As part of its ongoing efforts to increase and expand its supervisory role over payday and deposit advance loans, the Consumer Financial Protection Bureau (the CFPB) issued a White Paper on April 24, 2013 entitled “Payday Loans and Deposit Advance Products” (the Report). ¹   The Report constitutes the CFPB’s initial in-depth review of these loan products and the Bureau’s attempt to better understand the industry. In addition to educating consumers about how the industry works, the CFPB intends for the Report to serve as a reminder to lenders that the CFPB is watching and that it has concerns about the industry’s practices. ²  In other words, the CFPB is surveying the field to determine where and how to focus its on-going regulatory efforts.

The loans examined by the CFPB in developing the Report generally had three aspects in common:  (i) they are for smaller dollar amounts; (ii) the borrower must make quick repayment of the loan; and (iii) the borrower must repay the loan in full or give a lender access to a deposit account for repayment. The Report’s key finding and concern regarding such loans is that they can become “debt traps” for consumers.

Although the CFPB does recognize the utility of these loans for certain consumers, it based its label of “debt trap” upon a finding that many consumers do not use these loans as they are intended. More specifically, many consumers who obtain such loans often roll them over into new loans or borrow additional funds instead of timely repaying the original short-term obligations. As a result, such consumers engage in a cycle of borrowing and incur significant fees and costs over time. The CFPB’s Report tries to blame the lenders for this consumer behavior and focuses on three lender-side aspects of short-term lending: underwriting, loan structure and costs.

First, with respect to lending standards, the CFPB states that the lenders of these loans do not evaluate or account for a borrower’s general ability to repay. In short, the CFPB implies that underwriting standards are nearly absent and that lenders instead arrange things so that their loans takes priority over a borrower’s other obligations. Thus, instead of giving any consideration to factors such as housing and living expenses, the lender solely looks at the borrower’s ability to repay this sole obligation.   

Second, the CFPB characterized the subject loans as “risky” due to their rapid repayment structure, which generally requires full repayment within a couple of weeks in the case of payday loans the next time a borrower receives a qualified deposit into their depository account in the case of bank deposit advances.  ³  The CFPB considers these repayment terms to be unrealistic for many of the borrowers and attributes the need for additional loans to these repayment terms.

 Finally, the CFPB takes issue with the costs and fees associated with payday and deposit advance loans.  For example, the CFPB noted that payday loans generally require a fee of $10 - $20 per $100 borrowed.  Thus, using the median fee of $15 per $100 borrowed, a borrower will be required to repay $400 on a $350 loan in a two-week period. The CFPB likens such a fee to an annual percentage rate of 391. 

The foregoing three areas – underwriting ability to repay, loan structure, and fees – will be areas of intense CFPB focus in the coming months and years as the CFPB has already labeled them as raising “substantial consumer protection concerns.” ⁴   As a result, the CFPB intends to continue its inquiry into these loans and to develop strategies to regulate and change the industry. While the precise tools to be used by the CFPB may be uncertain, its intention is not. The CFPB Report indicates that the CFPB will continue its inquiry into these products and will analyze the effectiveness of limitations, such as cooling-off periods, to mitigate sustained use and other loan terms. Significantly, the CFPB sends an ominous reminder to the industry that the bureau is authorized to “prescribe rules… identifying as unfair, deceptive or abusive acts or practices in connection with the offering of a Consumer Financial Protection Service… and to prevent persons or service providers from engaging in such acts or practices” (UDAAP). ⁵

Indeed, the CFPB concluded its Report by stating: “The potential consumer harm and the data gathered to date are persuasive that further attention is warranted to protect consumers. Based upon the facts uncovered through our ongoing work in this area, the CFPB expects to use its authorities to provide such protections.” ⁶ 

Greenberg Traurig Observations:

1. The timing of this Report with the subsequent issuance of Proposed Guidance by the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) ⁷  is significant. ⁸          
   The Proposed Guidance of the OCC and FDIC is likely to be the base level from which the CFPB will start to establish its own standard and raises a number of questions.
   The Proposed Guidance identifies a number of supervisory concerns including: safety and soundness risks credit administrative practices and policies, including, compliance and consumer protection related concerns; and sets forth supervisory expectations in areas such as credit quality; underwriting; credit cooling-off periods, customer eligibility, capital adequacy; compliance with TILA, EFTA, TISA, ECOA and Section 5 of the FTC Act; management and board oversight and an effective compliance system; and review and assessment of third-party relationships.  

2. It is unclear whether the CFPB will seek to impose the conclusions and concerns in the White Paper to examinations that have been concluded but for which examination reports have not yet been issued, and, if so, whether they will serve as the basis for remedial action plans or enforcement actions regarding underwriting criteria, cooling-off periods, sustained use limits, and UDAAP.        
3. The use of the term “third-party relationship” instead of “third-party service provider” in the Proposed Guidance may be significant. It could reflect an intention to prevent or limit the ability of banks to provide payment and clearing services for non-bank payday lenders.
4. Both the Proposed Guidance of the OCC and FDIC and the CFPB White Paper would seek to impose an “ability to repay” requirements in the underwriting process that would effectively involve a comprehensive income and debt underwriting process.   
5. The Proposed Guidance would create the concept of the “non-performing performing loan” by indicating that loans could be classified as non-performing, regardless of delinquency if there’s credit weakness or borrowers have an inability to repay.   

_{1  A complete copy of the Report is available here.}

_{2  See CFPB Press Release entitled “CFPB Finds Payday and Deposit Advance Loans Can Trap Consumers in Debt,” dated April 24, 2013, available at www.cfpb.gov (hereafter, the Press Release).} 

 _{3  See Press Release.}

_{4  See Report, p. 44}

_{5  See Report, p. 45.}

_{6  See Report, p. 45.}

_{7 The OCC Proposed Guidance is available at entire Guidance is available here and here.}

 _{8  The Federal Reserve Board staff issued a Statement on Department Advance Products in response to the Report emphasizing state not banks obligation in connection with deposit advance products is available here.}