FDIC releases small-dollar loan template

Even as payday lenders in Colorado prepare for new rules governing their business, federal regulators are trying to encourage banks to step into the market. According to the Federal Deposit Insurance Corp. independent analyses put payday or small-dollar loan volume at more than $40 billion a year.

Following a two-year pilot project, the FDIC recently released a template for small-dollar loan programs. A total of 28 banks – none in Colorado – completed the study, extending 34,400 small-dollar loans with a principal balance totaling $40.2 million. The banks were spread across 27 states and had assets ranging from $28 million to $10 billion.

The goal was twofold: to demonstrate the feasibility of alternatives to payday loans and to address increasingly scrutinized fee-based overdraft programs, now worth more than $38 billion a year.

“Bankers in the pilot have found that using safe and affordable small-dollar loans to build long-term banking relationships is good for customers and the bottom line,´ said FDIC Chairwoman Sheila Bair, in a prepared statement. “What’s more, small-dollar loans may help banks better adhere to existing regulatory guidance on monitoring excessive overdraft usage and offering consumers other options, such as affordable small-dollar loans.”

Banks in the study provided loans of up to $2,500, with low or no fees for at least 90 days at annual percentage rates of less than 36 percent, with relatively streamlined underwriting processes.

While the FDIC is encouraging other banks to adopt similar programs built around the cleverly titled Safe, Affordable and Feasible Small-Dollar Loan Template, the programs are not without their risks. At the end of the fourth quarter, delinquencies for small-dollar loans were running at 9 percent for those less than $1,000 and 9.4 percent for those of more than $1,000. General unsecured “loans to individuals” had a delinquency ratio of 2.5 percent. The charge-off ratios for small-dollar loans were in line with other loans to individuals.

The banks that participated in the program overwhelmingly described the small-dollar programs as tools for building relationships rather than a potential cash cow like the payday loan industry.

Cash cow drying up

The cash cow, at least in Colorado, could soon be running a bit dry. Payday lenders here not only need to watch for increased competition should local institutions pick up on the small-dollar loan template, but they are also facing new rules that will dramatically change their business. After some softening, the state legislature passed House Bill 1351, putting into place new limits on payday lending.

The industry has been in the sights of the Legislature for the past several years. In 2000, state lawmakers initially enacted a measure to exclude payday lenders from the statewide usury cap of 45 percent APR.  There have been several more attempts – successful and not – to bring additional reform to the industry since.

The Colorado Attorney General’s office, charged with regulating the industry, has been gathering data on payday lending for the last 10 years. At the end of 2009, there were 487 licensed payday lenders, according to a recent AG report. The 10 largest companies, based on the number of locations, accounted for 64 percent of the locations actively making payday loans.

Based on data gathered through examinations since 2001, the “average” payday borrower is 37 years old and has been at her (more women than men take out payday loans) current job for about 3.5 years.

In 2009, the average amount financed was $366.96, up consistently since 2002 when the average was around $275. The average finance charge in 2009 was $60.68 and the average term was 17.58 days. When taking into account the averages for finance charges, amounts financed and terms, the average APR for a payday loan in Colorado was 343.31 percent. In 2009, more than 96 percent of  payday loans were contracted with finance-charge terms at the maximum limit permitted by law.

The AG report also found that larger loans have been on the rise. In 2009, loans of $400 or more accounted for 52.75 percent of all loans; loans made at the state-mandated maximum of $500 accounted for 40.58 percent of all loans. It was 2006 when loans written for $300 or less no longer represented the majority of transactions.

Under the new law, which goes into effect on Aug. 11, payday lenders will be required to:

• Document each loan transaction and renewal with a written agreement signed by both parties;
• Carry minimum loan terms of six months and charge no prepayment penalties;
• Charge an annual interest rate of no more than 45 percent and maintenance fees of no more than $7.50 per $100 loaned up to $30 per month;
• Not loan more than $500 to one borrower at a time with a 30-day waiting period between loans.

This puts payday loans on par, APR-wise, with the recommendations of the FDIC’s small-dollar template, while banks could enjoy a slight advantage with higher maximum loan amounts.

Kristen Tatti covers the banking industry for the Northern Colorado Business Report. She can be reached at 970-221-5400, ext. 219 or ktatti@ncbr.com.

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