pilot program participant. It extends unsecured loans
of up to $500 to finance purchases made by customers of the
Curacao department store chain in Los Angeles. Its loans are
not available elsewhere in California.
On February 11, 2013 the Assembly Banking Committee conducted an
oversight hearing to examine the issue of small dollar loans
under the CFLL. That hearing was inspired by concerns that low
income, low credit consumers face daunting and costly options
when seeking short term credit. During committee testimony,
Commissioner of DOC offered the following comments relevant to
the issue current under consideration:
The Committee has inquired about the barriers of access to
small dollar credit at lower costs. The leading barriers
to access to affordable small-dollar credit under the
California Finance Lenders Law appear to be (1) the
lenders' lack of access to affordable funds, resulting in
unprofitable lending margins, and (2) the statutory
restrictions on charges and rates. Based on discussions
with licensee, industry representatives, and anecdotal
observations, it appears that barriers exist to increasing
access to small-dollar credit while at the same time,
keeping the cost of credit affordable for consumers.
Lenders indicate that it is cost prohibitive to make small
dollar loans under the California Finance Lenders Law
because of the law's restriction on charges, the high costs
of capital to lender to make these loans and the thin
margins on generating loan volume? Many lenders indicate
that it is not cost effective to make small-dollar loans
even under the interest rates and charges allowed under the
pilot program.
In 2010, the Center for Financial Services Innovation (CFSI)
reviewed the subject of small dollar loans, including obstacles
to greater access and growing alternative approaches. CFSI
states that installment loans are costly to provide due to the
operation of physical stores and underwriting expenses.
Furthermore, they stated, "One industry representative estimates
that achieving breakeven with a $200 loan requires charging
borrowers an APR of about 250%. The breakeven APR drops to
approximately 145% if the volume of $250 loans reaches 1,000.
Larger loans in the amount of $2,500 would require APRs closer
to 44%, and the breakeven APR would drop to a projected 35% if
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1,000 loans at that amount were made." On the other side of
this debate some argue that the high interest rates are not a
reflection of actual risk, but an attempt to exploit customers
for greater financial gain.
Small dollar lending is typically not fulfilled by mainstream
financial institutions like banks and credit unions.
Furthermore, the preceding economic downturn has tightened
credit for all consumers, specifically low to moderate income
families with median credit scores. As traditional forms of
credit, such as credit cards have become more restrictive, the
use of alternative means has increased. While the economic
downturn has restricted credit in some cases, credit cards
remain the primary source of credit use for consumers seeking to
meet short term needs, though it is estimated that almost 1/3rd
of consumers do not have a credit card. According to the
Federal Reserve, nationwide credit card debt is $858 billion
making it the third largest source of household indebtedness.
Given the large percentage of credit card use, small installment
loans and payday loans are a drop in the credit ocean, yet that
makes them no less important, especially for consumers that
cannot access a credit card. Whether it is a credit card, or
non-traditional means of credit it is clear that the utilization
of credit to make up for diminished income is not sustainable
for a borrower.
The unbanked or those without an account with a financial
institution constitute approximately 22 million, or 20% of
Americans. This population spends $10.9 billion on more than
324 million alternative financial service transactions per year.
Bearing Point, a global management and technology consulting
company, estimates that the unbanked population expands to 28
million when you include those who do not have a credit score.
In addition, Bearing Point puts the underbanked population,
defined as those with a bank account but a low FICO score that
impedes access to incremental credit, at an additional 45
million people. Although estimates find that at least 70% of
the population has some type of bank account, these individuals
continue to use non-bank services, ranging from the purchase of
money orders, use of payday lenders, pawn shops or sending of
remittances. The Federal Reserve Board has noted that 50% of
current unbanked households claim to have had an account in the
past.
In California, 28% of adults do not have a checking or savings
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account, according to the U.S. Census. In San Francisco, the
Brookings Institution estimated that one in five San Francisco
adults, and half of its African-Americans and Hispanics, do not
have accounts. Recent market research indicates that Fresno and
Los Angeles have the second and third highest percentages of
unbanked residents in the country.
Nationwide, the unbanked are disproportionately represented
among lower-income households, among households headed by
African-Americans and Hispanics, among households headed by
young adults, and among renters. A Harvard Poll of Hurricane
Katrina evacuees in the Superdome found that seven out of ten
did not have a checking or savings account.
Installment Lending vs. Payday Lending.
It is difficult to discuss the CFLL without also briefly
reviewing the DDTL. The DDTL (Will also be referred to as
payday loans) provides that deferred depository lender may
accept a post dated check from a borrower, written at a maxium
of $300, in exchange for providing the borrower with a loan of
$255. The DDTL allows the lender to charge a maxium of 15% of
the face amount of the check. The DDTL in combination with the
CFLL provides that a consumer in need of a small dollar loan is
limited to seeking a payday loan, unsecured installment product,
or a car title loan. Data thus far demostrates that consumers
are utilizing payday loans far in excess of products offered
under the CFLL.
In order to put these options in perspective and in contrast the
following is a chart of informaton from the DOC 2011 Annual
Report: Operation of Deferred Deposit Originators:
Based on the 2011 data of CFLL loans and payday loans the
following are important highlights.:
CFL licensees conducted 381,131 unsecured installement
loans and 38,148 auto title loans for a total of 419,279.
The total dollar amount of these loans was $968,768,000.
258,273 CFL loans were made in amounts under $2,500.
A large percentage of CFL loans (89,989) occurred in the
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$2,500 to $4,999 range at APRs above 100%.
DDTL lenders conducted 12,427,810 transactions for a
total dollar amount of $3,267,629,497.
The average dollar amount of DDTLs made was $263 at an
average APR of 411% for an average loan term of 17 days.
Based on information provided by DOC, 90% of the CFLL
lending volume under $2,500 comes from two companies,
Progreso Financiero and Adir Financial.
Costly Installment Lending :
In addition to payday loans, financial institution overdraft
programs, and lending under the pilot, consumers seek out car
title loans and installment loans with no interest rate
regulation above $2500.
Personal loans made by CFL licensees typically go to consumers
with low credit scores in need of credit that cannot be acquired
via traditional means (Bank loans, credit card, family loans).
The most costly options under the CFLL are car title lending and
unsecured personal loans. These loans are most often made
without robust underwriting to determine if the borrower can
repay the loan, nor to what impact such a loan would have on the
borrower's debt to income ratio.
A car title loan is when a consumer borrows money against the
title of their car for a specified period of time. During the
loan period, the consumer continues to use their vehicle as
necessary. If the consumer defaults on the loan then current
law allows the lender to repossess the car for the cost of the
loan. Car title lending in California is conducted under the
CFLL, under which various forms of consumer lending are
authorized. The CFLL does not explicitly authorize car title
lending, but CFL licensees may offer these types of loans. Car
title loans are subject to the provisions of the CFLL, which for
loans above $2,500 no interest rate caps exist.
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Car title lending recently came under scrutiny due to media
coverage, specifically, an LA Times article, "Title Loans'
Interest Rates are Literally Out of Control," February 11,
2011, that highlighted the high interest rates on these loans
and the consequences if a consumer does not pay off such a loan.
One customer put up his truck as collateral for a $2,500 loan
with payments of $200 per month. The customer expected to pay
off $5000-$6000 by the time the loan was finished. This
particular customer was charged an APR of 108% as a return
customer vs. 120% for new customers.
Industry representatives argue that the borrowers who use their
services have very low credit scores and are not likely to have
access to other means of credit, if at all. Additionally, they
point out that while the loan may be securitized, the
repossession and disposition of an automobile is a costly
endeavor and such costs must be built into the cost of the loan.
On the unsecured side of the CFLL lending market are unsecured
personal installment loans. The most well-known entity offering
these loans is a company called CashCall. CashCall advertises
frequently on television. CashCall offers unsecured loans over
$2,500 that have no interest rate restrictions. A quick perusal
of their website reveals the terms and interest rates for
typical loan transactions. For example, on a loan of $2,525 the
following would apply:
$75 fee
139.22%
47 payments
$294.46 monthly payment.
Under the above scenario, if the borrower took the loan to term
for the full 47 months they would have paid back $13,914.62
(interest-principal-origination fee) on a $2,525 loan. This
comes out to $11,389 in interest charges.
Small dollar lending and financial institutions?
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In the discussion of small dollar lending often the number one
question is why do financial institutions not provide greater
lending opportunities in the small dollar markets? One obvious
answer is that underwriting standards at most mainstream
financial institutions would prohibit lending to consumers with
marginal credit. Another answer is the lending in this market
place is not cost effective without lending at interest rates
that might bring about reputational risk to the image of the
institution.
In order to better grasp the role of banks in small dollar
lending, and potentially encourage greater lending in this
space, the FDIC in 2007 started a two year Small-Dollar Loan
Pilot Program. This program was designed to demonstrate that
banks can offer affordable small dollar products that are
profitable for the participating banks, while also providing an
alternative to high-costs loans and costly overdraft protection
programs. The FDIC parameters for a loan under the program was
an amount of $2,500 with a term of 90 days or more at an APR of
36% or less. As the program came to a close, 34,400
small-dollar loans were made with a principal balance of $40.2
million nationwide. Small-dollar lending was often used as a
relationship building opportunity in order to building long term
opportunities with the customer. The Pilot began with 31 banks
participating, one of which was located in California (BBVA
Bancomer USA). The Pilot ended with only 28 participants.
Delinquency rates for the loans ranged from 9-11%, but loans
with longer terms performed better. It does not appear that the
Pilot led to widespread adoption of small dollar lending
programs at non-pilot banks.
In 2005, Sheila Bair, prior to her role as Chairman of the FDIC,
wrote a report (Low Cost Payday Loans: Opportunities &
Obstacles) that researched the ability of financial institutions
to offer affordable payday loan alternatives. She found that
banks and credit unions do have the ability to offer low-cost
small-dollar loans, however the use of fee-based overdraft
protection programs were a significant obstacle to offer
alternative programs. In additional research in this area,
Michael Stegman, "Payday Lending", Journal of Economic
Perspectives concluded that "bottom lines are better served by
levying bounced check and overdraft fees on the payday loan
customer base than they would be by undercutting payday lenders
with lower cost, short-term unsecured loan products..."
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An additional factor is also that many borrowers in the small
dollar lending environment have impaired credit that in most
cases will not allow them to get a loan from a bank, even if the
bank offers a small dollar loan. Mainstream financial
institutions have a perceived (or real) fear of regulatory
backlash if underwriting standards are lowered to serve these
populations.
A recent article highlight the struggles of financial
institutions to offer low costs products. In a May 9, 2013
article, California Thrift's woes Show Challenges competing with
Payday Lenders, American Banker, revealed that PacificCoast Bank
in Oakland, California stopped offering its short-term loan
program that was modeled on the FDIC pilot. A spokesperson from
the bank revealed that the model was economically sustainable,
and thus not able to compete with payday lenders. Finally,
PacificCoast Bank revealed that they plan to work with LendUp, a
San Francisco based lender, currently operating under the payday
lending law and the pilot program, on a revised product.
Differences between existing pilot and SB 318:
Interest rates:
Existing pilot: On loans between $300 and $1000 the interest
rate is 30%. On loans between $1001 and $2,499 the interest
rate is 26%.
SB 318: On loans between $300 and $1,000 the rate is the lessor
of 36% or the Prime rate plus 32.75% (currently equals 36%). On
loans of $1,000 to $2,499= the lessor of 36% or the prime rate
plus 28.75% (currently equals 32%).
Fees:
Existing pilot: The lessor of 5% of principal amount or $65.
SB 318: The lessor of 7% of principal amount or $90, or 6%
percent of the principal amount, exclusive of the administrative
fee, or eighty dollars ($80), whichever is less, on the second
and subsequent loans made to the same borrower.
Late fees
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Existing pilot: 7 day delinquency=$12; 14 day delinquency=$18
SB 318: 7 day delinquency=$14; 14 day delinquency=$20
Time limit on repeat fees:
Existing pilot: Licensee shall not charge the same borrower more
than one administrative fee in any six month period. An
administrative fee shall not be contracted for or received in a
refinancing of a loan unless one year has elapsed since the
receipt of the previous fee paid by the borrower.
SB 318: A licensee shall not charge the same borrower more than
one administrative fee in any four month period. An
administrative fee shall not be received in a refinancing unless
at least eight months have passed.
In addition to the differences listed above, the proposed
program in SB 318 is different from the existing pilot in
several non-controversial ways, while also retaining key
elements of the existing pilot such as mandatory underwriting
standards.
Arguments in support.
Progreso Financiero writes in support,
We are writing in support of SB 318 (Hill). SB 318 would
make some targeted, essential
changes to a currently existing Pilot Program for
Affordable Credit Building Opportunities under the
California Finance Lenders Law (CFL) which was established
by SB 1146 (Florez) in 2010 to address the very serious
lack of access to capital for low income borrowers. SB 1146
was a visionary and innovative attempt to remove numerous
barriers in California law to the making of socially
responsible, small loans at fair terms and rates to the
millions of Californians who are underbanked and
financially vulnerable.
At the time the Pilot was being considered, there were
relatively few unsecured, small dollar, credit-building
installment loans available to people of modest means with
little or no credit history. This is largely due to the
fact that mainstream lenders have struggled to serve these
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customers. Small dollar lending is high-cost and
challenging; lenders incur many of the same expenses and
risks with small dollar loans as they would with larger
loans but with much less profit. Despite these very real
challenges, there is an extraordinary and growing demand
for such small loans. This imbalance between supply and
demand drives individuals and families, particularly those
from low income, minority communities, to rely on
expensive, potentially dangerous financial options that can
be harmful to their financial well-being.
The Pilot Program took important, pioneering steps toward
addressing some of the statutory barriers relating to
making small loans. However, more needs to be done. SB 318
takes the experience and lessons learned from the existing
Pilot Program and proposes changes necessary to increase
the supply of good, small dollar lenders and loans so that
low income consumers have real, readily accessible
alternatives that will help them achieve positive financial
outcomes and build a more secure financial future.
Progreso Financiero is an innovative, mission-driven,
California-headquartered company that is dedicated to
helping more than 23 million hard working and under-banked
Latinos in the U.S. access responsibly priced credit and
establish positive credit histories. We lend to lower
income Latinos who have little or no credit histories. We
are able to do this by using our unique, proprietary,
innovative credit scoring system that we combine with
in-person, traditional customer relationship building. As
part of the Pilot Program, we also offer credit education
to our borrowers and help them fully understand what it
means to take out a loan and be financially responsible. We
have developed a robust, growing micro-lending platform
available in nearly 70 locations in California.
The result of our approach is that we have helped hundreds
of thousands of Californians move up the economic ladder.
We have an unsurpassed track record in this area of
lending, and since our founding in 2005 we have originated
nearly $600 million dollars in small dollar loans.
Approximately half of our customers come to us with no
credit score. Our loans help them build a positive credit
history and credit scores. Our efforts have been nationally
recognized on several occasions. We were certified as a
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Community Development Financial Institution (CDFI) in 2009
by the U.S. Department of Treasury, a designation that is
reserved for organizations who have demonstrated a
commitment to increasing economic opportunity and promoting
community development in underserved populations or
distressed communities in the US. We were the sponsor of
the original legislation and worked hard for its passage.
Much of the Pilot Program is modeled after our best
practices?
Now, after several years of experience in the Pilot it is
clear that more needs to be done to increase access to the
program for both lenders and borrowers. We need to make the
benefits of the Pilot more widespread, viable and useful to
Californians. SB 318 does that. SB 318 addresses some of
the economic barriers faced by current and potential
lenders in this market while preserving the responsible
lending practices of the program. We hope that this will
attract more program participants and help cultivate a
robust responsible small dollar lending industry in
California.
The best way to combat predatory and harmful lending is to
encourage and allow more socially responsible lending like
that enabled by the Pilot Program. SB 318 does this in a
measured, thoughtful way. The more lending flourishes under
the Pilot Program the better off are those who need better
options for small loans.
Arguments in opposition.
Consumers Union writes in opposition:
Although the lenders participating in the current pilot
program claim that SB 318 will better enable them to
achieve success and profitability, we still have relatively
little data regarding the performance of the outstanding
loans in the program. It is difficult to tell whether
consumers are benefiting from the existing pilot, since it
is only halfway complete. It is even less clear whether SB
318 would achieve a better outcome. Furthermore, we believe
it is important that the business needs of individual
lenders are balanced with consumers' need to get a fair
deal and improve their financial health.
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Given this context, we are concerned that the current
provisions of SB 318 may impose too many new fees on
consumers and result in riskier loans. Still, Consumers
Union firmly believes that consumers deserve reasonable
access to affordable credit. We appreciate the intent
behind SB 318 - to create a fair and viable framework for
installment loans under $2500.
We have been in discussion with the author's office to
address our concerns in three key areas: (1) interest
rates; (2) timing and amount of administrative fees; and
(3) refinancing standards. We have indicated to the author
that the following changes would remove our opposition:
Interest rates : allow the rates to float with prime, but
place an upper cap of 36% on the first $1000 borrowed and
an upper cap of 34% on additional principal above $1000.
Administrative fees : permit administrative fees to be
charged every four months, capped at the lesser of 7% of
principal borrowed or $90, but reduce the amount charged to
the same consumer on subsequent loans to the lesser of 5%
or $65.
Refinancing : permit administrative fees in connection with
a refinancing after 8 months but set minimum standards for
who is eligible for a refinance loan, so that borrowers
struggling to repay existing loans are not taking on
unsustainable debt burdens. Calculate applicable fees based
on the new additional amount borrowed only.
Arguments of concern.
Center for Responsible Lending, Law Foundation of Silicon
Valley, and the California Reinvestment Coalition have provided
letters expressing neither support or opposition, but concern
with the provisions of SB 318. The concerns generally expressed
are that it is too early to create a new pilot when the existing
pilot has yet to run its course and that the increase in fees
and interest proposed to be charged to consumers in the bill are
not appropriately justified. These groups also express concern
with the increased interest rates and administrative fee and
that the interest rate is tied to the Prime rate could rise.
Furthermore, concerns have been raised regarding the frequency
at which administrative fees may be charged.
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Questions & Discussion.
1)This bill would create a new small dollar pilot program prior
the exhaustion of the current pilot program. The reasons and
justifications for these changes are mentioned elsewhere in
this analysis. However, as a fundamental matter of policy,
the question must be asked as to whether it is appropriate to
give up on the pilot project before the release of the
required report on its impact and potential reforms? Related
to this issue, is whether it is appropriate to have two pilot
programs operating at the same time. The existing pilot is
schedule to sunset on January 1, 2015, meaning that it would
continue for one more year in conjunction with the pilot
proposed under SB 318. Staff recommends that that the
existing pilot should be terminated with language that ensures
that existing pilot lenders will transition automatically to
the new program proposed under SB 318 should it be signed into
law.
2)Two years after its creation, the pilot project has only three
licensees. Those three licensees made a combined 118,100
loans in 2012 under the pilot, with 118,000 of those loans
being made by Progreso. As noted earlier, during the same
period over twelve million payday loans were made in
California. From a standpoint of both volume of loans and
number of licensees the pilot has not garnered the
participation or market saturation that was hoped for when the
original legislation was passed in 2010. A major selling
point of the existing pilot was its potential to supplant the
lure of payday lending by providing a sustainable alternative.
Thus far, the numbers do not reflect that the existing pilot
has provided the alternative that policy makers hoped for. On
the other hand, not every borrower that can get a payday loan
would qualify for a loan from a pilot lender. The pilot
requires robust underwriting standards that are not required
for payday loans. Staff discussion's with pilot lenders
reveal that 40% or more of borrowers are rejected for pilot
loans for not meeting the underwriting criteria. While these
early indications may reveal that the existing pilot needs
revisions for success, the issue on how to determine "success"
is complicated. Staff is reminded of this by the 2002
statement of then Secretary of State Donald Rumsfeld when he
said, "There are known knowns. These are things we know that
we know. There are known unknowns. That is to say, there are
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things that we know we don't know. But there are also unknown
unknowns. There are things we don't know we don't know."
Loan volume and the number of licensees would indicate a lack of
pilot success. However, the lack of data is troubling in that
the committee does not have a clear view of other issues that
may be affecting the lack of success. SB 318 does require a
report to occur in two years after implementation of its
provisions that will shed some light on its success. However,
at this time the answers to the following questions regarding
the existing pilot would be helpful in making further
determinations:
a) How many borrowers are repeat borrowers, and of those,
what is the frequency?
b) How many borrowers refinance? Generally, what are the
reasons for refinance?
c) How many borrowers are rejected for a loan? What are
the reasons for rejection?
d) How many borrowers have improved credit scores? Do
those borrowers move on to different credit options?
e) How many borrowers had used payday loans, or had
outstanding payday loans?
3)Tiered interest rates. SB 318 provides for two interest rates
tied to the prime rate (currently 3.25%). For loans $1,000
and below the rate is 32.75%+Prime that currently equals 36%.
For loans from $1,000 to $2,499 the rate is 28.75%+Prime that
currently equals 32%. Amendments to this bill in Senate
Judiciary capped the rates at 36%. Should the Prime rate rise
4% in the next four years the rate for both tiers would be 36%
eliminating the slight savings a borrower would receive for
those amounts above $1,000. How likely is an increase of this
nature in the next four years? The Federal Reserve has
indicated that an increase in the federal funds rate is
unlikely until mid-2015. The federal funds rate has an impact
on prime so it is likely that the Prime rate will remain
stable for the next few years. The most important factor to
determine the appropriate response to this issue will be the
performance of the program itself. If, in a few years' time,
program participants are successful under the current rate
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structure and that structure has moved relatively due to
little fluctuation in the Prime rate then policy makers may
want to consider locking in rates before making this program
permanent.
4)The existing pilot provides that six months must elapse before
the same borrower can be charged an administrative fee. SB
318 shortens this to 4 months. The existing pilot provides
that an administrative fee may not be received for a
refinancing of a loan unless at least one year has elapsed
since the previous fee paid by the borrower. SB 318 shortens
this to eight months. If the decreased timeframes are
justifiable, then it may be worth considering that a limit be
placed on the number of times a loan can be refinanced.
Repeat refinancing has been a feature of very high cost
lending in other states on installment loan products. While
this bill has worthy goals, the potential of increasing
participants in this market could also increase the potential
for abusive refinancing by new entrants.
5)The existing pilot and the program provided for under SB 318
both contain an element of credit education in that a lender
must provide access to a borrower to a credit education
program. While it was not an issue in the existing pilot, it
may be appropriate to specify that any credit education
programs must be offered free of charge.
6)As noted earlier, under the current CFLL, loans above $2,500
have no rate restrictions leaving borrowers in need of amounts
over $2,500 with expensive options. The current pilot and the
program provided for in SB 318 would allow lending between
$300 to $2,500. Should this range be increased to $5,000
under the proposed program? This increased range of loan
amounts would not change the existing CFLL but could allow
program participants to demonstrate whether loans up these
amounts are profitable for the lenders and responsible for the
borrowers.
Amendments.
1)Eliminate the Pilot Program for Affordable Credit-Building
Opportunities and ensure that existing licensees under that
Pilot will automatically migrate to the proposed program in SB
318 should it be signed into law.
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2)Clarify that the credit education program shall be at no-costs
to the borrower.
3)SB 318 requires licensees to apply to the Deputy Commissioner
of DBO and provides the Deputy Commissioner with the authority
to regulate these entities. Delete reference to "Deputy"
throughout so that the "Commissioner" of DBO is the primary
regulator.
4)The June 17th, 2013 amendments contained a drafting error.
The following change is recommended:
a) Page 7, line 6, strike "a" and insert: that
5)A licensee would be allowed to provide certain disclosures
about their loan via a "mobile phone application." Given
rapid changes in technologies (smart phones, tablets,
tablet/phone hybrids) that program participants may want to
use to reduce overhead costs, staff recommends the following
amendment:
a) Page 5, line 39: required by paragraph (3) in a mobile
phone application, on which
REGISTERED SUPPORT / OPPOSITION :
Support
Silicon Valley Community Foundation
California Hispanic Chambers of Commerce
Progreso Financiero
FairLoan
LendUp
OpenCoin
Vallarta Supermarkets
Silicon Valley Leadership Group
Opposition
Consumers Union
Analysis Prepared by : Mark Farouk / B. & F. / (916) 319-3081
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