Testimony of Kansas Association of Financial Services ...

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Testimony of Kansas Association of Financial Services (KAFS) Presented by Ron Gaches

Regarding Small Installment Loans House Financial Institutions Committee

Thursday 13, 2014

Thank you Chairman DeGraaf and members of the Committee. My name is Ron Gaches and I appear today in my capacity as Executive Director of the Kansas Association of Financial Services. KAFS is a state trade group dedicated to passage of a bill granting authority to offer small installment loans in Kansas.

With me today is Phillip Holt, representing the National Installment Lenders Association, and Dr. Rickie Keys of Renewal Financial, a financial literacy program that is distributed free through most of the small installment loan companies.

Our proposal would authorize a new category of small installment loan lenders, usually referred to as subprime or "B" lenders, to conduct business in Kansas. These lenders would be under the direct supervision and regulation of the Office of the State Bank Commissioner, Deputy Commissioner for Mortgage and Consumer Lending. Our proposal has been reviewed by Deputy Commissioner Jennifer Cook and her staff and incorporates several components intended to protect the interests of our borrowers and to facilitate the efficient regulation of this new category of lenders.

There is general agreement that installment loans are the safest loan product for consumers. Lenders test the ability to repay by their borrowers, checking the customer's credit report and performing a comprehensive interview to determine the credit worthiness of the borrower. Loans are paid off in equal monthly installments of principal and interest. The loans are easily understood and the obligations of the borrower are clear and transparent.

Equally important, the loans are made from local brick and mortar offices, which are licensed and regulated by state authorities. Loans are not sold off but are held and serviced by the local loan office, giving both borrowers and regulators real people directly involved in the business to talk to when they need to.

Rates are fixed and are the same for all borrowers; there are no prepayment penalties and the product is as understandable as we can make it. Installment lenders do not require post dated checks, access to a borrower's bank account, or clear title to your automobile to make a loan, unlike other kinds of subprime lenders.

One of the most important characteristics of installment lenders is that they report good and bad credit to the credit bureaus, thus enabling responsible borrowers to improve their credit scores, which can help them gain access to more traditional financial services. Also, small installment lenders have a strong commitment to the financial literacy of our customers. We offer two primary forms of financial education.

The American Financial Services Association Education Foundation is a founding member of JumpStart for Financial Literacy and has developed an excellent education program called Money$kill, which is used many in schools. Money$kill is available for free for use in public and private school classrooms.

The second program is from Renewal Financial and was developed by Dr. Keys, whom you met earlier. The Renewal Financial program is targeted for adults and uses online tools to educate consumers about budgeting, use of credit, identity theft, home ownership, banking and creating wealth. The tools are extensive and begin with the basics and build towards the sophisticated, including online tutorials and coaching.

There are ten to twelve major national and regional lenders that compete in the subprime small installment loan market. And in most states, they are joined by a number of local lenders who also offer these loans. The small installment loan industry has existed since the early 1900's.

Our Kansas proposal puts a cap on the size of loans at $2,000 and a maximum length on the loans of 25 months. The annualized rate of interest varies by the size of the loan. The smallest loans have the higher interest rates and the larger loans have the lower interest rates.

The average small installment loan is for $600-700 over a term of ten months. This is an effective annualized interest rate substantially less than the products currently available in the Kansas marketplace. The typical installment loan office has 1200-1500 accounts and 4-6 employees. All of the companies hire locally and the industry estimates they would have 400 - 500 employees in Kansas within two years following approval of our proposal.

All potential borrowers go through a rigorous loan application process. The application process does not cost the customer anything. These loans are typically signature loans, meaning that the borrower doesn't offer any collateral for the loan. So the lender is looking for indications that the prospective borrower has a stable presence in the community. We want to see job stability and a stable residence. Our borrowers don't have to have a checking account and don't have to have clear title to their car in order to secure a loan.

One of the most distinctive characteristics of these loans is that the lender pulls a credit report for the prospective borrower, as one indicator of the person's ability to pay. Our borrowers typically do not have a great credit report or high credit score. If they did they could be making a loan at a traditional bank or consumer lender.

In addition to reviewing a borrower's credit report, lenders in this category all report their borrowers payment history to the credit reporting companies, just like a traditional bank or consumer lender.

This is an important and valuable difference for borrowers. Participating in credit reporting allows a borrower with a not very good credit history to improve their credit history and eventually become eligible for more traditional credit. Other lenders operating in the subprime market, like Payday and Title Lenders, do not report their borrowers payment history to the credit reporting agencies.

Our proposal allows the lender two charges or fees. The first is a loan origination fee equal to but no more than 10% of the value of the loan. For example, a loan of $600 would generate a loan origination fee of $60. There are no other fees due from the borrower at the time of the loan origination. The lender pays for the credit report out of that fee as well as all other costs of conducting the evaluation of potential borrowers.

The second fee is the monthly installment loan charge. This charge is determined by the size of the loan, and the maximum monthly charge is enumerated in our proposal. That means we can't increase our fees unless we come back to the legislature for approval.

Our proposal includes a restriction on the number of loans that a customer can have with any lender at one time. The limit is one.

A common question is "Can't the borrower just go to another lender and get a second loan?" The answer is yes they can. But these loans are reported to the credit bureaus, so any other potential lender will see that the borrower already has a loan and the amount, and will take that into account in determining the credit worthiness of a second loan. Also, a potential lender can see immediately when another lender has pulled a credit report on a potential borrower, sending all lenders a clear signal that the consumer has been shopping for credit.

Many of our borrowers don't have bank accounts, so a Payday loan isn't available to them. Other borrowers don't own a vehicle with a clear title, so a title loan isn't available to them.

Our proposal also includes a prohibition of the lender requiring the borrower to purchase credit insurance or other ancillary products in order to qualify for the loan.

I've been asked several times, why don't our lenders use current Kansas authority to offer open ended credit, which has no interest rate caps in Kansas? We don't because we believe closed end credit, a loan that has a limited number of months in which to pay off the loan, is a safer and lower cost alternative for our specific customers.

The chief disadvantage of open-ended credit, like a credit card or revolving credit account, is that the borrower has the option of making minimum payments on the loan for a very long time. While the annualized interest rate may look attractive, the result of making very small payments over a long period of time in an open-end credit loan can result in dramatically higher interest costs.

Because these are typically signature loans, our lenders are successful only when our borrowers are successful.

From a national consumer perspective, please consider that the National Black Conference of State Legislators in December 2012 and the National Hispanic Conference of State Legislators in July of 2013 each adopted a resolution supporting the offering of small installment loans as a safe and affordable product to compete with other products in the subprime marketplace.

In addition, the National Defense Authorization Act capped all interest rates for military personnel and their dependents at 36%, but deemed our traditional small installments loans as "beneficial credit." As such, our small installment lenders continue to provide unrestricted service to our military and their families.

In closing, the Kansas marketplace for subprime lending is currently heavily restricted. We believe availability of our small installments would increase access to credit to many Kansans at terms more favorable than the current marketplace. In addition, our loans offer responsible borrowers an opportunity to improve their credit history and work towards participation in the traditional financial markets.

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