[co-author: PJ Hoffman- Project Manager]
On March 26, the Consumer Financial Protection Bureau (CFPB or Bureau) announced several proposals to regulate short-term and longer-term consumer loans. According to the Bureau, the proposals will likely have the effect of reducing the market for small-dollar loans by 60 percent, and others believe it will be 75 percent. An outline of the proposals under consideration was prepared prior to the convening of a Small Business Review Panel (under the Small Business Regulatory Enforcement Fairness Act [SBREFA]) to gather feedback from small lenders affected by the proposals. These proposals provide a road map for future rulemaking and a glimpse into the Bureau’s thinking as it relates to short-term and longer-term high-cost consumer loans. The Bureau’s hostility toward this $18 billion industry is quite clear from the proposals.
Authority to Issue the Proposals
Although the Bureau has specific authority to regulate “payday loans,” the proposals are issued under its unfair, deceptive or abusive acts and practices (UDAAP) authority. This raises some interesting questions about the scope and breadth of the proposals, and it is the first time that the Bureau has issued a regulation for an entire industry under its UDAAP authority. Prior to these proposals, the CFPB has relied on UDAAP authority to open investigations, initiate proceedings and enter into a number of broad-ranging consent orders requiring regulated entities to pay restitution and penalties. Until now, they have not issued rules to define or describe acts or practices deemed to be UDAAP, choosing instead to define UDAAP through enforcement. Whether the Bureau has the authority to regulate an entire industry in this manner, as opposed to specific restrictions it finds abusive, is a question that will be hotly debated and possibly litigated at some point.
What Is a Small Business Review Panel?
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) requires the CFPB to organize a Small Business Review Panel when it is working on a rule that could have a substantial impact on a significant number of small entities (a SISNOSE), including small business organizations. Each Small Business Review Panel consists of small entity representatives (SERs) from companies with less than $35 million in revenues and representatives from the CFPB, the Small Business Administration Office of Advocacy and the Office of Management and Budget’s Office of Information and Regulatory Affairs. The panel holds an outreach meeting with the representative groups of SERs (usually 12–25 people) to discuss the potential rules it is considering. The CFPB has released a list of questions on which the Small Business Review Panel will seek input from the SERs.
The panel’s meetings are private, and, typically, there is no transcript of the proceedings. Within 60 days of the meeting, the panel must complete a report on the input it received from the SERs. The report may include any significant alternatives that would minimize the economic impact on small businesses. The panel’s report is published with a proposed rule as the next step in the rulemaking process. More information on the SBREFA process can be found on the CFPB's website and in our prior client alerts.
Which Types of Credit Products Are Covered by the Proposals?
The proposals cover short-term lending products, such as payday loans, deposit advance products, vehicle title loans, high-cost installment loans and open-end lines of credit. The Bureau’s proposals also cover longer-term loans, such as vehicle title loans, high-cost installment loans and open-end credit products of more than 45 days where the lender has access to repayment from the consumer’s deposit account or paycheck, or holds a security interest in the consumer’s vehicle, and the all-in “military” annual percentage rate (APR) is more than 36 percent.
Short-Term Loans
The Bureau has issued two sets of proposals by which lenders would be required to either engage in “preventive” measures at the outset of each loan or provide “protective” measures throughout the lending process.
The proposals under consideration would cover short-term credit products that require consumers to pay back the loan in full within 45 days, such as payday loans, deposit advance products, certain open-end lines of credit and some vehicle loans. Specifically, all lenders making covered short-term loans would have to adhere to either “preventive” or “protective” requirements.
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“Prevention” Requirements
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Ability to Repay: Requires lenders to determine at the outset that the consumer can repay the loan when due — including interest, principal and fees for add-on products — without defaulting or reborrowing. For each loan, lenders would have to verify the consumer’s income, major financial obligations and borrowing history to determine whether there is enough money left to repay the loan after covering other major financial obligations and living expenses.
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Cooling-Off Period: Lenders would generally have to adhere to a 60-day cooling-off period between loans, unless they document that the borrower’s financial circumstances have improved enough to repay a new loan without reborrowing between the first and second or second and third loans.
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Limit Number of Loans: After three loans in a row, all lenders would be prohibited from making any new short-term loans to the borrower for 60 days.
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“Protection” Requirements
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Limit of Number of Loans: Requires lenders to provide affordable repayment options by limiting the number of loans a borrower could take out in a row and over the course of a year. Lenders could not keep consumers in debt on short-term loans for more than 90 days in a 12-month period.
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Limit on Rollovers: Would be capped at two — three loans total — followed by a mandatory 60-day cooling-off period. The second and third consecutive loans would be permitted only if the lender offers an affordable way out of debt.
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Amortization Required: The Bureau is considering two options — (1) requiring that the principal decrease with each loan so that it is repaid after the third loan or (2) requiring that the lender provide a no-cost “off ramp” after the third loan to allow the consumer to pay the loan off over time without further fees.
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Limit on Loan Size: For each loan under these requirements, the debt could not exceed $500, carry more than one finance charge or require the consumer’s vehicle as collateral.
Longer-Term Loans
The CFPB’s proposals would also apply to longer-term credit products of more than 45 days where the lender collects payments through access to the consumer’s deposit account or paycheck, or holds a security interest in the consumer’s vehicle, and the all-in “military APR” is more than 36 percent (including add-on charges). This includes longer-term vehicle title loans, certain installment loans and open-end lines of credit with account access or a security interest in a vehicle.
Similar to the requirements for short-term loans, the Bureau’s proposals require that lenders either engage “preventive” measures at the onset of the loan or provide “protective” measures throughout the lending process.
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“Prevention” Requirements
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Ability to Repay: Similar to short-term loans, this option would require lenders to determine at the outset that the consumer can repay the loan when due — including interest, principal and fees for add-on products — without defaulting or reborrowing. For each loan, lenders would have to verify the consumer’s income, major financial obligations and borrowing history to determine whether there is enough money left to repay the loan after covering other major financial obligations and living expenses.
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Ability to Repay Refinances: Lenders would be required to determine if a consumer can repay the loan each time the consumer seeks to refinance or reborrow. If the borrower is having difficulty affording the current loan, the lender would be prohibited from refinancing into another loan with similar terms without documentation that the consumer’s financial circumstances have improved enough to be able to repay the loan.
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“Protection” Requirements: The Bureau is considering two specific approaches to the protection requirements for longer-term products. Under either approach, loans would have a minimum duration of 45 days and a maximum duration of six months.
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NCUA Loan Option: The proposal being considered would require lenders to provide generally the same protections offered under the National Credit Union Administration (NCUA) program for “payday alternative loans.” These loans have a 28 percent interest rate cap and an application fee of no more than $20.
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Five Percent Repayment Option: With the second option, the lender could make a longer-term loan, provided the amount the consumer is required to repay each month is no more than five percent of the consumer’s gross monthly income. The lender could not make more than two of these loans within a 12-month period.
Debt Collection
In addition, the Bureau’s proposals contain measures aimed at debt collection for small-dollar loans, including collection notification requirements and limits on unsuccessful attempts to make authorized payment withdrawals from consumer accounts.
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Collection Notification Requirements: Lenders would be required to provide consumers with three business days’ advance notice before submitting a transaction to the consumer’s bank, credit union or prepaid account for payment. The notice would include key information about the forthcoming payment collection attempt. This requirement would apply to payment collection attempts through any method.
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Limits on Unsuccessful Withdrawal Attempts: If two consecutive attempts to collect money from the consumer’s account were unsuccessful, the lender would not be allowed to make any further attempts to collect from the account unless the consumer provided a new authorization.
The Future Timeline
The SBREFA panel is scheduled to meet on April 28, 2015. It is required to provide its report within 60 days of the meeting. We expect a proposed regulation to be issued sometime this fall, with an extensive comment period of at least 180 days. The final rule would likely not be issued until fall 2016 and would have a long implementation date, perhaps as long as a year. Therefore, the final rule is not likely to become effective until sometime in 2017.
Pepper Points: Based on how the Bureau dealt with previous SBREFA panels during the TILA-RESPA consolidation rule, mortgage servicing and loan origination standards, it is possible that we anticipate a Notice of Proposed Rulemaking (NPRM) to follow shortly after the Small Business Review Panel is completed. The proposals fit within the overall approach taken by the Bureau when it comes to lending and will serve as the roadmap for the upcoming NPRM. it is possible that a Notice of Proposed Rulemaking will follow shortly after the Small Business Review Panel is completed.
The proposals raise many troubling issues, such as the following:
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Does the Bureau have the authority to set a de facto national usury rate by making all loans in excess of the 36 percent military APR abusive when it was specifically prohibited by the Dodd-Frank Act from regulating rates?
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How the monitoring of the number of loans will be accomplished by either a national database or the use of credit reporting agencies
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How the ability to repay will be implemented in a way that makes underwriting loans affordable given their small size
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The proposal’s impact on traditional bank products, because the all-in military APR can bring many bank products, such as subprime auto loans, subprime instalment loans and some credit card products, as well as some marketplace lending products, such as those offered by Lending Club and Prosper, within the proposals’ coverage
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Congressional reaction to the substantial reduction in the amount of credit available to consumers — particularly those most in need, who may find obtaining credit difficult — will no doubt be a factor in the future of the proposals. We expect congressional hearings on these proposals in the very near future.
