Picking his first public fight with the banking industry, Washington's top consumer cop, Richard Cordray, promised on Thursday that his examiners will scrutinize a handful of big banks that make high-cost loans. Inspection of major financial institutions will be part of a broader review of payday lenders, he said at a public hearing organized by the Consumer Financial Protection Bureau in Birmingham, Ala.
The move is significant in that Cordray made no distinction between established financial institutions, including Wells Fargo and U.S. Bank, and less-respectable storefront and online payday lenders with names like EZ Money and AmeriCash Advance, widely criticized for making high-cost, short-term loans to the most desperate borrowers.
Although he was careful not to strike a directly confrontational tone, by specifically mentioning banks' high-cost loans in his first major speech as the new CFPB chief, Cordray suggested that his agency doesn't buy the bank industry line that its loans are not traditional payday products because they are structured differently.
Cordray did not single out any bank. But the listing of specific names of such payday lending programs in an examination guide released at the hearing -- such as Fifth Third Bank's "early access advance" -- is likely to chill the blood of bank executives, whose companies make big profits off payday loans.
"We recognize the need for emergency credit," Cordray said in a transcript of his opening remarks, provided in advance. "At the same time, it is important that these products actually help consumers, rather than harm them."
Cordray said that he chose Birmingham as the site for the hearing because Alabama has one of the highest concentrations of payday lenders in the U.S. The increase in payday lending shops in Birmingham recently drove the city council to pass a six-month moratorium on new stores, he said.
A field guide for CFPB examiners, released as part of the event, instructs them to assess the risks in payday lenders' interactions with consumers, "including potentially unfair, deceptive, or abusive acts or practices." The CFPB is the first federal regulator to examine nonbank payday lenders, though bank payday loans are technically subject to oversight from other federal regulators.
A handful of large banks -- Wells Fargo, U.S. Bank, Fifth Third Bank and, most recently, Birmingham-based Regions, which launched its product last year -- are in the payday business. Most charge $10 for every $100 borrowed. (Wells Fargo recently lowered its fee to $7.50 per $100.) That works out to an annual percentage rate of 365 percent, based on a typical loan term of 10 days.
"This is designed for customers in an emergency situation," said Wells Fargo spokeswoman Richele Messick of her bank's payday product. "It is an expensive form of credit. It is not an answer to their long-term financial needs."
John Owen, a Regions executive, was set to appear at the hearing. According to a Regions spokeswoman, he was going to participate in the discussion, but would submit his formal testimony directly to the CFPB.
"We are mindful of our responsibility to partner with our customers and we seek to establish an environment that encourages responsible lending and repayment," said Owen in his written remarks. "We listened to our customers' input and developed a service that would meet their short term financial needs."
Customers who borrow from Regions can establish a credit history, which may allow them to borrow at cheaper rates in the future, Owen pointed out, and that is something not traditionally available at storefront payday lenders.
U.S. Bank and Fifth Third could not be reached before publication. All note in disclosure forms on their websites that these loans are expensive and not intended for repeated use. The banks also require customers who take out too many loans in a short period of time to observe a "cooling-off" period of 30 days to six months before they can borrow again. The banks say this is evidence that they take seriously concerns about over-use.
Regions and Wells Fargo also give customers the option to repay these loans in installments.
But the Center for Responsible Lending, a consumer group that has been practically clanging cymbals together to get the regulatory community to pay more attention to bank payday lending, says its data show that bank payday borrowers are likely to fall into the same cycle of debt that traps many traditional payday borrowers.
The typical bank payday borrower takes out 16 loans and is in debt 175 days per year, according to the advocacy group's study of checking account data that it bought from a third-party vendor. That stretch of 175 days is twice as long as the maximum amount of time that the Federal Deposit Insurance Corp. has advised is appropriate.
"The very structure of a bank payday loan makes it likely to trap customers in long-term debt even while the bank claims that the loans are meant for short-term use," said Rebecca Borne, a senior policy analyst at the Center for Responsible Lending.
Banks also appear to charge far more than is necessary, given the low risk of default. The banks will not disclose how many customers default on payday loans. But in a letter to the Office of the Comptroller of the Currency, which is considering new guidelines for bank payday and overdraft products, the American Bankers Association wrote that the historical "charge-off rates" -- money the bank has written off as lost -- for direct deposit products are low, ranging between 3 and 4 percent. This suggests that the fees charged payday borrowers are mainly pure profit.
Traditional payday lenders say the high cost of their loans is justified because the risk of default is also high. At those lenders, where average annual interest rates on borrowing top 400 percent, customers leave behind a post-dated check for the amount borrowed, plus a fee.
Bank payday loans, also described as direct deposit advance products, work differently. Customers must have checking accounts and must have their pay or benefits check directly deposited into that account. When the check is deposited -- the maximum loan term is 30 days; the maximum loan usually $500 -- the bank pays itself what it is owed, plus the fee. If direct deposits are not sufficient to repay the loan within 35 days, the bank repays itself anyway, even if the repayment overdraws the customer's account, triggering more fees.
For some borrowers, there are much cheaper forms of short-term credit. Members of State Employees' Credit Union in North Carolina, for example, can take out a payday loan at 12 percent interest. Further, they are required to sock away 5 percent of what they borrow in a savings account. When that balance tops $500, they can borrow money for even less -- just 5.5 percent.
Payday loans are still the most profitable loans the credit union makes, said Jim Blaine, president of the company. Blaine said that the credit union earns a 4 percent return on the average loan.
More than 110,000 members participate in the program, with as many as 90,000 taking loans on a recurring monthly basis. They have put away $23 million collectively through the mandatory savings program, according to the credit union's data.
Blaine said he didn't want to comment directly on bank payday lending, but noted, "It sometimes seems like our financial system is set up to penalize those who know the least and have the least."
He added, "It appears to me that the system has gone beyond buyer beware to buyer be damned."