High-interest lending has just become riskier, and investors need to be aware that the upcoming CFPB’s regulations may reduce or eliminate the profitability that is inherent in high-risk lending.
On March 26, the Consumer Financial Protection Bureau (CFPB) announced that it expects to propose regulations [1] that would, if issued, likely significantly reduce lenders’ ability to make certain types of consumer loans, including payday loans, vehicle title loans, and other high-interest loans. Even more significantly, the proposals, if adopted, would materially reduce the profitability of these businesses. Those considering investing in such businesses or loans should carefully consider what the CFPB may do in the near future as the regulatory landscape is almost certain to change and therefore the risk presented by investing in these consumer-lending businesses will increase significantly. Any proposed regulations would be issued under the CFPB’s general authority to regulate unfair, deceptive, or abusive acts or practices in the consumer financial markets (12 U.S.C. §5531(b)).
We believe, based on CFPB statements made on March 26 and public statements made by the CFPB’s director and other CFPB officials in the past, that the CFPB will promulgate rules consistent with the proposals.[2] We note that proposed rules have not yet been issued, and all the CPFB has released is an outline of proposals that it is considering. The CFPB intends to consult with industry and convene a Small Business Panel Review to work on developing formal proposed rules. In addition, the CFPB’s announcement is not merely the action of a lone independent agency. On the same day of the CFPB announcement, US President Barack Obama specifically referenced these new proposals in remarks on the federal budget in which he emphasized his view of the CFPB’s importance as a consumer protection agency.
Short-term loans have a term less than 45 days (typically salary advance or “payday” loans). Proposed limitations include the following:
a. Prior to making the loan, lenders must determine that the consumer can repay the loan when due, including all principal, interest, and fees.
b. A mandatory 60-day “cooling-off” period between loans, thus prohibiting rolling over one loan into another.
c. Maximum term of any loan would be 45 days and could not exceed $500 or require the consumer’s vehicle as collateral.
d. The consumer may not have any other short-term loans with any other lender.
e. Limitations imposed on delinquencies in a 12-month period.
Long-term loans exceed 45 days and typically include vehicle title loans, high-interest installment loans, and other open-ended products. Proposed limitations include the following:
a. Prior to making a loan, lenders must determine that the consumer can repay the loan when due, including all principal, interest, and fees.
b. Limits on the size of monthly payments, either as a percentage of a consumer’s gross monthly income or as an absolute number.
c. A maximum interest rate.
d. Loans would be prohibited when the consumer has other covered long-term loans.
e. A limit on the number of loans that may be made over a given period of time.
a. Lenders would have to provide notice to consumers before accessing a consumer’s bank account to repay any outstanding loan.
b. Limitations on collection attempts from consumer bank accounts to limit overdraft or insufficient fund fees charged to a consumer.
The CFPB lacks the statutory authority to ban outright the covered loans. As noted above, the proposals would be issued under the CPFB’s general authority to promulgate rules and regulations regarding unfair and deceptive practices.
We believe that if promulgated, these rules would effectively end loans covered by the rules because the loans could not be made in a profitable environment, and the costs of compliance would likely exceed the net revenue from the loans.
The CFPB announcement acknowledges in passing the need for consumers to have access to affordable credit. Further, there is no serious dispute in general that these types of credit present risks to consumers that need to be managed and regulated. However, a regulatory regime that materially reduces or eliminates the profitability of this sector of consumer loans may create the risk of eliminating an important source of credit for a large sector of consumers who may lack access to “mainstream” sources of credit. In turn, these consumers may be forced into seeking credit from unregulated entities that impose more harmful terms than currently used in the short-term loan industry.
We will closely monitor these developments and expect to report on further actions taken by the CFPB in this area.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Washington, DC
Nicholas M. Gess
Melissa R. H. Hall
[1]. “Factsheet: The CFPB Considers Proposal to end Payday Debt Traps” (CFPB: March 26, 2015), available here; “Small Business Advisory Review Panel, for Potential Rulemakings for Payday, Vehicle Title, and Similar Loans: Outline of Proposals Under Consideration and Alternatives Considered” (CFPB: March 26, 2015), available here.