On January 19, 2012, the Consumer Financial Protection Bureau ("CFPB") released its Short-Term, Small-Dollar Lending Examination Procedures Manual ("Procedures Manual") to supplement the CFPB's Supervision and Examination Manual. The manual sets forth the CFPB's examination objectives and outlines the modules examiners will follow to determine compliance with federal consumer financial laws and regulations. Before an examination is conducted, examiners are directed to conduct a risk assessment and draft an examination scope memorandum. The risk assessment will be based, in part, on the size and volume of the business, but other factors will be taken into consideration, such as customer complaints, product offerings and methods of marketing.

Based on an assessment of the scope of the proposed examination, and in connection with the compliance management system and consumer complaint response review procedures, the examination will be comprised of one or more modules covering a payday loan's lifecycle. The five examination areas include (1) Marketing; (2) Application and Origination of Loans; (3) Payment Processing and Sustained Use; (4) Collections, Accounts in Default, and Consumer Reporting; and (5) Third-Party Relationships. The Procedures Manual details the CFPB's examination process under each of the modules, several aspects of which are noteworthy. Certain aspects of the examination procedures might signal to the payday lending industry that the CFPB plans to impose significant recordkeeping and documentation requirements, question the pricing methodology, discourage interest rates beyond a certain level and challenge certain marketing practices.

Applicability of the Procedures Manual

The Procedures Manual applies broadly to depository and non-depository institutions supervised by the CFPB. It also applies to open-end and closed-end credit products that are small-dollar amounts with short-term repayment periods, "commonly known as payday lending." This definition includes certain bank lines of credit, but not all such products. The Procedures Manual indicates that overdraft services are not included in the definition of small dollar loans that are attached to bank accounts. It also describes certain payday loan variants marketed by banks as "advances," whether they are known as a direct deposit advance, an early access advance, a ready advance, or a checking account advance, but notes that the product is neither an overdraft line of credit nor an overdraft service. The CFPB defines an overdraft service as a service under which a financial institution assesses a fee or charge on a consumer's account held by the institution for paying a transaction (including a check or other item) when the consumer has insufficient or unavailable funds in the account. The language used to differentiate these products may signal an intention to establish separate rules for overdraft products and payday loans. Payday lenders have argued that these products operate functionally in a substantially similar manner and should be regulated with that in mind.

Disclosure Requirements under the Electronic Funds Transfer Act and Regulation E

Module 2 of the Procedures Manual highlights two practices that are not customary in the payday lending industry. First, it requires examiners to determine whether the lender requires compulsory use of electronic funds transfers ("EFTs") and conditions the extension of credit to consumers on the repayment of loans by preauthorized electronic debits. Examiners must then determine whether the lender offers borrowers the option to pay using a non-EFT method of payment. To assess potential risks to consumers, examiners must also verify whether the lender clearly and prominently discloses the consumer's rights regarding payment methods.

Treatment of Sustained Use of Payday Loans

In prepared remarks delivered by CFPB Director Richard Cordray on January 19, the CFPB made it clear that particular attention will be paid to so-called "sustained use" of payday loans. Module 3 of the Procedures Manual describes sustained use as repeated, long-term use of payday loans. Examiners are directed to determine whether a payday lender offers rollovers, back-to-back transactions or conversions from a balloon payment to an installment plan. If such options are offered, examiners must make a series of determinations, including (i) whether the lender discloses all fees and material terms of the transactions; (ii) whether the lender has policies and procedures pertaining to sustained use to which it is adhering; (iii) whether the lender monitors or limits borrower usage of payday loans; and (iv) whether the lender considers income or other financial information to determine a borrower's ability to repay the loan without modifying or refinancing the loan. Some industry participants warn that Module 3 could be used by the CFPB to require either or both mandated cooling off periods and limits on rollovers.

Fair Debt Collection Practices Act

The Fair Debt Collection Practices Act ("FDCPA") applies only to third parties collecting on behalf of a lender. It does not apply to a lender collecting debts on its own behalf and under its own name. However, the Procedures Manual appears to impose responsibility on payday lenders to ensure that third parties collecting on their behalf are in compliance with FDCPA. For example, examiners are directed to determine whether the lender contacts the borrowers in an appropriate manner by assessing whether third party contractors clearly disclose to consumers that they are contacting the consumer about the collection of a debt; and that third party contractors do not disclose the existence of a consumer's debt to members of the public without the consent of the consumer, except as permitted by law. Moreover, even if a lender's own debt collection practices are not subject to the FDCPA, the CFPB could take the position that these practices are "unfair, deceptive, or abusive".

SNR Denton Observations

There are many lessons to be learned from the financial crisis, and policymakers and supervisors have been aggressive in trying to limit the likelihood of a recurrence. While experts differ on the exact causes of the crisis, there is a consensus that the economic recovery depends in large part on consumer spending and access to credit. The challenge for the CFPB is find a balance that allows lenders to provide access to credit based upon fair and appropriate underwriting standards. For many consumers, access to credit is unavailable from banks, and many of those consumers make a voluntary choice to satisfy their credit needs from alternative providers such as payday lenders.

First, during Congressional testimony, the CFPB has taken the position that it has no plans to either ban payday lending or regulate the rate of interest charged on such loans. Nonetheless, the CFPB has also consistently focused criticism on high interest rates for small dollar loans. This tension is likely to show up during examinations where an examiner falls short of instructing a lender to stop extending such credits, but raises so many related issues that a lender must stop making the loans in order to address the issues raised by an examiner. This type of action will typically show up in documentation and recordkeeping and monitoring requirements.

Second, Section 1027(o) of the Dodd Frank Act provides that "no provision of this title shall be construed as conferring authority on the Bureau to establish a usury limit applicable to an extension of credit offered or made by a covered person to a consumer, unless explicitly authorized by law." During Congressional testimony, the CFPB has alluded to this limitation on its authority. Thus, absent such an explicit authorization elsewhere, nonbank lenders should be able to use risk based pricing and an interest rate that reflects the risk related to an extension of credit so long as the rate of interest complies with other consumer protection laws such as the laws related to disclosures to consumers, the laws and regulatory policies related to credit underwriting, including the ability of the consumers to repay the loan, the laws related to marketing and sales practices and related federal laws and the state law equivalents. Nonbank lenders, however, must continue to review state usury laws and interest rate limitations.

Third, while the CFPB extensively publicized its recent payday loan hearing and other activities related to stories about small dollar lending and the problems some consumers have faced, the CFPB does not appear to have publicized comments from any of the consumers who studies have shown are very satisfied with small dollar loans made by nonbank lenders. Some of those studies show that many consumers prefer to obtain credit from nonbank lenders because of the convenience involved, including the location of the nonbank lender, the simplicity of the paperwork involved and the immediate access to credit. For those nonbank lenders who wish to demonstrate the benefits of the small dollar loans, they should consider routinely providing such studies, market intelligence and consumer feedback to the examiners. Indeed, nonbank lenders should actively seek consumer feedback and provide that feedback to examiners to balance out the feedback that is provided to the CFPB from other sources.

Fourth, many policymakers, even some of the policymakers who supported the establishment of the CFPB, were concerned that consumers should continue to have access to credit from nonbanks. Those policymakers often cited the lack of access to credit from banks to the "unbanked," the "underbanked," low income families and consumers with impaired credit scores. Policymakers did not want to eliminate all access to credit to these consumers. Rather, policymakers wanted to make sure that, if credit were extended to these consumers, the lender took into account the consumer's ability to pay, the consumer's ability to understand the product or service that was offered, the lender's willingness to develop a product that met the needs of the consumer without unnecessarily or unfairly placing the consumer into a financial position that the lender knew the resources of the consumer could not meet. Many of these policymakers came to believe that the underwriting standards and the reserve requirements imposed on banks by the Federal banking agencies meant that many banks were unwilling or unable to extend credit to these consumers. Those policymakers felt that the best alternative for access to credit for these consumers was nonbank lenders. In this respect, the CFPB's mission should not be to put nonbank lenders out of business. Rather, it is to help nonbank lenders provide a useful product to consumers. Nonbank lenders and the CFPB should work together to expand, not restrict, the products and services that are available to consumers.

Fifth, it is possible that much of the negative perception that some examiners may have about small dollar loans exists because those examiners do not have much experience with how the product works and the benefits provided to consumers. Where this is the case, nonbank lenders have an opportunity to help the examiners change their perceptions. Experienced examiners, especially those who have worked for a Federal banking agency, are typically open to assistance related to how products actually work rather than how academics and others assert that they work. When lenders provide examiners with information showing that a product was developed to meet a specific need of a customer and the product actually met that need to the satisfaction of the customer, examiners generally support that product. Nonbank lenders should consider helping examiners to develop this understanding.

Sixth, examiners are aware, and studies have shown, that small dollar loans can be profitably made where technology is used to reduce certain administrative costs. Anecdotal evidence suggests that nonbank lenders may be able to provide these types of credits more efficiently and more profitably than bank lenders due, in part, to differences in infrastructural costs, technology and customer conveniences such as the quick and easy application process and the flexible delivery system. While there are many banks who desire to make small dollar loans, many more banks have conceded that they are unable to do so profitably. This point is well known to policymakers and to supervisors. This is a key point that nonbank lenders should consistently make clear to the CFPB.

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