Payday Lending Study Gives Both Sides More Ammo

May 5, 2005

For all the heat generated in the debate over the legitimacy of payday lending, data on the workings of the business can be hard to come by.

Whereas regulators have made ample data available through the Home Mortgage Disclosure Act, there's no national loan database to track payday lending trends, according to a recent American Banker newspaper. Until recently, critics and defenders of the business had to rely on a patchwork of state-level studies to back up their arguments.

Last week, both sides got more to work with when the Federal Deposit Insurance Corporation published what many believe to be the first attempt to analyze the business on a national level. The working paper, presented at a Federal Reserve conference in Washington, found no evidence to back up consumer activists' claims that payday-loan stores are disproportionately in minority neighborhoods. That finding obviously buttressed industry representatives.

But the FDIC also found that repeat borrowers, while no more profitable than first-time customers, are "an important profit-building component" because they boost volumes, according to FDIC economist Katherine Samolyk. "Our results show that payday lending could survive with fewer high-frequency borrowers, but long-term scale would be smaller," she said. On that score, activists claimed vindication for their charge that payday lenders trap borrowers in never-ending loans.

An FDIC spokesman said its researchers undertook the working paper because the agency wanted to learn more about "the pricing of the payday lending industry," one of activists' chief targets of complaints. Of course, the FDIC is the only federal regulator that has tolerated bank participation in payday lending, but the spokesman said the working paper was not motivated by a desire to justify its stance.

"We did not conduct it to support or defend or vilify payday loans," he said. "We had a unique opportunity to take a look at pricing, something that nobody else has been able to do."

The researchers "were able to obtain some loan information from payday lenders that no one else has had access to in the past," he added. The FDIC report also found that payday lending was not as wildly profitable as the annualized percentage rates, which exceed 300%, suggest.

"To a great extent," the report said, "the 'high' APRs implied by payday loans can be justified by the fixed costs of keeping stores open and the relatively high default losses suffered on these loans." The paper draws on store-level revenue and cost data for two large payday lenders from 2002 to 2004. The FDIC's researchers examined random samples of 300 stores from each lender.

The spokesman emphasized that the working paper is "preliminary" and that the researchers would use feedback they got at the conference to continue to work on it.

But the FDIC's tentativeness did not stop payday lenders from trumpeting its conclusion that there's no evidence of racial targeting. They contrasted that finding with a widely publicized study published in March by the Center for Responsible Lending, a nonprofit organization in Durham, N.C. The title said it all: "Race Matters: The Concentration of Payday Lenders in the African-American Communities in North Carolina."

The Community Financial Services Association, the payday lenders' trade group, sent the Durham organization a letter challenging it to "reveal the back-up data from its report."

"Frankly, given the inflammatory tone of the report, we are surprised that it was not backed by a more detailed, scientific, and transparent presentation of the data," wrote Lynn DeVault, the trade group's president.

Mark Pearce, the director of the Center for Responsible Lending, stuck by its research. "Anyone looking at our maps for North Carolina will see the obvious concentration of payday loan stores in African-American neighborhoods," he said. Regarding the FDIC's report, he said, "a key finding from their research is that high-volume users account for a significant portion of payday loan volume, which is in line with our prior research and the research of other industry analysts."

Pearce also noted that the FDIC report focused on profitability in the industry and not on race, and he said the report simply acknowledged that the FDIC "sees the need to do more research. We hope they will."

Steven Schlein, a spokesman for the payday lender group, which is based in Alexandria, Virginia, said he presumes the FDIC's research is "good." According to Schlein, the group will have "to look at" the FDIC's assertion that repeat borrowers are a major contributor to volume and therefore to profits.

Nonetheless, he said, "One of the things we know about our industry and wish people would study is that borrowers use our products for a very short period in their life, usually for a year or so, and then they move on to other products, like home equity loans."

In March, the FDIC issued new guidelines limiting the number of months a customer can be in a payday loan to three a year. Since payday loans typically have two-week terms, this effectively caps the number that can be taken out to six a year. The new guidelines also require banks to make sure they are not enabling customers to exceed the three-month limit, even if the customer got loans from another lender.

Samolyk said she would like to gain a better understanding from further research about what determines payday store location as well as customer use.

This article was prepared by the staff at the Point for Credit Union Research and Advice and is published online at http://thepoint.cuna.org/. Reprinted with permission.