Preying on Payday
By Brendan Koerner
Markle Fellow

Financial woes dogged Stewart Wilson throughout the summer of 1996. A Naval petty officer in Jacksonville, Florida, Wilson was in the midst of a costly divorce and his credit rating was abysmal. He needed cash, fast, but local banks wouldn't give him the time of day. His only option was a local check-cashing outlet, where he was asked to hand over a check, postdated to his next payday, for $250. In exchange, he received a measly $200.

Wilson visited another storefront, and another, until he'd borrowed close to $1,400, while coughing up $227. To prevent his postdated checks from bouncing on payday-his biweekly pay was just $800-he borrowed from one lender to pay off another, each time shelling out exortibant fees just to stay afloat. By 1999, this smoke-and-mirrors trick was costing him $5,640 per year, a cycle of debt he now laments as "a financially damaging snowball."

Such usurious cash advances have long been commonplace in poor communities. But mindful of the big profits at stake, nationally chartered banks are now rushing to hop in bed with the controversial "alternative financial services" industry. And the loan-shark stigma doesn't seem to bother them one bit.

The cash cow that banks are rushing to milk is commonly known as "payday lending," though image-conscious check cashers prefer the euphemism "deferred deposit advances." To obtain one of these short-term loans, a gainfully employed customer writes a personal check for the amount they wish to borrow (typically $100-$300) plus a sizeable fee, postdated to their next payday. The check casher holds the check until the effective date and gives the borrower the principal in cash. If a check casher's fee is $17.65 per $100, for example-the maximum permissible in California-then a postdated check for $117.65 is tendered, and the customer receives $100 in return. Assuming the customer's next payday is two weeks later, the annual percentage rate (APR) for the loan works out to be a staggering 459 percent.

The practice is assailed by consumer groups and social justice advocates, who denounce APRs that average nearly 500 percent (and occasionally exceed 2,000 percent). Payday lenders have also been vilified for allowing unlimited "rollovers," whereby borrowers who find themselves with insufficient funds at month's end take out a new payday loan to pay off the old one, and are thus forced to pay the fee again and again. Customers like Wilson can end up spending hundreds, even thousands, without ever paying down any of the principal. One study in Indiana found that over 75 percent of payday borrowers rolled over at least once, and some rolled over dozens of times. Lenders occasionally coerce delinquent borrowers by threatening to cash their bad checks, which can lead to crippling fines, even criminal charges.

The criticism has scarcely harmed the industry's prospects. Over 8,000 companies made $9.2 billion worth of loans in 2000, and that figure is conservatively projected to more than double by 2004. The profit margins are impressive; one Tennessee survey estimates that the industry's return on equity is close to 35 percent.

The astronomical yields have tempted several conventional banks, which are forging dubious alliances with payday-loan outlets. Most of these partnerships are expressly designed to circumvent state usury laws. Nineteen state ban payday lending outright and 21 (plus the District of Columbia) have enacted rate ceilings. But thanks to a federal banking loophole, nationally chartered banks are permitted to "export" rates from their home states. By acting as the "agent" of a bank based in a deregulated state, a payday lender in a regulated state can legally charge almost any fee it desires.

At least a dozen small banks are enthusiastically participating in "rent-a-charter" schemes. Eagle National Bank of Upper Darby, Penn., teams up with Dollar Financial Group, the nation's second largest check-cashing chain. Nearly half of Eagle's annual earnings are derived from payday loans made via Dollar, at APRs that typically range from 390 to 520 percent. County Bank of Delaware-a state infamous for having the nation's laxest banking regulations---makes high-interest loans via the Internet and a toll-free number, under the name Easy Cash. And Goleta National Bank of Goleta, Calif., has a relationship with ACE Cash Express of Irving, Tex., which operates over 1,000 storefronts nationwide-including in states where usury laws theoretically cap APRs at 36 percent. Payday loans are expected to account for 20 percent of Goleta's profit this year. Wells Fargo Bank, which eschews direct partnerships with payday lenders, is the second largest institutional shareholder of Goleta's parent company, Community West Bancshares.

The alliances "enable check cashers who might be operating in several states to provide a uniform product across state lines," claims Rick Lyke, spokesman for the Financial Service Centers of America, a check cashing trade group. But state regulators detect less savory motives than bureaucratic streamlining. "If you can't do it legally, you fancy two-step around [the law] by hooking up with a lender in a state that doesn't put any limit on APRs," says Kathleen Keest, of the Iowa Attorney General's Consumer Protection Division, who notes that her state's legal APR is already 391 percent. "It's a race to the bottom…Is the Delaware legislature going to set all of my commercial banking standards?"

Banks insist their behavior is not unusual. "Yes, we are exporting Pennsylvania rates to other states that have different rate caps," says Eagle president Murray Gorson. "But that's exactly why all the credit card companies moved to Delaware." Besides, he adds, nationally chartered banks are sticklers for fair play; Eagle, for example, has coaxed Dollar into permitting a maximum of four rollovers per loan, and Gorson asserts that his check-cashing ally is a respectable operation, "not the behind-iron-bars type."

Yet eye-popping APRs remain the norm for rent-a-charter lenders, spurring critics to question the banks' commitment to reform. "How are they cleaning it up?" asks Jean Ann Fox, who monitors payday lenders for the Consumer Federation of America. "Are they not holding checks? Are they not charging triple-digit interest rates? Are they not insisting you pay them on your next payday, even though they are not evaluating your ability to repay?"

Efforts to curb rent-a-charter deals have been a bust. A 1978 Supreme Court decision affirmed the concept of rate exportation, and Congress has been reluctant to close the loophole with legislation. A class-action RICO suit brought against Eagle and Dollar by a Californian named Josh Phanco was settled out-of-court last October; in exchange for $5.5 million, the defendents were exempted from admitting wrongdoing. The Office of the Comptroller of the Currency issued an advisory letter on the practice last November, warning banks not to "engage in abusive practices," but it has no legal weight.

The check cashers' political clout, which led to state-by-state legalization of payday lending throughout the 1990s, makes state-level reforms a virtual impossibility. In California, for example, a Senate bill that would have imposed modest restrictions on payday loans-capping fees at $12 per $100, for example, and limiting rollovers-was killed in committee. The Los Angeles Times estimates the industry spent $528,131 in lobbying and political contributions to defeat the measure.

A few major banks are bypassing the rent-a-charter model in favor of more direct involvement. Union Bank of California, which is majority-owned by Bank of Tokyo-Mitsubishi. Last March, Union purchased 40 percent of Nix Check Cashing, which owns 47 stores in greater Los Angeles. 'The Nix acquisition allows us to, in effect, gain a presence in a marketplace where there are far too few banks," says Thom Branch, Union's director of strategic planning and projects. "Our strategy is to work with Nix to provide access to mainstream financial services, to encourage financial education."

Shelly Curran of the Consumer's Union, which has analyzed the partnership, is skeptical of Union's strategy. "Yes, we think it's great that Union Bank is interested in offering small loans," she says. "No, we don't think that payday loans are the way for them to do that."

From: http://web.archive.org/web/20011201203437
/http://www.newamerica.net/articles/article.cfm?pubID=309&T2=Article