California non-bank consumer lenders are moving away from small-dollar short term payday loans and are, instead, embracing longer-term installment loans with amounts over $2,500 to avoid interest rate caps, according to the state’s banking regulator. According to the Department of Business Oversight (DBO), this was the takeaway from reports it issued about two key lending laws: the California Financing Law (CFL) and the California Deferred Deposit Transaction Law (CDDTL), often called the payday lending law.
What happened
According to a press release about the reports quoting DBO Commissioner Manuel P. Alvarez, the movement away from payday loans “underscores the need to focus on the availability and regulation of small-dollar credit products between $300 and $2,500, and especially credit products over $2,500 where there are largely no current rate caps under the CFL.” According to the CDDTL report, payday lending in the state dropped to its lowest levels in several years under various metrics. For example, the total number of loans and total amount borrowed dropped to their lowest levels since 2006. The number of consumers receiving payday loans fell to its lowest level since 2005; those customers also had fewer places to borrow from as the number of physical payday lending locations plunged to its lowest level since 2005.
Conversely, although the total number of CFL loans has stayed remarkably consistent from 2016 to 2018, according to the CFL report unsecured consumer lending showed a marked increase over the past year. Unsecured consumer loans of up to $2,500, between $2,500 to $4,999, and between $5,000 to $10,000, all saw double-digit percentage increases in both the total number of loans and the total amount loaned. Despite these increases, however, the average consumer loan size actually fell to its lowest level since 2014. This may have been driven by an increase in the number of loans between $2,500 and $4,999. Notably, more than 55 percent of loans with principal amounts in this range had interest rates of 100 percent or more. The CFL report also indicated that lending over the internet continued to increase as well, with nearly two-thirds of loans originated online having principal amounts of $2,500 or higher, with the accompanying deregulated rate cap.
Commissioner Alvarez’s comments about increased regulation under the CFL are consistent with actions taken by the DBO in the past year. In September 2018, the regulator DBO sent letters to twenty consumer installment lenders asking for details about their annual percentage rates and online lead-generation activities. In a statement announcing the inquiry, the DBO noted that it was considering whether to promulgate regulations to more effectively oversee lead generators; according to the DBO, lead generators play a key role in originating high-rate loans to California consumers.
Why it matters
This is a time of significant upheaval for CFL lenders in the state. In some cases, California courts are now allowing consumers to use California’s Unfair Competition Law to claim that high-interest-rate loans were unconscionable and therefore somehow violated the CFL. This conclusion was reached even though, as noted above, the state has deregulated interest rates for loans above $2,500. This jurisprudence has several consequences:
- Copycat Litigation—There a now a string of copycat cases claiming that high-rate loans made by other lenders were also unconscionable. Those cases are still winding their way through the courts.
- Regulator Attention—The DBO has received increased attention. In a press release about an enforcement action against an auto title lender, the regulator noted that it had “commenced an investigation to determine whether the more than 100 percent interest rates [charged by the company] may be unconscionable under the law.” Although the DBO has not yet asserted an unconscionability theory to attack high-rate loans, this statement indicates that it may do so in the future. Moreover, this statement may further embolden local prosecutors or the California attorney general to assert such a theory. Both may bring claims under California’s Unfair Competition Law.
- Legislation—In February, a bill was introduced in the California State Assembly that would substantially change several aspects of the CFL, including imposing an interest rate cap of 36 percent plus the federal funds rate on loans greater than $2,500 but less than $10,000. The bill, AB 539, would also require that loans of at least $2,500 but less than $10,000 have terms longer than 12 months and would prohibit prepayment penalties for any CFL loan, among other things. The legislation passed the California State Assembly by an overwhelming 60-4 majority in May and is currently being considered by the Senate. Given the Democratic control of both chambers of the California legislature and the governorship, the prospects of this legislation passing appear high.
The CFL report suggests that consumer installment lending is on an upward trajectory in parallel with the national economy, despite the uncertainty created by the recent developments discussed above. However, the two reports also reflect regulator concerns with the shift from small payday loans, which are subject to fee limits, to installment loans over $2,500, which currently are not subject to specific statutory rate limitations. It remains to be seen whether new litigation, legislation or regulation will respond to this apparent regulator concern, will reduce this uncertainty or further exacerbate it.
We reported on the release of last year’s CFL report here.