Transcript Red Flags for Bank Directors

Regulated Aspects of
Installment Lending
Installment Lending Panel
Payday Loan Bar Association Summit
_______________________________________________________
Presented by
Michael A. Raskasky
Harlowe & Falk LLP
November 14, 2006
Why are we talking about installment lending?


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Changing laws, negative climate for
PDLs
Stay in business if the legislative axe
falls
Diversify product offerings
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Why are we talking about installment lending?
Offer installment product that combines
features of payday loans…:
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Small dollar amounts not offered by banks
Limited underwriting/credit check
Fast cash for borrower
“Above prime” interest rates
“Secured” by check or ACH authorization
Payments tied to paydays
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Why are we talking about installment lending?
…and additional features of traditional
installment loans:

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Multiple payments over time v. single
repayment
Simple interest (generally) on unpaid
balance v. fee-based finance charge
Secured lending option
4
Why are we talking about installment lending?

What legal and operational issues
arise with this new product?
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Why are we talking about installment lending?
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Contract terms
Servicing and Payments
Default
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Caveats
Focus -- issue spotting
Rules can vary dramatically by state
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Consumer loan laws
Uniform Consumer Credit Code (7 states)
Usury laws
UCC Rev. Article 9 (secured lending)
Motor vehicle codes (vehicle secured
lending)
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The Contract
Loan amount


Large amounts (e.g., >$25,000) or real
estate loans frequently outside scope of
consumer loan statutes
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The Contract (cont’d)
Finance charges

Origination fees
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Typical limit - 2% of principal
Prepaid finance charge - special treatment
under TILA
Contract interest rate (not just the APR)
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The Contract (cont’d)
--Finance charges

Interest calculation methodology
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Simple interest/365 day year
Precomputed interest
Compounding of interest
Describe in the contract
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The Contract (cont’d)
Loan term

May be tied to loan amount
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Ex: loans up to $300 - up to 25 months
Loans $301 to $1,000 - up to 37 months
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The Contract (cont’d)
Payment schedule
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Small loan amounts (e.g., <$1,000) –
substantially equal amounts, intervals
Big TILA issues, particularly with
payments tied to pay periods (irregular,
semi-monthly, etc.)
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The Contract (cont’d)
Method of payment
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ACH
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Preauthorized ACH – Reg. E limitations,
NACHA rules
Check
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NSF fee limits
Broader bad-check remedies may be
available
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The Contract (cont’d)
Secured lending – collateral
considerations
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Grant language
Collateral description (UCC 9-108 and
TILA 226.18(m))
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The Contract (cont’d)
--Secured lending - collateral considerations
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Motor vehicles
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Household goods
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Certificate of title
May implicate title loan statutes
FTC Unfair or Deceptive Credit Practices Rule
Limits non-possessory security interests in household goods
Exceptions for PMSI, art works, antiques, jewelry (not
wedding rings), one television and one radio
Insurance on collateral – Special disclosure required to
exclude from finance charge (Reg. Z 226.18(n), 4(d))
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Servicing and Payments
Caveat—
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Servicing methodology should be
described in the loan agreement
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Servicing and Payments
Late payments
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Late payment charges
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Ex: 10 days late, charge lesser of 5% of
installment amount or $20
No “pyramiding” of interest on late fees
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Servicing and Payments (cont’d)
--Late payments
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Deferral
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By agreement after-the-fact, or
Unilateral – in loan agreement
Deferral charges authorized
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Generally cannot charge deferral AND late charges
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Servicing and Payments (cont’d)
Partial payments
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Application of payments
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Specify in contract, but check state law
Event of default
Triggers a late charge to extent of unpaid
installment
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Servicing and Payments (cont’d)
Prepayments
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Nearly always allowed
Rebate for precomputed loans
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“Earned” may be complicated
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Servicing and Payments (cont’d)
--Prepayments
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Prepayment penalty
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Frequently prohibited or limited
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Certain real estate loans, refinancings by same
lender, etc.
Disclosures required (TILA, contract)
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Servicing and Payments (cont’d)
Extra payments
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Application of payments – generally
applied to principal, but check statute
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Servicing and Payments (cont’d)
Last payment
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Balloon payments (ex: 2x average of
other payments)
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May have a statutory right to refinance at
same terms
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Servicing and Payments (cont’d)
Receipts and statements
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Amount paid to date, amount applied to
principal and interest, pay-off amount
Requires additional programming
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Default
Statutory definition?
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May be limited to actual nonpayment
Acceleration generally permitted
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Precomputed loans – if a judgment is
obtained, some statutes require rebate
as if full payment was made on judgment
date
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Default (cont’d)
Secured lending issues
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Repossession – how?
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Post-repossession interest
What if customer brings collateral to store?
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UCC 9A-620 (acceptance in satisfaction of debt)
Limits on taking motor vehicles, other collateral in
satisfaction of debt (TRUE predatory lending!)
Pawn statutes?
Disposition of collateral - Art. 9
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Regulatory challenges for
“converting” payday lenders
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Regulatory climate
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(not exactly “global warming”)
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Regulatory challenges for
“converting” payday lenders
“Nightmare on Winter Street” – the Oregon
example
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Politics and competition – the two fronts meet
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New proposed consumer finance rules
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Gubernatorial election
Resistance by existing consumer finance lenders
“In consultation with” (read: written by) existing
consumer finance licensees
Press release
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Regulatory challenges for
“converting” payday lenders
Initially –
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36% rate cap
Now – regulate aspects of PDL
business model
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Make it very difficult to operate on PDL
platform
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Regulatory challenges for
“converting” payday lenders
Sampling of proposed rules
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Regulation of portfolio mix (90%
“consumer loans”)
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6 month minimum term
“Documented” underwriting (but no
substantive “ability to pay” requirements)
Equal periodic payments
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Regulatory challenges for
“converting” payday lenders
--Sampling of proposed rules
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“Are you experienced?”
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Store level
“District” level
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Regulatory challenges for
“converting” payday lenders
--Sampling of proposed rules
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Indirect attempts to regulate interest rate
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Include interest rate in business plan
Notice if rate changes more than 25%
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Regulatory challenges for
“converting” payday lenders
--Sampling of proposed rules
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Limits on holding checks/ACH
authorizations for payments
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“DISCLOSURE!!!”
required
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Challenges are in the works, but who
knows?
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Regulatory challenges for
“converting” payday lenders
Last, but not least….
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Washington payment plans
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Contact Information
Michael A. Raskasky
Harlowe & Falk LLP
One Tacoma Avenue North, Suite 300
Tacoma, WA 98403
253-284-4417
[email protected]
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Payday Lending Legal Summit
Installment Lending Panel
APR Misconceptions and Problems
TILA Misconceptions

Loan Origination Systems—OK To Buy An
Off-The-Shelf Product
 “Buy
Ours—We’ve done installment loans for
years!”
Like New!
Problems:
 Not
Designed For Payments Tied To Paydays
 Built for Long-Term Loans

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Lower Rates
More Tolerance For Error
37
Off-The-Shelf Software
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PDL Example
 Lender’s
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Target Yield: Approximately 260%
Loan Amount: $500
Simple Interest Rate: 200%
Loan Fee: $50 (10 % of Loan Amount)
Repayment Schedule: 3 “Monthly” Pmts @ $245.03
Problem:
 Disclosed APR: 264.66%
 Actual APR: 388.12%
 Restitution
Violation: Understated by 123.46%
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TILA Misconceptions
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If You Only Charge Interest—Then The APR
Is Always The “Interest Rate!”
 It
has to be:
are no other “Finance Charges”
 e.g., 250% Interest Rate Equals 250% APR
 There

Fact Or Fiction?
 Answer…
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Fact or Fiction?

Answer…That Depends
 Depends
On Your Tolerance To Risk
 Depends On How Gutsy You Are
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Fact or Fiction?

Issue: US Rule versus Actuarial Methods:
 US Rule:
Will Always Be The Interest Rate If There Are
No Other TILA “Finance Charges”
 APR
 Actuarial

Method:
APR Is Almost Never The Same As The Interest
Rate—Even If No Other “Finance Charges” Are
Imposed
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Gutsy?

Which Would You Rather Defend?
US Rule Method
 One Paragraph Authorization In Appendix J
(3) In contrast, under the United States Rule method, at the end of each payment
period, the unpaid balance of the amount financed is increased by the finance
charge earned during that payment period and is decreased by the payment
made at the end of that payment period. If the payment is less than the finance
charge earned, the adjustment of the unpaid balance of the amount financed is
postponed until the end of the next payment period. If at that time the sum of
the two payments is still less than the total earned finance charge for the two
payment periods, the adjustment of the unpaid balance of the amount financed
is postponed still another payment period, and so forth.

No Formulas or Other Support in Reg. Z
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Which Would You Rather Defend?
US Rule Method
 Not Used In APRWIN Software (Actuarial)
 US Rule Produces Different Results
 APRWIN Is Accepted Standard For
Verification
Regulators & Litigators
 No
Supporting Case Law
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Which Would You Rather Defend?
Actuarial Method
Clearly Spelled-Out In Appendix J
 15 Pages of Formulas and Examples
 Too Many To Show Here
 Support in Official Staff Commentary
 Exact Match With APRWIN
 Provided There Is No “Garbage In”

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What’s The Difference?

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Both Take Into Account “Time Value of Money”
 Based On Timing And Amounts Of Payments &
Advances
US Rule:
 No Compounding Of Interest
 No Negative Amortization
Actuarial Method:
 Allows For Compounding of Interest
 May Have Negative Amortization
Both Are “After The Fact” To Test APRs, And Both Igno
Interest Accrual Method
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Monthly Payment Example
Interest Rate: 300.00%
Amount Financed: $750.00
Finance Charge: $1657.76
Pmt Schedule: 12 Monthly Pmts
11 @ $200.66
1 @ $200.50
Actuarial APR: 298.77% (APRWIN)
US Rule APR: 300.00%
Which One Is Correct?
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Which One Is Correct?
They Both Are!
Actuarial APR: 298.77% (APRWIN)
US Rule APR: 300.00%
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TILA Misconceptions
 Payments
Due “Semi-monthly” Means
“Twice-Per-Month”
 Or Does It?
Problems:
Only Example In Appendix J is 1st & 16th
 Only Example In APRWIN is 1st & 16th
 Webster Definition: “Occurring Twice A
Month”
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So What’s the Problem?
 Are
The Following Payment Frequencies
Semi-monthly?
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Due On the 1st And the 15th?
Due On the 5th and the 25th?
Due on the 15th and the 30th?
Problem:

APR For Each Loan Must Be Based On The
“Unit Period” (i.e., the Time-Base) For That
Loan
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What’s The Unit Period?
Unique To Each Loan
 The Interval Of Time (Time-Base) That Best
Fits The Contracted Payment Schedule
 Identified By:

 (1)
Measure All “Periods” In The Loan, &
 (2) Determine The “Common Period”

Need To Know Before Proceeding With The
APR Calculation Process
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Twice-Monthly Examples

What’s the Unit Period When Pmts. Are Scheduled:
 1st
and the 16th ?
 Answer—15 days (“Semi-monthly”)
 That’s Easy—Supported by Appendix J &
APRWIN
 1st and the 15th?
 Answer—14 days (“Bi-Weekly”—Not “Semimonthly”)
 Look At All The Periods
 Common Period
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Twice-Monthly Examples

What’s the Unit Period When Pmts. Are Scheduled:
 5th
and the 25th?
 Answer—20 Days (Not “Semi-monthly”)
 Look At All The Periods
 Common Period is 20
 15th & 30th (or Last Day of the Month)?
 Answer—15 days (Not “Semi-Monthly”)
 Look
At All The Periods
 Then The Common Period Is 15
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Twice-Monthly Examples
 Four
Loans With Pmts. Due Twice-PerMonth—Three Different APRs

2 APRs Matched By Coincidence Caused
By Dates And Number Of Payments
 Assumptions:


No “Odd Days”
8 Payments Due Twice-Per-Month
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Best Guess—When to Use “SemiMonthly”
If All Of The Following 3 Conditions Are Met,
Then
Always Use 15 Days For the “Unit Period”:
1. Must Be 2 Scheduled Due Dates Within Each Full
Month,
2. Due Dates Must Have The Same Two Anniversary
Dates In Each Full Month (e.g., 5th And 20th Of
Each Month), AND
3. There Are Exactly 15 Days Between The Two
Payment Dates In Each Month
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Best Guess—“Semi-Monthly”

All Other “Twice-Monthly” Payments, then:


Look For Common Period
If no Common Period—Then Use “Standard
Interval of Time” As Defined By Appendix J
 Another Topic For Another Conference
55
RONALD D. GORSLINE
CHAMBLISS, BAHNER & STOPHEL, P.C.
1000 TALLAN BUILDING
CHATTNOOGA, TN 37402
423-756-3000
www.cbslawfirm.com
56
CLIFF E. COOK
COMPLIANCE SERVICES, INC.
TACOMA, WASHINGTON
(253) 756-5767
[email protected]
57