Critics say McHenry bill would revive payday lending in North Carolina; he disagrees

ASHEVILLE – Before North Carolina outlawed payday lending in 2001, credit counselor Celeste Collins often worked to help people buried in debt with payments due weekly on three to five loans.

One client nearly lost her house to foreclosure because so much of her income was going to repay seven payday loans, Collins said.

Such loans typically carry exorbitant interest rates and fees, so much so that a lender might collect two to five times the amount of a loan if the borrower took a year to repay it.

The woman needed money quickly because of an unexpected bill, couldn't pay off the loan then kept borrowing more, said Collins, now president of OnTrack WNC, a nonprofit provider of financial education and counseling.

"You've got families who are not getting their food, people who can't pay for medicine. It just goes on and on," she said.

Collins and many other consumer advocates say a bill passed by the U.S. House will bring those problems back to North Carolina, reversing a years-long effort to rid the state of lending companies that make short-term loans essentially secured by the borrower's paycheck.

But bill sponsor Rep. Patrick McHenry, a Lincoln County Republican whose district includes Asheville, says that's just not true.

"Not only is the bill not intended to override payday lending laws, there is nothing in the bill that would allow that to occur," he said.

Instead, McHenry said his bill is intended to override a 2015 court decision that called into question the ability of banks to resell some loans to another company.

That decision has introduced uncertainty into the financial system, McHenry says, which in turn means it is harder for banks to decide whether a loan will be profitable and thus less likely to make a loan.

"We now have consumers and small businesses getting turned away from basic loan agreements," he said. That, he said, harms potential borrowers and is a drag on the economy.

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Valid when made or made up?

The argument over payday lending usually revolves around whether it should be permitted and, if so, under what rules.

Critics say the loans prey on unsophisticated or desperate consumers. Backers say people sometimes need a loan quickly and the government should not stand in the way.

"Many Americans don't have the savings to cover a common, $1,000 emergency like a car repair," McHenry said in House floor debate on his bill.

McHenry has been a frequent backer of the payday loan industry and, according to consumer advocacy group Center for Responsible Lending, has gotten more than $130,000 in campaign contributions from the industry over the years.

In this case, the two sides can't agree whether payday lending would even be affected by McHenry's bill or what the implications are of a court ruling the bill is designed to overturn.

McHenry says the bill is intended to address a situation that arose from a lawsuit over credit card interest in New York.

The bank that issued the card charged more than New York's interest rate cap, but that was OK under the law because it was a national bank. They are not subject to state interest rate limits.

Then it sold a woman's credit card debt to another company to collect what it could. The woman sued and a federal appeals court ruled in 2015 the company had to abide by New York's interest rate cap because it was not a bank. The Supreme Court declined to intervene.

McHenry says the 2015 ruling violates a long-standing principle in federal law called "valid when made." The idea is that if Bank A loans money to Borrower B and the loan is legally valid at the time it is made, it is still valid if Bank A sells the loan to Company C.

That principle has been around for nearly 200 years, McHenry says, and some other attorneys agree. He said the appeals court decision means the law is different for now in the three states it covers – Connecticut, New York and Vermont – than it is in the other 47, and banks and other lenders cannot be sure whether it will change in the 47.

That's a problem, he says, because "bank branches are closing, community banks are dying, and small businesses in places like Western North Carolina are getting turned away from loans."

McHenry says the court ruling could affect the growing business of making small business loans online. Lenders sometimes resell the loans they make to other companies. The practice reduces their risk and allows them to make more loans.

But Adam Levitin, a Georgetown University law professor, told a House committee last month there "is no historical pedigree" for the legal principle McHenry claims. "It's a modern invention."

For instance, "It is obvious that the sale of loans by a bank does not transfer with it the bank's FDIC insurance coverage or banking charter," he said.

Is lending tight?

There are also differing views on how much impact the court decision will have.

McHenry cites a study done after the ruling that found certain types of loans to people with low credit scores in the three states affected had dropped by half immediately after the decision. Loans to those with better scores increased.

But, the study looked at private data provided by three lenders only. Levitin said that means there is no way for others to judge its validity or to know what other lenders did.

Two Washington-based attorneys who represent banks, Charles Horn and Melissa Hall, wrote that while they believe the appeals court made the wrong ruling, its decision "will not result in significant changes to the law and principles of bank lending and usury."

The question of whether it is difficult for small businesses to get credit is a politically charged one. McHenry and other Republicans argue that it is too tough and several federal regulations should be loosened as a result.

A survey of small business owners done by the National Federation of Independent Businesses – which backs McHenry's bill – suggests that for now, at least, the problem is not so dire.

Only 3 percent of small business owners told the NFIB last month that all their borrowing needs were not met – a historic low, the NFIB said. Only 2 percent said financing was their top business problem.

The head of the Center for Responsible Lending, the leading critic of the McHenry bill, told a House committee in March that profits for banks are at record levels – and, banks make much of their money by lending.

Effects in NC

Just as controversial is what McHenry's bill might mean for North Carolina's payday lending law if it passes the Senate and goes on to become law.

"The amount of misinformation about this simple bill has been surprising and frustrating," McHenry told the Citizen Times via email.

On the House floor, he called arguments Democrats made against the bill "straw men that don't have anything to do with the contents of this very simple bipartisan piece of legislation."

Horn, an attorney with international law firm Morgan, Lewis & Bockius, has a similar view.

“There is nothing in the ... bill that would make it harder or easier” for states to enforce their usury laws, he said.

After North Carolina banned high-interest payday lending, the lenders partnered with national banks that were exempt from the state law in what critics called "rent-a-bank" arrangements. The payday lending companies did all the work, but the loan money actually came from the bank, which then sold it to the payday companies.

It took a few years, but state regulators stopped the practice, convincing the courts that payday companies were the true lenders.

The issue of “who is the true lender” would still provide states or plaintiffs a legal basis on which to challenge rent-a-bank operations if McHenry's bill passes, he said. “That’s not changed by this bill.”

Critics see it differently. So does a UNC Chapel Hill law professor not otherwise involved in the debate.

"We're just throwing consumers to the wolves," U.S. Rep. Carolyn Maloney, D-N.Y., told the House last week. "Let's be clear: The only loans that would be allowed by this bill that are not already allowed are loans that violate state usury laws that are put in place in states to protect their consumers."

Kate Sablosky Elengold, who teachers consumer financial law and attorneys' professional responsibility at the UNC law school, said McHenry's bill would clearly pre-empt North Carolina's payday lending law.

Even if McHenry explicitly stated that was not his intention, it probably would not matter, she said.

"If the statute is clear on its face, then the courts don't look beyond it" to statements made by lawmakers, she said. "The law speaks for itself."

Kelly Tornow, director of North Carolina policy at the Center for Responsible Lending, said North Carolina regulators would "technically" be able to argue again that banks are not the true lenders if payday lenders partner with banks again in the state. That is "in part" how the state shut down payday lending before, she acknowledged.

"However, the U.S. Congress giving its blessing to rent-a-bank schemes will likely make it much more difficult for states and others to challenge these schemes," Tornow said.

The arrangements are more complicated now and some courts may not even reach the question of who is actually making a loan, she said.

N.C. Attorney General Josh Stein is concerned the legislation will undermine North Carolina's anti-payday lending law, said his spokeswoman, Laura Brewer.

A senior deputy attorney general for consumer protection from 2001 to 2008, Stein was involved in efforts by the state Department of Justice to shut down the lenders.

McHenry's bill and a similar one in the Senate started out with significant bipartisan backing, but some Democrats have changed from support to opposition as consumer groups have raised concerns about its impact on payday and other forms of so-called "predatory" lending.

The bill passed the House 245-171 last week, but only 16 of 186 House Democrats present voted for it. That raises questions about its fate in the Senate, where at least nine Democrats must go along for most legislation to move.

Collins, the OnTrack president, hopes the bill goes no further.

She said she is leaving interpretation of the legal fine points to the Center for Responsible Lending. But she wants to avoid any risk that state regulators would be unable to keep the payday lending industry out of the North Carolina.

"People who are targeted by these companies are low-income, low-wealth families," Collins said. "These loans trap them in a cycle of high-cost borrowing that jeopardizes their financial and housing stability. We do not need this product back in our state."

What does it say?

A bill sponsored by Rep. Patrick McHenry, R-Lincoln, would add the following language to federal banking and lending laws:

"A loan that is valid when made as to its maximum rate of interest in accordance with this section shall remain valid with respect to such rate regardless of whether the loan is subsequently sold, assigned, or otherwise transferred to a third party, and may be

enforced by such third party notwithstanding any State law to the contrary."

NC's payday lending history

North Carolina was among the first states in the country to ban high-interest payday lending, passing a law in 2001 that effectively outlawed the practice by capping fees and interest rates.

The state was a magnet for the operations – many concentrated around military bases – and one study found that payday lenders made 2.9 million transactions involving $535 million in 1999.

Before it passed, payday lenders would charge what amounted to interest rates of 300 or 400 percent if considered on an annual basis. The loans were ostensibly designed to be repaid on the borrower's next payday, but the high costs and borrowers' tight finances often meant they paid on them for years.

For instance, a Winston-Salem woman recounted to The Associated Press paying more than $1,200 in fees over several years on what began as a $255 payday loan.

Some lenders got around North Carolina's 2001 law for a few years by partnering with so-called "national" banks, meaning banks with a federal charter regulated by the federal government. They are exempt from state usury laws limiting how much interest can be charged on a loan.

In what critics call a "rent-a-bank" arrangement, the payday lender would operate storefront offices and its employees would take applications and hand out loan proceeds. Technically, the money for the loan came from a bank, but the bank typically transferred ownership of the loan to the payday lender as soon as it was made.

State regulators including then-N.C. Attorney General Roy Cooper, now the governor, acted to shut that down. They argued the payday lending companies were the true lenders and couldn't take advantage of the loophole enjoyed by national banks. The courts agreed, putting the companies out of business in the state in 2006.

That's where things stand today. It is legal to make a payday loan, but the interest rate on loans of $4,000 or less is capped at 30 percent. Some credit unions offer short-term loans to their members at rates below the cap.

North Carolina is one of 18 states by one count that have banned high-interest payday loans. There was discussion in the state General Assembly in 2013 of easing the law, but Gov. Pat McCrory opposed the idea and it died.