Missouri, payday-lending haven

By Felix Salmon
December 20, 2011

Is there an expert out there on the subject of payday lending in Missouri? It certainly seems to be something of a haven for payday lenders, despite the state’s attempts to paint itself as a strict regulator:

Sections 408.500-408.505 subject this type of lender to a host of consumer safeguards, i.e., places a 75% cap on interest and fees on the initial loan and renewals, limits renewals to no more than six, limits the term of the loan to 14-31 days, applies daily interest calculations, etc. These sections contain some provisions which go well beyond most “consumer protections”.

I’m not sure why the Missouri Division of Finance is so defensive, here, or why it feels the need to put the phrase “consumer protections” in scare quotes. But the fact is that in 2011, some 2.43 million payday loans were made — this in a state with a population of less than 6 million — and the average APR on those loans was an eye-popping 444%.

So it’s easy to see why consumer groups are pushing a law capping interest rates at 36%, and why payday lenders are opposing it.

The details here aren’t pretty. First of all, look what’s been happening to the payday lending industry over the past eight years, according to the state’s own figures.

payday.tiff

There’s been a steady rise in average APR, but that’s pretty much the only trend that can be seen in these figures. The total number of loans is actually down by 15% from its 2007 peak, while the number of active payday lenders has fallen by 18% in just two years. And borrowers seem to be getting smarter, too: they’re borrowing more money at a time, and rolling it over fewer times, thereby incurring fewer fees.

Meanwhile, the payday-loan default rate has been hovering steadily in the 6% range — reaching its peak before the financial crisis, interestingly enough — and acting as a silent rebuke to anybody who would dare to argue that interest rates in the triple digits are necessary to make up for the fact that so many payday loans go bad. (In fact, they’re reasonably safe, if only because they’re secured by a future paycheck.)

But the most interesting thing about the Missouri debate, for me, is the role of a group calling itself Stand Up Missouri, which has promulgated a particularly tasteless video which implies that standing up for high-interest-rate lenders is somehow analagous to the acts of the “poor people who followed Dr. King and walked with him hundreds of miles because they believed in civil rights that much”.

Stand Up Missouri is at pains to say that it does not represent payday lenders, and indeed that payday loans, which “do not include a budget review to determine if the borrower has the ability to repay the loan at the two-week or one-month maturity”, “can be difficult for a borrower to manage”.

Yet according to Scott Keyes at Think Progress, Stand Up Missouri “is funded – to the tune of $216,000 – by just seven payday lending corporations”.

The truth, I think, is a bit more complicated. There are payday lenders — and then there are Consumer Installment Lenders, as defined by Section 408.510 rather than 408.500 of the Missouri code:

In 2001, the “traditional” small loan companies and the “payday” lenders separated themselves at $500 with the payday lenders authorized for very short-term loans of up to $500 and traditional lenders able to make any loan from a minimum amount of $500 on up. The consumer installment lender provisions were needed to cover a gap: the borrower of a very small amount who needed more time than the 14-31 day limit on payday lenders… These loans are very much like Consumer Loans, but with some notable exceptions. For instance, the loans may be in any amount, secured or unsecured, but must be repayable in at least four (4) equal installments over a period of 120 days.

Stand Up Missouri represents these installment lenders, who are distinct from payday lenders: I think that Keyes is wrong that it’s just a bunch of payday lenders who “prefer the phrase ‘traditional installment loan’”. In the biennial report of the Missouri Division of Finance, payday lenders are listed over the course of 32 pages (119-150), while the installment lenders fill up just over 19 (160-179).

Installment loans are bigger than payday loans, and they’re not subject to biennial surveys in the same way that payday lenders are. But just eyeballing the sheer number of these entities, and the money they’re putting into opposing the current bill, I think it’s fair to assume that they’re more or less the same size as the payday lenders, in aggregate.

Which means that the number of loans made in Missouri every year at an interest rate of more than 36% is actually much greater than 2.43 million: it could be more like 4 million. Which is crazy, given the size of the population.

Even the Missouri Better Business Bureau has come out swinging against the abuses of the payday-loan industry. In a hard-hitting report dated July 2009, it noted that Missouri uniquely among nine contiguous states allows payday loans to be rolled over; that at least two Missouri nursing-home groups own payday lenders designed to lend money to their own employees; and that, in general,

Missouri’s weak payday loan laws have attracted major out-of-state lenders to engage in predatory lending, costing Missourians who can least afford it millions of dollars a year. Because the continually increasing debt owed to payday loan companies is so onerous, some consumers are caught in the “debt trap,” unable to pay the loan off or meet other needs such as utilities, rent and food. Bankruptcy is the only answer for some of these consumers.

All of which is to say that I’m no fan of facile columns defending payday lending in principle without getting too caught up in the way that it’s used in practice. Yes, as Tim Harford says, it’s possible that taking a loan at an interest rate of 1,350% could be a rational thing to do. But it’s simply not possible that most or indeed many of the recipients of those loans are doing the economically rational thing — even if you take into account the cost of a bank overdraft as the alternative source of funds.

The dreadful conceit of the Stand Up Missouri video is that a college professor who didn’t use credit cards and therefore didn’t have a credit history walked into her local credit union and was turned down for a loan — and that the credit union officer pointed her to an installment-loan shop instead, where she happily got a loan at an interest rate of somewhere well north of 36%.

Well, here’s my challenge for Stand Up Missouri: name that credit union. Credit unions exist to serve precisely this kind of person: I simply don’t believe that any credit union would turn her away and deliberately send her to a usurious lender.

And here’s my other question for Stand Up Missouri: we know the average APR on payday loans, so will you publish the average APR on your loans? These loans are all, by definition, over $500, so it’s hard to make the case that the APR has to be low just to make up for the small dollar amounts involved. And if New Mexico is any indication, it’s the lenders with 120-day term loans which are the very worst — worse than the payday lenders whose regulations they successfully skirt.

Finally, here’s a question for the Consumer Financial Protection Bureau: can you at the very least collate information on nonbank lenders in the 50 states, and the interest rates they charge consumers? One of the problems in Missouri is that while the payday lenders have their activities monitored in biyearly reports, the installment-loan shops seem to be acting without any need for any disclosures at all. And if we don’t know how big the problem is, it’s very hard to tell what kind of solutions might be necessary.

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Comments
13 comments so far

Eliminating the payday loan opportunities for those that couldn’t get credit from banks, unions or other ‘mainstream’ lending sources – drive the borrowers underground where they will resort to borrowing from unlicensed lenders with large dogs and never ending payment options. People need to borrow money, if these lenders are banned or even capped people will have to use loan sharks (thugs who will impose real physical threat upon non-repayment of ‘cash’ loans). I for one think short term loans through visible lending streams is fine as long as the repayments are clearly stipulated.
http://cashadvancesus.com/missouri-cash- advance-loans/

Posted by EmilyMorgan | Report as abusive

“Meanwhile, the payday-loan default rate has been hovering steadily in the 6% range — reaching its peak before the financial crisis, interestingly enough — and acting as a silent rebuke to anybody who would dare to argue that interest rates in the triple digits are necessary to make up for the fact that so many payday loans go bad.”

Err, what?

That’s a 6% failure rate on 30 day loans. What annual interest rate do you have to charge to cover 6% of your loans going sour every 30 days? Doesn’t it *start* at 72%?

Month one, you lend out $10,000. $600 of that defaults. What do you need to charge on the $10,000 for one month to cover $600 in defaults? $600 interest, obviously.

6% per month to cover the 6% default rate.

Posted by TimWorstall | Report as abusive

The data in the columns are annual figures, so it’s 6% default for the entire year, not per month.

Posted by djiddish98 | Report as abusive

@djiddish98, the sums in the table are annual, but 6% applies to the number of loans (e.g. 124,000/2mm is about 6%), not the annual rate of default. The 6% figure is the default rate per loan term, not per year. If 6% of all 1M term loans held to maturity default, then 6% default, whether the measurement period is 1M, 1Y, or 100Y. The 6% monthly breakeven rate is actually about 101% annualized, so TimWorstall’s floor is too low.

But how are you guys interpreting that table with such confidence? The document states that in Missouri, such loans may have terms between 14 and 30 days, and the table says e.g. that on average loans were rolled over between 1.6 and 2.8 times. So is the typical loan closer to 14 days or 30? I would guess 30, since so many are rolled over. And is a rolled over loan counted as one loan or two? I would guess two, since the default rate is fairly stable even though the rollover rate is not. But those are just guesses.

Posted by Greycap | Report as abusive

@greycap

I read the chart as follows:

From the time frame between October 1, 2009 and September 30, 2010, 6% of loans defaulted – that’s why I assumed it was an annual default rate. Basically, I assumed this was data from FY10, not from January 2011.

Are you interpreting this as monthly data?

Posted by djiddish98 | Report as abusive

I also see a huge problem with this analysis. Based on the row descriptions given, it seems clearly spelled out that the default rate is for the number of loans and is not an annualized rate. So for a two week loan at 6.4% default rate, over 1/26 of the year, would requre an APR of 166.4% just to break even. Capping APR at 36% would clearly shut down the industry, handing the industry over to loan sharks.

Can you check on this Felix? Love your blog.

Posted by Anonymous | Report as abusive

I’m still wrapping my head around this, but please disregard my previous comments.

Posted by djiddish98 | Report as abusive

Anonymous- You have a valid point, but you are assuming all loans are for 2 weeks and all defaults are 100% losses to reach your 166% break even point. I can’t see either of these being true. And 166% is a still a long long way from 445% interest rate that the industry is charging.

Posted by AdamJ23 | Report as abusive

AdamJ23 – “breakeven” is earning $0 return before considering any administrative costs or earning any return on capital. Administrative costs are not trivial – labor, real estate, etc. – and are likely especially large on such small average loan amounts. There’s also the need to earn some rate return on the capital deployed before making real profit. Granted, that amount of capital appears not to be huge, as 2.43 million loans at an average of $307.56 equals $747 million of loans originated per year. To the prior point, however, this figure is an annual number, so the loan amount outstanding at any 1 time is in the range of approximately $14 million (if the average term on each loan is 1 week) to $60 million (if the average term is 1 month).

This loans outstanding estimate also puts Felix’s alarm over the size of the industry in a different context. The total outstanding payday loans in a state of 6 million people – plus whatever number are coming to Missouri from the “9 contiguous states” since it sounds like Missouri’s regulations really are laxer – adds up to the assets of 1 extremely small community bank.

Is there any evidence other than Felix’s musings that this industry earns abnormally high returns? It sounds like there are a reasonable number of competitors, so I’d think that competition drives rates to a reasonable level of profit relative to risk. I agree with Felix that in most cases it’s a poor life decision for people to take these loans, but, at some point we have to let people make their own decisions, so long as the economics of a transaction are fairly disclosed.

Posted by realist50 | Report as abusive

@AdamJ23, good catch about the recovery – all of the preceding calculations assume 0%. But … the amounts involved are so small – $300 average – that if there is any legal or administrative cost to collection, recovery would quickly be driven to zero.

But for the record, 166% = 26 x 6%, yes. But this calculation has no practical purpose. If you want to know the expected fraction of lent money that will be lost (assuming zero recovery), it is 6%. No matter how many loans are in your portfolio or what time period you are considering, it is 6%. If you want to know what interest rate you need to charge to cover credit losses, it is 6% *per loan period*. By assumption, that is 14 days in this case. That works out to a 402% annual rate: (1 + 0.06)^26 – 1. Then you still have to charge for costs, the time value of money, and the price of risk.

Posted by Greycap | Report as abusive

Oops – preceding calculation was actually done with the 6.4% rate. 6% annualized is only 354% Woo hoo!

Posted by Greycap | Report as abusive

There may be less mystery to the differences between “payday” and “small loan” lenders than meets the eye.

I believe many payday lenders also have overlapping licenses as small loan and title lenders. So there’s a distinction with no difference — except that the company will sometimes claim it was lending under the less-constraining license when accused of not complying with particular regulations (e.g. too many renewals or disguised renewals of payday loans).

The payday loan industry, based purely on its loan volume, may not be huge. But it’s hardly trivial. The critical feature of a payday loan is, as much as anything, that it is the LAST loan. It’s rarely the first or only loan. It’s the one you get because you are so overextended in every other source of finance that you either default on other loans or grasp this straw. It’s rarely a good straw to grasp.

But for repeated and cyclical payday loan borrowing, these are consumers who would default on their other debt. But because of the high rates paid for this last bit of liquidity, they most often give up the ability to “get ahead” of their debt problem. So when the next “hit” comes to their cashflow, the payday lender — holding a post-dated check — jumps ahead of the mortgage, rent, car, tax, credit card, child support, etc. It gets paid while the other largely default.

That’s noty good for anyone — except the payday lender.

Posted by wjsherk | Report as abusive

If payday loans are lenders of last resort for so many Missourians, what happens if these lenders are run out with a rate cap? Surely, our state’s “lax” lending laws would have facilitated better options by now… Instead of nixing the businesses doing the only lending, I’d rather see payday loan opponents present a better way to loan to the people that use these loans. But chances are they can’t, and they’d rather have these folks begging for welfare and food stamps than making their own way.

Posted by Sameoldsameo | Report as abusive
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