Payday Lenders Are Changing the Game Ahead of a U.S. Crackdown

Regulators want to make it tougher to make big bucks off short-term loans.
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Getting cash-strapped people into very expensive debt has been a good business for Matt Martorello. His company, Bellicose Capital, helps an American Indian tribe in Michigan run websites that offer small loans to the public at annualized interest rates as high as 780 percent. Bellicose has collected tens of millions of dollars, with the tribe keeping about 2 percent of the revenue, according to documents provided by a person involved in the deal. Now Martorello is selling Bellicose to the tribe for just $1.3 million upfront, plus as much as $300 million in future payments, depending on how the business does. Bellicose projects the tribe will eventually earn $58 million a year, the documents show.

Martorello isn’t the only person in the high-cost-loan industry who seems to be eager to get out these days. Many are making drastic changes to their businesses, such as switching products or moving overseas. One possible reason: The Consumer Financial Protection Bureau is poised to release new regulations this year, after more than four years of studies and speeches. The agency, which hasn’t finalized the details, says the rules will stop borrowers from taking out short-term loans they can’t afford and racking up fees week after week to buy more time. Lenders say the CFPB will kill off payday advances and similar loans, hurting borrowers with no other options.

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“The CFPB made it extraordinarily clear that the path they’re going down is going to eliminate the vast majority of payday lending,” says Ed Groshans, an analyst at Height Securities.

Payday loans are short-term advances, for which the borrower must write a check postdated for the next payday. The regulations will also cover similarly costly loans that allow payment over a longer period of time but still require borrowers to provide access to their bank accounts. Bellicose, which provides consulting services and is not a lender, specializes in these types of installment loans.

So far, such lending has largely been regulated at the state level, and the rules have proved easy to get around. Many online companies made arrangements like the one between the Lac Vieux Desert Band of Lake Superior Chippewa Indians and Bellicose. Dubbed “rent-a-tribe” by critics, the deals allow companies to get around state laws that cap interest rates by claiming the tribes aren’t subject to those rules. Avoiding federal regulations, like those the CFPB will propose, is tougher. The Federal Trade Commission already has won cases involving tribal payday lenders.

Bellicose’s Martorello says sale talks began years ago and weren’t influenced by the coming rules. James Williams, chairman of the Lac Vieux Desert tribe, says the websites have a bright future and will help fund medical, educational, and social services. “This is, without question, the most important economic development in the more than 179-year-long history of our tribe,” Williams says.

Some storefront-based lenders aren’t even waiting to see the final version of the federal rules before making major changes. The regulations won’t cover pawnshops, so customers at EZCorp’s 522 U.S. stores now need to put up valuables such as jewelry or electronics to get emergency advances. The company stopped offering its EZMoney unsecured loans in July, citing an “increasingly challenging legislative and regulatory environment,” even though U.S. and Canadian loans generated $165 million in fees in 2014. Cash America International, which has 825 stores, is making a similar shift.

Others are looking overseas. First Cash Financial Services, which closed 22 stores in Texas last year, bought 211 pawnshops in Mexico, Guatemala, and El Salvador in January. Online lender Enova International is opening divisions in Brazil and China.

Consumer advocates and even some religious leaders have railed against payday lenders as long as they’ve been around. Their argument is that the lenders prey on desperate people. The business “relies on borrowers who are unable to repay the loan,” says Paul Leonard of the Center for Responsible Lending. What’s supposed to be a two-week, $300 loan for a $45 fee ends up costing hundreds and hundreds of dollars. The industry says its terms are clear and it’s helping customers who need money for emergencies.

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Critics “don’t appreciate the demand for the product,” says Dennis Shaul, chief executive officer of the Community Financial Services Association of America, a lobbying group. “You’re never going to see a bumper sticker that says, ‘I’m in debt, and I use payday loans.’ ”

Payday lenders seemed to dodge a death sentence when the Dodd-Frank Act, which created the CFPB, specifically barred the agency from putting caps on interest rates, over the objections of Senators Bernie Sanders (D-Vt.), Sheldon Whitehouse (D-R.I.), and others. The first actions by Richard Cordray, its director, were targeted at credit card and mortgage lenders.

Then the agency started studying the payday market. A 2013 report found that the median borrower took out 10 loans over the course of a year and spent $458 on fees. The next year, Cordray said he was concerned that too many were falling into “debt traps,” citing findings that some borrowers getting Social Security benefits were indebted year-round.

In March, the agency released a draft proposal for the payday industry. The main requirement is that lenders make sure potential borrowers will have enough left over after other expenses to pay back their loans. It sounds like something anyone would ideally want to do, but payday lenders say many of their borrowers wouldn’t qualify.

Economists hired by the industry lobbying group found that just 16 percent of stores would be profitable under the proposal. Shaul says the rules are a backdoor way to cap rates, since lenders that charge less than 36 percent are exempt from many of them. “If that final rule is still as objectionable, we would have no choice but to look at our legal options,” he says.

Brian Lynn, president of a 26-store chain called LendingBear, puts it more starkly: “We would absolutely, positively have to close our doors.”

The bottom line: The CFPB wants lenders to show they don’t lock their customers in “debt traps.” Many payday lenders could fail the agency’s test.

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