Regulated Aspects of Installment Lending

1. Regulated Aspects of Installment Lending Installment Lending Panel Payday Loan Bar Association Summit _______________________________________________________ Presented byMichael A. RaskaskyHarlowe & Falk LLP November 14, 2006

2. Why are we talking about installment lending? • Changing laws, negative climate for PDLs • Stay in business if the legislative axe falls • Diversify product offerings

3. Why are we talking about installment lending? • Offer installment product that combines features of payday loans…: • Small dollar amounts not offered by banks • Limited underwriting/credit check • Fast cash for borrower • “Above prime” interest rates • “Secured” by check or ACH authorization • Payments tied to paydays

4. Why are we talking about installment lending? • …and additional features of traditional installment loans: • Multiple payments over time v. single repayment • Simple interest (generally) on unpaid balance v. fee-based finance charge • Secured lending option

5. Why are we talking about installment lending? • What legal and operational issues arise with this new product?

6. Why are we talking about installment lending? • Contract terms • Servicing and Payments • Default

7. Caveats • Focus -- issue spotting • Rules can vary dramatically by state • Consumer loan laws • Uniform Consumer Credit Code (7 states) • Usury laws • UCC Rev. Article 9 (secured lending) • Motor vehicle codes (vehicle secured lending)

8. The Contract • Loan amount • Large amounts (e.g., >$25,000) or real estate loans frequently outside scope of consumer loan statutes

9. The Contract (cont’d) • Finance charges • Origination fees • Typical limit - 2% of principal • Prepaid finance charge - special treatment under TILA • Contract interest rate (not just the APR)

10. The Contract (cont’d) • --Finance charges • Interest calculation methodology • Simple interest/365 day year • Precomputed interest • Compounding of interest • Describe in the contract

11. The Contract (cont’d) • Loan term • May be tied to loan amount • Ex: loans up to $300 - up to 25 months • Loans $301 to $1,000 - up to 37 months

12. The Contract (cont’d) • Payment schedule • Small loan amounts (e.g., <$1,000) – substantially equal amounts, intervals • Big TILA issues, particularly with payments tied to pay periods (irregular, semi-monthly, etc.)

13. The Contract (cont’d) • Method of payment • ACH • Preauthorized ACH – Reg. E limitations, NACHA rules • Check • NSF fee limits • Broader bad-check remedies may be available

14. The Contract (cont’d) • Secured lending – collateral considerations • Grant language • Collateral description (UCC 9-108 and TILA 226.18(m))

15. The Contract (cont’d) • --Secured lending - collateral considerations • Motor vehicles • Certificate of title • May implicate title loan statutes • Household goods • FTC Unfair or Deceptive Credit Practices Rule • Limits non-possessory security interests in household goods • Exceptions for PMSI, art works, antiques, jewelry (not wedding rings), one television and one radio • Insurance on collateral – Special disclosure required to exclude from finance charge (Reg. Z 226.18(n), 4(d))

16. Servicing and Payments • Caveat— • Servicing methodology should be described in the loan agreement

17. Servicing and Payments • Late payments • Late payment charges • Ex: 10 days late, charge lesser of 5% of installment amount or $20 • No “pyramiding” of interest on late fees

18. Servicing and Payments (cont’d) • --Late payments • Deferral • By agreement after-the-fact, or • Unilateral – in loan agreement • Deferral charges authorized • Generally cannot charge deferral AND late charges

19. Servicing and Payments (cont’d) • Partial payments • Application of payments • Specify in contract, but check state law • Event of default • Triggers a late charge to extent of unpaid installment

20. Servicing and Payments (cont’d) • Prepayments • Nearly always allowed • Rebate for precomputed loans • “Earned” may be complicated

21. Servicing and Payments (cont’d) • --Prepayments • Prepayment penalty • Frequently prohibited or limited • Certain real estate loans, refinancings by same lender, etc. • Disclosures required (TILA, contract)

22. Servicing and Payments (cont’d) • Extra payments • Application of payments – generally applied to principal, but check statute

23. Servicing and Payments (cont’d) • Last payment • Balloon payments (ex: 2x average of other payments) • May have a statutory right to refinance at same terms

24. Servicing and Payments (cont’d) • Receipts and statements • Amount paid to date, amount applied to principal and interest, pay-off amount • Requires additional programming

25. Default • Statutory definition? • May be limited to actual nonpayment • Acceleration generally permitted • Precomputed loans – if a judgment is obtained, some statutes require rebate as if full payment was made on judgment date

26. Default (cont’d) • Secured lending issues • Repossession – how? • Post-repossession interest • What if customer brings collateral to store? • UCC 9A-620 (acceptance in satisfaction of debt) • Limits on taking motor vehicles, other collateral in satisfaction of debt (TRUE predatory lending!) • Pawn statutes? • Disposition of collateral - Art. 9

27. Regulatory challenges for “converting” payday lenders • Regulatory climate • (not exactly “global warming”)

28. Regulatory challenges for “converting” payday lenders • “Nightmare on Winter Street” – the Oregon example • Politics and competition – the two fronts meet • Gubernatorial election • Resistance by existing consumer finance lenders • New proposed consumer finance rules • “In consultation with” (read: written by) existing consumer finance licensees • Press release

29. Regulatory challenges for “converting” payday lenders • Initially – • 36% rate cap • Now – regulate aspects of PDL business model • Make it very difficult to operate on PDL platform

30. Regulatory challenges for “converting” payday lenders • Sampling of proposed rules • Regulation of portfolio mix (90% “consumer loans”) • 6 month minimum term • “Documented” underwriting (but no substantive “ability to pay” requirements) • Equal periodic payments

31. Regulatory challenges for “converting” payday lenders • --Sampling of proposed rules • “Are you experienced?” • Store level • “District” level

32. Regulatory challenges for “converting” payday lenders • --Sampling of proposed rules • Indirect attempts to regulate interest rate • Include interest rate in business plan • Notice if rate changes more than 25%

33. Regulatory challenges for “converting” payday lenders • --Sampling of proposed rules • Limits on holding checks/ACH authorizations for payments • “DISCLOSURE!!!”required • Challenges are in the works, but who knows?

34. Regulatory challenges for “converting” payday lenders • Last, but not least…. • Washington payment plans

35. Contact Information Michael A. Raskasky Harlowe & Falk LLP One Tacoma Avenue North, Suite 300 Tacoma, WA 98403 253-284-4417 mraskasky@harlowefalk.com

36. Payday Lending Legal Summit Installment Lending Panel APR Misconceptions and Problems

37. TILA Misconceptions • Loan Origination Systems—OK To Buy An Off-The-Shelf Product • “Buy Ours—We’ve done installment loans for years!” Like New! Problems: • Not Designed For Payments Tied To Paydays • Built for Long-Term Loans • Lower Rates • More Tolerance For Error

38. Off-The-Shelf Software • PDL Example • Lender’s Target Yield: Approximately 260% • Loan Amount: $500 • Simple Interest Rate: 200% • Loan Fee: $50 (10 % of Loan Amount) • Repayment Schedule: 3 “Monthly” Pmts @ $245.03 Problem: • Disclosed APR: 264.66% • Actual APR: 388.12% • Restitution Violation: Understated by 123.46%

39. TILA Misconceptions • If You Only Charge Interest—Then The APR Is Always The “Interest Rate!” • It has to be: • There are no other “Finance Charges” • e.g., 250% Interest Rate Equals 250% APR • Fact Or Fiction? • Answer…

40. Fact or Fiction? • Answer…That Depends • Depends On Your Tolerance To Risk • Depends On How Gutsy You Are

41. Fact or Fiction? • Issue: US Rule versus Actuarial Methods: • US Rule: • APR Will Always Be The Interest Rate If There Are No Other TILA “Finance Charges” • Actuarial Method: • APR Is Almost Never The Same As The Interest Rate—Even If No Other “Finance Charges” Are Imposed

42. Gutsy? • Which Would You Rather Defend? US Rule Method • One Paragraph Authorization In Appendix J (3)  In contrast, under the United States Rule method, at the end of each payment period, the unpaid balance of the amount financed is increased by the finance charge earned during that payment period and is decreased by the payment made at the end of that payment period. If the payment is less than the finance charge earned, the adjustment of the unpaid balance of the amount financed is postponed until the end of the next payment period. If at that time the sum of the two payments is still less than the total earned finance charge for the two payment periods, the adjustment of the unpaid balance of the amount financed is postponed still another payment period, and so forth. • No Formulas or Other Support in Reg. Z

43. Which Would You Rather Defend? US Rule Method • Not Used In APRWIN Software (Actuarial) • US Rule Produces Different Results • APRWIN Is Accepted Standard For Verification • Regulators & Litigators • No Supporting Case Law

44. Which Would You Rather Defend? Actuarial Method • Clearly Spelled-Out In Appendix J • 15 Pages of Formulas and Examples • Too Many To Show Here • Support in Official Staff Commentary • Exact Match With APRWIN • Provided There Is No “Garbage In”

45. What’s The Difference? • Both Take Into Account “Time Value of Money” • Based On Timing And Amounts Of Payments & Advances • US Rule: • No Compounding Of Interest • No Negative Amortization • Actuarial Method: • Allows For Compounding of Interest • May Have Negative Amortization • Both Are “After The Fact” To Test APRs, And Both Ignore Interest Accrual Method

46. Monthly Payment Example Interest Rate: 300.00% Amount Financed: $750.00 Finance Charge: $1657.76 Pmt Schedule: 12 Monthly Pmts 11 @ $200.66 1 @ $200.50 Actuarial APR: 298.77% (APRWIN) US Rule APR: 300.00% Which One Is Correct?

47. Which One Is Correct? They Both Are! Actuarial APR: 298.77% (APRWIN) US Rule APR: 300.00%

48. TILA Misconceptions • Payments Due “Semi-monthly” Means “Twice-Per-Month” • Or Does It? Problems: • Only Example In Appendix J is 1st & 16th • Only Example In APRWIN is 1st & 16th • Webster Definition: “Occurring Twice A Month”

49. So What’s the Problem? • Are The Following Payment Frequencies Semi-monthly? • Due On the 1st And the 15th? • Due On the 5th and the 25th? • Due on the 15th and the 30th? Problem: • APR For Each Loan Must Be Based On The “Unit Period” (i.e., the Time-Base) For That Loan

50. What’s The Unit Period? • Unique To Each Loan • The Interval Of Time (Time-Base) That Best Fits The Contracted Payment Schedule • Identified By: • (1) Measure All “Periods” In The Loan, & • (2) Determine The “Common Period” • Need To Know Before Proceeding With The APR Calculation Process