Court Rules NY Can Regulate Internet Payday Lending

The Court of Appeals for the Second Circuit held yesterday that New York’s Department of Financial Services has the authority to regulate Internet payday lenders based on Indian Reservations.  The decision is a major victory for the Department and its logic paves the way for the further regulation of out-of-state payday lenders that use the Internet to facilitate their loans.

In 2013, DFS ordered payday lending operations, most of which were based on Indian Reservations, to stop making payday loans in New York State.  Since New York State caps interest rates at 16% for unlicensed lenders, it effectively bans payday loans.  In addition to ordering these businesses to stop making loans that exceeded New York’s usury cap, the State strongly urged lenders, including several credit unions, to stop facilitating ACH payments to the payday loan providers.

Faced with a dramatic decline in their business, two tribes sued New York State in federal court, seeking to prevent it from blocking their Internet payday lending activities,  They argued that under the federal Constitution’s Indian Commerce Clause, the State had no authority to regulate lending activity taking place on New York State Indian Reservations.  They argued that the loans in question were processed through websites owned and controlled by Indian tribes, that the loans were granted based on underwriting criteria developed by the tribes, and that the lending contracts specified that tribal law would control any disputes.  In addition, they complained that by sending letters to banks and credit unions urging them to stop working with Indian lenders, the State was singling out Indian tribes for retribution.

A district court rejected the argument of the tribes and refused to grant an injunction against the DFS.  Yesterday’s decision by the Court of Appeals for the Second Circuit upheld that decision.  Most importantly, the Court agreed that the tribes had not presented sufficient evidence that the loans in question were, in fact, loans made on the Reservations.  It concluded that even though the tribes argued that the loans were “processed through websites owned and controlled by the tribes” they “never identified the citizenship of the personnel who managed the websites, where they worked, or where the servers hosting the websites were located.  Loans were approved by a tribal loan underwriting system, a vague description that could refer to the efforts of Native American actuaries working on the Reservation but could also refer to a myriad of other systems” located anywhere in the world.

Jurisdiction over Internet-based lending has implications that go far beyond questions of tribal law.  For instance, the rationale articulated by the Court yesterday strengthens New York’s ability to block Internet loans offered by banks located in states that authorize payday lending.  However, the decision is by no means a total victory for the State and underscores just how unsettled this area of the law is.  For instance, the Court stressed that even though it would not impose an injunction against the DFS at this time, the tribes could ultimately win their lawsuit if they provide additional evidence demonstrating that most of the lending activity took place on tribal lands.  Such a claim could take years to prove, and in the meantime the tribal business model is frozen.

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JP Morgan had personal information of 76 million customers stolen off its website this summer.  The announcement is the latest example of hackers targeting bank websites and online services not simply to gain access to member funds but to gain access to information such as names, addresses and phone numbers that can be used to facilitate other data breaches in the future.

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I know you all are dying to get this information:  my bet the mortgage World Series Champion prediction is that the California Angels will defeat the St Louis Cardinals in six games.  Just how trustworthy are my predictions?  NCUA is considering making them acceptable investments when it comes out with its updated Risk-Based Capital proposal.

October 3, 2014 at 8:21 am Leave a comment

What Tom Brady, subprime loans and White House break-ins have in common

There are some things we just instinctively know don’t happen. Like we know that a lunatic can’t jump the white house fence with the ease of a drunk teenager diving into a neighbor’s pool and that the same lunatic couldn’t procede to run for more yards on White House than Tom Brady passes for in a Monday Night Football game. Similarly, we know instinctively that credit unions don’t make subprime loans. As a result I’ve seen otherwise studious compliance professionals daydream when the presenter starts talking about subprime lending disclosure requirements.

So you may have been a little surprised by yesterday’s CU Times article suggesting that Navy Federal Credit Union may be setting itself up for Fair Housing examination scrutiny by offering No- Money-Down mortgages with 5% interest rates . The article exemplifies a simmering problem in mortgage regulation: Everyone is against sub prime lending but there is no set definition of what makes a subprime loan a subprime loan. With interest rates continuing near record lows all credit unions and banks for that matter, should  double-check if they are making loans that regulators could single out for greater scrutiny.

So what exactly is a subprime loan? First let’s keep in mind that almost all statutes and regulations now tie subprime loans to the APOR. The APOR is generally an average index of comparable loans. As interest rates go down so do the subprime trip wires.

First grab some more coffee. Then here are some of the differing definitions of a subprime loan,

Regulation Z defines a higher-priced mortgage loan as follows:

Higher-priced covered transaction Higher-priced covered transaction means a covered transaction with an annual percentage rate that exceeds the average prime offer rate for a comparable transaction as of the date the interest rate is set by 1.5 or more percentage points for a first-lien covered transaction, other than a qualified mortgage under paragraph (e)(5), (e)(6), or (f) of this section; by 3.5 or more percentage points for a first-lien covered transaction that is a qualified mortgage under paragraph (e)(5), (e)(6), or (f) of this section; or by 3.5 or more percentage points for a subordinate-lien covered transaction

12 C.F.R. § 1026.43

High-Cost Mortgage which regulation Z defines as The annual percentage rate applicable to the transaction, will exceed the average prime offer rate, as defined in), for a comparable transaction by more than:

(A) 6.5 percentage points for a first-lien transaction,

(B) 8.5 percentage points for a first-lien transaction if the dwelling is personal property and the loan amount is less than $50,00012 C.F.R. § 1026.32

But wait there’s More…The state of course has its own definitions for what constitutes a High Cost Loan in 6-L of the Banking Law and a Sub Prime loan in 6-M.

There are many more examples with which I could sedate you; Keep in mind that each one of these definitions comes with its own disclosure requirements and penalties for noncompliance, and it quickly becomes apparent that what started as a genuine attempt to rein in abusive lending practices has morphed into a regulatory minefield more analogous to a speed trap then a legitimate regulatory framework. While it is true that none of this would matter much but for the fact that interest rates are so low they are, and now a bank or credit union making a 5% mortgage can be scrutinized for making a subprime loan.

Clearly something should be done. Congress could come up with a definition that preempts competing state requirements. Conversely, states could streamline their own subprime definitions   so that they are defined in reference to federal law.

Of course, I’ve given up on commonsense changes at least on the federal level, so my suggestion to you is to take a quick look at your mortgage interest rates this morning. You may be making “subprime loans” without even knowing it…

Speaking of subprime loans the New York Times is continuing to sound the alarm against the tactics used by used car dealers to qualify individuals for auto loans, they can’t afford. This morning, it is reporting that: “some of the same dynamics-including the seemingly insatiable demand for loans as the market heats up and the dwindling pool of qualified borrowers that helped precipitate the 2008 mortgage crisis are  now playing out, albeit on a smaller scale in the auto loan market”

The paper is reporting this morning that prosecutors in New York, Alabama and Texas are zeroing in on used car dealerships and have discovered hundreds of fraudulent loans given to people with inadequate credit. If you do indirect lending now would be a good time to double check the credit union’s underwriting policies and to make sure that you can document adequate oversight over the dealerships with which you have a relationship..

 

October 2, 2014 at 9:37 am Leave a comment

Military Misfires on Consumer Protection

Today’s blog provides a good example of how well-intentioned people can end up doing more harm than good.  The Department of Defense recently proposed expanding the coverage of consumer protection laws that currently apply to pay-day loans, refund anticipation loans and vehicle title loans to most consumer loans covered by the Truth in Lending Act. It would not apply to loans to purchase a vehicle or a home.  If the DOD isn’t careful, it will dry up the swamp of creditors who prey on our service members, which of course is a good thing, but do so in a way that will make it more difficult for members of the armed forces to get access to consumer credit, especially from credit unions.  Here’s why.

Back in 2007, responding to wide spread reports of predatory lending activities targeting the military, Congress passed the Military Lending Act.  The Act empowered the Department of Defense to define and regulate consumer credit products provided to active duty members of the armed forces and their dependents.  It gave the military wide discretion in determining what products would be subject to the enhanced regulatory restrictions.  Under the regulations promulgated by the DOD, a 36% interest rate cap was placed on refund anticipation loans, pay-day loans, and vehicle title loans.  In addition, the cap is calculated based on the Military Annual Percentage Rate (MAPR), which is succinctly summarized by the CFPB to include interest, fees, credit service charges, credit renewal charges, credit insurance premiums and other fees related to credit products sold in connection with the loan.  Creditors selling these loans have to provide enhanced disclosures, as well as take affirmative steps to identify eligible consumers.

At the time the legislation was enacted, credit unions and other financial institutions were concerned that if regulations were written too broadly, they would require the wide-spread adoption of two types of consumer loan products:  one for the military and one for civilians.  However, the final regulations were narrow enough in scope so that they didn’t impact the vast majority of credit unions, most of which would have no desire to offer these types of products in the first place, even if located in states where they were permitted to do so.

The statute as it has been implemented by the DOD made sense, at least until last Friday.  The DOD is proposing regulations that would expand the definition of products covered under the statute to include credit cards and other consumer loans covered under the Truth in Lending Act.  As a result, credit cards offered to members of the military and their dependents would be subject to a 36% cap calculated by a refined MAPR.  To be fair, the military recognizes that a poorly drafted regulation runs the risk of denying mainstream credit to members of the armed forces, so it is refining the MAPR to, for example, exclude customary and reasonable fees.  But the calculation of an MAPR would still differ for members of the military and civilians.  Furthermore, by expanding the reach of the MLA to most consumer loans except home mortgages and car loans, the military will make it more difficult for credit unions to provide legitimate loans to service members.

In fact, the proposal is such a bad idea that NCUA took the highly unusual step of issuing a statement critical of the proposal the same day it was announced.  It pointed out that NCUA’s pay-day lending alternative was designed specifically to fit within the Department’s existing regulations.

Current NCUA regulations allow federal credit unions to offer payday alternative loans with an interest rate of up to 28 percent and an application fee of up to $20. Under the Military Lending Act regulations, consumer credit to covered borrowers is subject to a 36 percent cap on the military annual percentage rate, or military APR, which includes application fees. If these regulations are revised to cover payday alternative loans, the rate and fee for many payday alternative loans would be higher than the military APR cap.

Conversely, our good friends at the bureau that never sleeps, the CFPB, thinks the Department’s proposal is a swell idea.  Proponents of the DOD’s approach point out that it is extremely easy to avoid compliance with the MLA.  For example, a loan with a 91-day repayment period isn’t classified as a pay-day loan under the regulations, but a 90-day loan could be.  They argue that by expanding the size of the jurisdictional net, it will be easier to catch those creditors who prey on members of our armed forces.  The problem with larger fishing nets, of course, is that they scoop up everything in their wake, including fish that no one wants to catch in the first place.

Perhaps DOD should consider expanding the definition of the existing products covered under the MLA rather than grabbing everything into its jurisdiction.  Another alternative, which it notes in the preamble that it is open to considering, is to exempt certain types of institutions from coverage of the expanded regulations.  Considering that federal credit unions are already subject to an interest rate cap on loans and that the vast majority of credit unions are places that members of the military looking for a fair deal should be encouraged to patronize, an exemption makes sense to me.

At ease.

October 1, 2014 at 8:30 am Leave a comment

What a new comment period means for RBC reform

Yesterday’s announcement by NCUA Chairman Debbie Matz that NCUA would Issue an amended Risk Based Capital Proposal and that credit unions would be given an additional comment period to respond to it has several important implications .

– The most important statement yesterday was not Chairman Matz’s but Vice Chairman Rick Metsger’s “As I have often said, I believe interest rate risk is important and must be addressed in the risk-based capital rule, but it should be addressed separately from credit risk. Weighting credit risk and interest rate risk with a single numerical value created conflicts that ultimately made it difficult to accurately weigh the risk of either.”

This is absolutely crucial news since many of the most onerous risk weightings, most notably dealing with mortgage concentrations, were designed to avoid interest rate risk by deterring credit union’s from holding otherwise sound financial products. NCUA tried to accomplish with a hatchet a goal for which it needed a surgeon’s knife. Hopefully its proposed revisions will provide a more nuanced approach to interest rate risk and risk-based capital.

– Chairman Matz has been about as reluctant to extend the comment period for risk-based capital regulations as the Patriots are to show up for practice this morning after getting destroyed by the Kansas City Chiefs last night. I thought it was telling that Chairman Matz said she made the decision in consultation with NCUA’s lawyer’s (Whenever you have to do something you don’t want to do it’s always convenient to blame the lawyers).

Under the Administrative Procedures Act, an agency may promulgate a final rule that differs from the rule it has proposed without first soliciting further comments if the final rule is a “logical outgrowth” of the proposal (Louisiana Fed. Land Bank Ass’n, FLCA v. Farm Credit Admin., 336 F.3d 1075, 1081 (D.C. Cir. 2003).   It’s safe to assume that NCUA’s proposal will contain some really big changes.

– Chairman Matz is no longer driving the bus when it comes to RBC reform. Not only did Board member Metzger apparently already secure changes he wanted to the RBC proposal but the newest Board member c J. Mark McWatters  has some serious doubts about the regulation. He issued a separate statement yesterday in which he explained that “the previously proposed risk-based capital rules are deeply flawed and merit substantial revision. The devil is in the details, and I await the details before I can pass judgment on the next draft of the proposed rules.”

– I’ve consistently said that one of the major problems with NCUA’s proposal is that it inadequately explained the rationale behind many of its individual provisions. NCUA should use this new round of proposed rule making to explain in greater detail why it decided on the weightings that it ultimately is proposing. There are times that regulations should be long and complicated because they deal with long and complicated issues: this is one of those times. The initial proposal was presented in such a cursory manner that a review of the proposal and its preamble, and nothing else, leads to the conclusion, rightly or wrongly, that NCUA didn’t know what it was doing.

– The process is by no means over.  Depending on how the second proposal Is drafted there are still legitimate legal questions as to whether NCUA is overstepping its authority and whether credit unions should do something about this.

– Comment letters matter. As someone whose job is dedicated in part to getting credit unions to respond to proposed regulations and not simply complain about implementing them once they are promulgated, NCUA’s decision provides the best example yet of how responding to regulations with a large volume of thoughtful critiques can and does influence the regulatory process. NCUA would not be announcing a new round of propose regulations but for the fact that credit unions showed how flawed its initial proposal was.

Lawsky comments on role of regulators

Benjamin Lawsky, the Superintendent of New York State’s Department of Financial Services, had some very provocative thoughts about regulation at a recent forum hosted by Bloomberg News. He said that what has surprised him the most about financial misconduct since he has been Superintendent is that the misconduct “doesn’t go away.” As a result, regulators have to look in the mirror and ask themselves if they are going about deterring misconduct the right way.

He suggests that instead of focusing so much on corporate misconduct greater emphasis should be placed on holding the individuals behind the misconduct responsible.

If he is right than big fines are a start but unless you couple them with sanctions against the individuals driving the misconduct than they will continue to be viewed as a cost of doing business.

Here is a link to the interview.  The portion to which I am referring starts at 2:10.

http://www.bloomberg.com/video/new-york-s-benjamin-lawsky-on-banking-regulation-XZFvgEuVRHaS5a8ooxvo8Q.html

September 30, 2014 at 9:02 am Leave a comment

Shell-shocked by Hackers . . .Again

I’m sorry to start off the week with such downbeat news, but if it makes you feel any better as you’re reading this blog, I am getting poked and prodded by a dentist.
In case you missed it on Friday, the FFEIC, the joint body representing all financial regulators including the NCUA, issued a bulletin warning financial institutions to take steps to guard their computer systems against the “Shell shock” vulnerability. With the caveat that I am not an IT person, regulators and industry professionals are concerned that operating systems including UNIX, Linux, Mac OS 8 X and certain Windows servers are vulnerable to hackers being able to take over your computer system.
Just how big a deal is this? It appears that no one knows for sure yet, but according to the BBC, the bug could impact as many as 500 million machines. If what the experts are saying is correct, a hacker could easily use the vulnerability to compromise your banking operations.
Be sure to read the FFEIC memo, if you haven’t done so already. For those of you with a third-party vendor, make sure to reach out to them and assess your credit union’s vulnerability. Apparently, the bug can be squashed with an easy to install patch.
Since we’re on the subject of cybersecurity, those of you really interested in getting background on the subject should find time to watch a show about the science behind hacking defenses. You don’t need to be a computer genius to find it informative. Trust me.
Good luck and have a good day.

September 29, 2014 at 7:39 am Leave a comment

Handle Electronic Repo Man With Care

Let me start this morning’s blog by announcing that I am dedicating it to Derek Jeter and formally throwing my weight behind his beatification at the earliest possible opportunity.  However, let me remind Yankee fans that Derek is not dead, life will go on, and yes, the Yankees will win championships without him.

Now for today’s blog.  One issue that got a surprising amount of attention recently was highlighted in a New York Times article about the increasing use of GPS-based technology that allows lenders to freeze vehicles in place.  According to the Times, with the growth of so-called subprime car lending, lenders have increasingly turned to technology that allows them to stall a vehicle being driven by a delinquent driver.  As one financer happily explained that without the technology, “we would be unable to extend loans because of the high risk nature of the loans.”

First, there is nothing in state or federal law that would prohibit the installation of these ignition freeze devices.  In fact, right now the field is wide open.  I say right now because it is the type of technology that state legislators, in particular, will scrutinize to ensure that it is implemented consistent with a state’s general repossession requirements.  Does this mean that anything goes when it comes to using this technology?  Absolutely not.  In fact, aspects of the way it is already being used make the hair on the back of my lawyer’s neck stand up. 

For example, if the paper is correct that lenders are disproportionately using this technology for subprime borrowers, then what we have is an Equal Credit Opportunity Act lawsuit in waiting.  Remember that under federal law, you can’t have policies that have either the intention or effect of imposing higher lending standards for applicants based on their race, sex, and other types of protected classifications.  If a lawyer can prove that a bank or credit union disproportionately conditions the granting of car loans to African-Americans, for example, on agreeing to the installation of GPS technology, then he has proven a violation of federal lending law.  One easy way to avoid this problem is to simply make GPS technology a condition of all your car loans.  Here’s some advice for you:  if you can’t justify using this technology on all of your members, then don’t ask any of them to agree to have it installed.

Another legal landmine to be avoided has to do with negligence.  In a nutshell, make sure you have common sense policies in place to protect you.  For example, the article highlights delinquent borrowers whose cars were frozen in the middle of the day.  Simply put, any money that the credit union recoups as a result of repossessing a delinquent owner’s vehicle is going to be miniscule compared to the damage award it will pay out when a jury hears that a credit union member was broadsided in the middle of the day after their vehicle was frozen in the middle of an intersection or that a member’s infant was locked inside a vehicle on 100 degree day.  Let’s use common sense here.  First, the use of the technology should be reserved only for car loans that are at least 30 days delinquent.  Secondly, members should be called and told in advance that they are in danger of having their car frozen.

Third, a tremendous amount of information can be derived about a member’s personal life from tracking their movements.  For instance, New York’s Court of Appeals examined a case in which a state employee’s extramarital affair was exposed tracking his whereabouts in a state vehicle.  Have strict policies in place about who can access the GPS technology and under what circumstances.  This is one of the few areas where there are things you are better off not knowing.

Finally, reserve your right to use this technology explicitly in your lending documents.  The use of tracking devices on someone’s personal vehicle understandably raises privacy concerns.  The more members are put on notice about the use of the technology, the better off everyone is going to be.

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A lot of people disagreed with my blog yesterday assessing the impact that Walmart’s entrance into banking will have on the credit union industry.  This article in today’s CU Times provides further arguments for those of you who mistakenly think that I have exaggerated the impact.

September 26, 2014 at 8:42 am 1 comment

5 Ways Walmart Will Impact Your Credit Union

In July of 2005, Walmart filed an application to open an Industrial Loan Bank in Utah. The Utah bank regulator was flooded with 3,500 comment letters describing Walmart’s application as a sign of the Apocalypse. One commenter described a Walmart bank as a “dangerous and unprecedented concentration of economic power.” Others fretted that Walmart would drive independent financial institutions out of business by utilizing its network of stores as low cost bank branches.

Fast Forward to September 24, 2014. Walmart announced that it is teaming up with on-line GoBank started by the California-based tech company Green Dot. It will start offering off-the shelf, low-cost checking accounts by the end of October to anyone 18 years of age or older with an ID. The mobile account startup kit will be available at Walmart stores nationwide. Customers will have access to 42,000 ATMS. How is this going to impact your credit union? Let me count the ways.

  1. Say goodbye to even more non-interest income.  With GoBank’s mobile banking platform, Walmart and its banking partner clearly feel they can attract enough customers to make up in volume what they lose in potential fee income.  As Steve Streit, Green Dot’s CEO and founder explained yesterday: “Many so-called ‘free’ checking accounts aren’t really free because they have high overdraft fees. In fact, an independent study by Bretton Woods estimates that consumers pay approximately $218 – $314 per year for a basic checking account.” He further noted: “No other checking account makes it this easy and affordable to manage your everyday finances.” Of course, there is some fine print being glossed over here. There is an $8.95 monthly fee that is waived in any month with qualifying direct deposits totaling $500 or more. Other fees include a 3 percent foreign transaction fee and out-of-network ATM fees (typically $2.50 for an out-of-network ATM plus any fee the ATM owner may assess).
  2. Walmart has the potential to challenge traditional banking on two fronts. If you believe that people still want branches to do their banking then you have to fear Walmart. You don’t have to be Nostradamus to see that one day all those bank branches that Walmart has been gracious enough to lease space to in their stores are going to gradually become GoBank branches. If you believe, as I do, that banking is going virtual, then by teaming up with GreenDot, WalMart has a mobile platform than can compete with anyone’s as I explained in a previous blog.
  3. Just how are you going to attract those young people who are indifferent to walking into a credit union or the person of modest means who is intimidated about doing so? These are people who were increasingly relying on prepaid cards and mobile banking even before Walmart’s announcement.  Now, they have the option of getting a full-fledged FDIC insured bank account by walking into a store. No one is intimidated by Walmart and the store has a reputation for great deals and fair prices. And, don’t fool yourself, Walmart is starting out just offering a basic banking account but it will be offering car loans and mortgages in the not too distant future.
  4. Walmart and Apple are now your two biggest competitors. How do you offer traditional banking services in an industry where the appeal of the new guys is that they are non-traditional bankers? I don’t know, but at the very least, if you still don’t have a mobile platform you better get one soon or merge with a credit union that does.
  5. Back in 2005 many smaller financial institutions correctly feared that a Walmart bank could put them out of business. Maybe I’m missing something, but, if anything, those fears are even more justified today. Only credit unions with a very unique niche or large institutions will have the economy of scale to compete against big volume consumer banking. So, it is Walmart’s entry into retail banking, coming on the heels of Apple Pay, that makes this one of the most transformative periods in retail banking credit unions have ever witnessed.

Scam Alert

The IRS sent out an alert yesterday warning financial institutions against a scam that makes me think yet again that some compliance officers have gone over to the dark side. Fraudsters, posing as IRS employees, are calling up financial institutions complying with the Foreign Account Tax Compliance Act (FATCA) and requesting account information. As the IRS explains:

“The IRS does not require financial institutions to provide specific account holder identity information or financial account information over the phone or by fax or email. Further, the IRS does not solicit FATCA registration passwords or similar confidential account access information.”

Down So Long That It Looks Like Up To Me Category

In a press release “The U.S. Department of Education announced today that the official three-year federal student loan cohort default rate has declined to 13.7 percent for students who entered repayment in FY 2011. That drop was across all sectors of higher education – public, private and for-profit institutions – even though an additional 650,000 students entered repayment in FY 2011 compared to FY 2010.”

That default rate for 2010 was 14.7.

The Good News Is Good News Category

New home sales hit their highest level since August 2008.

September 25, 2014 at 9:06 am Leave a comment

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Authored By:

Henry Meier, Esq., Associate General Counsel, Credit Union Association of New York

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