At a field hearing on short-term, small-dollar lending in Birmingham, Alabama, Director Richard Cordray noted that the role of the agency is to provide “fundamental fairness for all consumers.”  To achieve that goal, the Bureau is seeking to “expose the hidden risks” in financial products to ensure that consumers can make informed financial decisions.

One step in exposing those hidden risks is conducting examinations of short-term, small-dollar lenders (the “Lenders”).  Accordingly, the Bureau has released examination procedures (the “Procedures”) for these Lenders.  Before we discuss these Procedures in detail, we first identify the federal financial laws governing short-term, small-dollar loans (the “Loans”).

Applicable Laws

Regardless of whether the Lender operates via a storefront or online, the Lender must comply with the following laws:

• Truth in Lending Act: requiring disclosure of the cost of the Loan;
• Electronic Fund Transfer Act: governing authorization for electronic payments;
• Fair Debt Collection Practices Act: governing collection activities;
• Fair Credit Reporting Act: requiring that furnishers of information to credit bureaus report accurate information;
• Gramm-Leach-Bliley Act: requiring privacy notices and protection of nonpublic personal information; and
• Equal Credit Opportunity Act: prohibits discrimination based on a protected class.

Examination Objectives

The purpose of the examinations under the Procedures is fourfold.

1. Risk Management: to assess the quality of the Lender’s compliance risk management systems, including its internal controls and policies.
2. Compliance: to identify acts or practices that materially increase the risk of violations of federal consumer financial laws.
3. Gather Facts: to determine whether a Lender engages in acts or practices that violate federal consumer financial laws.
4. Enforcement: to determine if a violation of a federal consumer financial law has occurred and whether supervisory or enforcement actions are appropriate.

Examination Scope Applicable Laws Marketing

The Procedures cover five “modules:”

1. Marketing
2. Application and Origination
3. Payment Processing and Sustained Use
4. Collections, Accounts in Default, and Consumer Reporting
5. Third-Party Relationships

Marketing

Examiners are tasked with developing a detailed understanding of the Lender’s marketing program. This includes reviewing all advertising materials for compliance with ECOA and TILA.

With respect to lead generators, examiners are instructed to determine whether the parties clearly disclose their relationship and whether any fees charged are clearly disclosed.

Application and Origination

Examiners will ensure that Lenders originate Loans in conformance with applicable federal laws – ECOA, FCRA, TILA and EFTA.  With respect to the EFTA, examiners will specifically research whether the debits authorized are one-time or recurring and whether the authorization was properly obtained.

Even though the CFPB does not have jurisdiction over the Military Lending Act, examiners will look for violations of that law (i.e., originating payday loans to active military or their dependents), and if they detect any, the examiners will refer that violation to the appropriate enforcement agency.

Payment Processing and Sustained Use

Examiners are instructed to look for “sustained use” programs.  The CFPB considers “sustained use” to be: (i) “rollovers” where the borrower pays a fee to extend the term of the loan; or (ii) “back-to-back” transactions where use of the proceeds of an old loan are used to pay a new loan.

If a Lender is engaged in a “sustained use” program, then the examiner must:

• Payment Options: determine whether the Lender represents accurately and non-deceptively the payment options that will be available to borrowers and whether the Lender provides borrowers with all available repayment options it offers;
• Fees: determine whether the Lender discloses clearly and prominently all fees and material terms associated with the sustained use transactions;
• Policies and Procedures: determine whether the Lender has policies and procedures related to sustained use of the loan product and whether the Lender is adhering to its policies;
• Disclosures: if the sequential transaction is considered a refinance, determine whether the Lender provides disclosures required under Regulation Z.  If the request for new loan terms is considered an application under Regulation B, determine whether the Lender complies;
• Monitoring: determine whether the Lender monitors or limits a borrower’s usage of payday loans on an ongoing basis; and
• Ability to Repay: determine whether the Lender assesses income or other financial information to determine an applicant’s ability to repay a loan without modifying or refinancing the loan.

Note that examiners are tasked with reviewing loan files to determine whether the underwriting process includes a review of the borrower’s ability to repay (even though no such legal requirement exists under federal law for the Loans).

Collections, Accounts in Default and Consumer Reporting

Generally speaking, the Fair Debt Collection Practices Act will not cover Lenders that collect on their own defaulted Loans.  However, any Lender that purchases Loans that are in default (at the time of purchase) and collects on them or any Lender that collects on Loans under an assumed name will be covered.

For those Lenders who decide to report to the credit bureaus, Lenders need to have written policies and procedures regarding data accuracy, and appropriate resolutions of complaints.

What Will Examiners Review?

Lenders should prepare to provide examiners with the following (among other things):

• Organization charts and process flowcharts;
• Board minutes;
• Annual reports;
• Management reports;
• Aggregate loan data;
• Policies and procedures;
• Price structure;
• Loan applications;
• Loan account documentation;
• Telephone recordings;
• Operating checklists;
• Worksheets;
• Historical examination information;
• Audit and compliance reports;
• Training programs and materials;
• Third-party contracts;
• Advertisements;
• Marketing research;
• Website information; and
• Complaints.

In addition to reviewing the above materials, examiners also may perform transaction testing of a sampling of loans.  Examiners also will engage in on-site interviews of appropriate management and staff.

Venable attorneys have significant experience with lending examinations and can assist any Lender with preparing for an on-site examination.  Please contact a member of the CFPB Task Force if you have questions about this alert.