Payday Lenders Didn’t Get a Boost From the Pandemic’s Hard Times

(Bloomberg Businessweek) -- For payday lenders, the pandemic could have been a once-in-a-century event for generating new customers. A bad economy can force people to turn to high-cost lenders for quick cash. But the story turned out differently this time. Trillions of dollars of federal relief, including direct cash payments and enhanced unemployment benefits, have had the opposite effect: reduced demand.

The federal efforts could upend an industry that’s preyed on low-income Americans, making small-dollar loans payable upon the receipt of a next paycheck, Social Security check, or unemployment benefit. With interest rates as high as 400% annualized, the loans rake in more than $9 billion a year in fees and interest, according to Pew Charitable Trusts, a nonprofit research group. Payday loan shops are as common as fast-food joints in struggling towns across the U.S. But demand fell 67% in the midst of lockdowns last spring and early summer, according to the Online Lenders Alliance trade group, and has yet to recover to pre-Covid levels.

At the same time, community banks are making plans to expand on turf they once abandoned—areas such as West 12th Street in Little Rock, an historically Black neighborhood near the interstate. Storefronts here include a coin-operated laundry and a dollar store, but no banks. Local lender Southern Bancorp plans to open the area’s first branch later this year, in a building that also houses a police station.

As part of a pandemic relief bill passed late last year, the U.S. Treasury is injecting $12 billion into community development financial institutions, or CDFIs, like Southern Bancorp. That’s more than triple what they received in the entire quarter century since the government first extended support. Payday lenders have long said that the rates they charge are commensurate with the risks of default, and that cutting access to cash would be worse for borrowers. The expansion planned by Southern Bancorp will be a real-life experiment in whether a bank can make a profit doing business with poor customers.

“We did not have access to the type of equity capital to allow us to grow,” says Chief Executive Officer Darrin Williams, who plans to double Southern’s assets to $4 billion and expand to underserved areas in cities such as Memphis, Nashville, and St. Louis in the next few years. “That’s changed. It’s an unprecedented amount of funding now available to us. I hope that will be a real counter to the payday lending space.”

CDFIs target minority, rural, and impoverished communities. They’ve attracted hundreds of millions of dollars from big finance and technology companies, spurred by national attention to issues of racial equity. Bank of America Corp. last year purchased 5% of Southern Bancorp’s shares, and MacKenzie Scott, the ex-wife of Amazon.com Inc. founder Jeff Bezos, donated $2 million.

Another community lender, Hope Credit Union of Jackson, Miss., got a $10 million deposit from Netflix Inc., which is investing 2% of its cash holdings in banks that serve Black communities. Hope, which provides 83% of its mortgages to people of color, expects to apply for about $100 million in capital from the Treasury, says CEO Bill Bynum. That support can be “game-changing,” he adds, if it addresses an historic disparity that’s left Black-owned CDFIs with less capital than their counterparts. “We’ve seen some of the poorest communities have to work the hardest to get their access to federal resources,” he says. The credit union offers loans of $500 to $1,000, capped at an annual interest rate of 18%, which compete directly with payday lenders.

Another threat to payday demand: the Biden administration’s April 28 proposal to extend a child tax credit that gives parents as much as $300 a month per child. Most of the 12 million low-income Americans who rely on payday loans are age 25 to 44, and a disproportionate number are parents, according to Pew. They spend $360 on average to borrow $400 for about three months.

Large banks have started offering small-dollar loans, partly at the urging of regulators. A Bank of America product for customers who’ve had checking accounts for more than a year lets them apply to borrow as much as $500 for a flat $5 fee. “It would save borrowers billions of dollars in fees if more banks got into this space,” says Alex Horowitz, Pew’s senior research officer for consumer finance. The challenge is making loans as convenient as the ubiquitous payday loan—and available even to those with low credit. That will require investment in underwriting technology. “Small-dollar loans aren’t going to take off unless they’re automated,” Horowitz says.

The new branch Southern Bancorp plans in Little Rock will offer the kinds of services usually reserved for higher-income customers, CEO Williams says. These include credit counseling, wealth planning, and small-business technical assistance. “Low-income people need wealth advisers, too,” he says. About half of the bank’s loans last year were for less than $10,000.

The Biden administration is also likely to impose restrictions on payday loans through an emboldened Consumer Financial Protection Bureau. Through its trade group, the Online Lenders Association, the industry argues these efforts will cut off credit to poor people. Meanwhile, some companies are pivoting to new products, such as income share agreements that offer loans to students in exchange for a percentage of their future income.

David Fisher, CEO of subprime lender Enova International Inc., expects to find opportunities as small businesses reopen. “Many of these businesses have used up their savings trying to survive the pandemic,” he told investors on a conference call in April. “This can lead to a large surge in demand that we’re ready to fill.”
 
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