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Andrew Silton: Legislators coddle consumer loan industry in NC while poor, military suffer

This column incorrectly identified BB&T as the owner of Lendmark Financial Services. BB&T sold Lendmark to the Blackstone Group in October 2013 for approximately $540 million.

In the early 19th century, gold fever ran through the Piedmont of North Carolina. While traces of gold can still be found in some of our streams and hillsides, our state’s biggest gold mines are now tucked away in strip malls all across the state. You’d never know that a collection of desks, chairs, and computers could produce gold, but furniture and fixtures are all you’ll see if you peer into storefront office of a consumer loan company. While some of these companies are small and independently owned, some of the biggest prospectors are the Blackstone Group, Citigroup and a hedge fund called Fortress. Since their business mainly caters to the working poor and enlisted military, consumer loans are offered under separate brands, such as OneMain Financial, Lendmark Financial Services, and Springleaf Financial Services.

This week, I went back to two of my favorite repositories of information, the Securities and Exchange Commission and the N.C. General Assembly. I was prompted by an industry claim reported in The New York Times. Michael Corkery, a business reporter, detailed the successful efforts of the industry to loosen the regulations governing personal loans. In at least eight states, including North Carolina, the personal loan industry has successfully argued that it needs higher interest rates and larger maximum loan amounts in order to cover the increasing costs of doing business. It’s a pretty dubious argument, but it convinced legislatures (along with campaign contributions). In fact, the industry persuaded Republicans and even some Democrats in North Carolina to pass the Consumer Finance Act Amendments in the last session of the General Assembly.

Consumers pay more

Our politicians don’t agree on a great deal these days, but they decided the interest on consumer loans should rise from 19.2 percent on a $10,000 loan to 22.8 percent on a $15,000 loan and that the maximum term should increase from seven to eight years. By increasing the maximum interest rate and term of the loan, the industry was able to increase the amount of interest they can collect by 43 percent. If the industry can get consumers to borrow the maximum amount, the benefits of North Carolina’s new law are staggering. Under the old law, the biggest loan ($10,000) could produce $8,251 in interest over seven years. Under the new law, the biggest loan ($15,000) will produce $17,774 over eight years. Consumers will pay more in interest than principal, and that’s before accounting for processing fees, recording fees, late fees, or deferral charges.

Let’s suppose a soldier at Fort Bragg needs to borrow $5,000 for five years. Under the old law, she could be charged an interest rate 20.4 percent, while the new law will cost her 28.8 percent. Her monthly payment jumps 18 percent from $134 per month to $158 per month, and the total interest charges jump from $3,443 to $4,486 over the life of the loan. When it comes to soldiers, North Carolina’s laws now provide that the soldier can rescind the loan within 30 days, receive the federal government’s Truth-In-Lending brochure, and avoid binding arbitration. The enlisted soldier’s commander will be notified of the loan, and neither the soldier nor her family will be contacted while the soldier is in combat. For a soldier short on cash, these provisions don’t amount to much protection. It also strikes me as odd that we now expect commanding officers to receive information about their troops’ finances and presumably counsel them. Apparently, the General Assembly thought these were important consumer safeguards, although they didn’t see fit to apply them to the working poor. As a result, a soldier who fixes the commanding officer’s jeep in the motor pool can rescind his loan and avoid arbitration, but the car mechanic who repairs the CO’s family SUV is out of luck.

Industry gold mine

As I mentioned earlier, the industry argued that it needed these legislative changes in North Carolina and elsewhere in order to maintain its profitability. This is where the SEC comes into the story. Springleaf, owned by Fortress, went public last fall, and OneMain, owned by Citigroup, just filed to go public. As a result, we are now privy to their financials and the secrets of their gold mine. In 2012, Springleaf’s personal loan business produced an average yield of 24.1 percent, or 20.5 percent after accounting for bad loans, and solid pretax profits of $75.4 million. In 2013, the yield rose to 25.9 percent, and profits rose to $203 million, thanks, at least in part, to state legislatures across the country.

Springleaf’s results aren’t an aberration. OneMain reported a yield of 23.3 percent in 2012 and 24.8 percent for the first six months of 2014. Loan volumes and average balances are rising steadily, and North Carolina is OneMain’s second-largest market. This was a great business before the legislative amendments, and it’s even better now. Why shouldn’t business be good? The industry’s target clients are strapped for cash, and their incomes are stagnant. Moreover, the cost to finance the business is incredibly cheap.

While the industry is charging its customers well north of 20 percent for a loan, their borrowing costs are in the single digits. For example, OneMain borrowed from Citigroup at 3.7 percent before the IPO and was able to complete two sizable securitizations with yields of 2.6 percent and 3.1 percent respectively. Springleaf has had similar success in financing its business. With borrowing costs for banks at historically low levels, it is no surprise that personal loan companies are enjoying extremely good times. If you can lend at 20 percent and borrow at less than 5 percent, you have the financial equivalent of a gold mine.

Search for yield

There’s one more component to this story. How are OneMain, Springleaf, and the other lenders able to borrow at such attractive interest rates? Shouldn’t creditors demand high interest rates when lending to a personal loan company or investing in their asset-backed securities? This is where you and I and our state pension come into the picture. Whether you are managing for your own retirement or investing on behalf of a public pension plan, you are in search of yield for your fixed-income portfolio. Many of you are invested in high yield mutual funds or ETFs. Our state’s pension plan has a $4.8 billion allocation to investments in credit, and many other public pensions are following the same strategy (in fact, Fortress is one of North Carolina’s credit managers). As a result, all of us are madly seeking yields that will beat U.S. Treasuries and investment grade corporate securities. Whether it’s debt backed by student loans, automobiles, credit cards, or personal loans, we seem very eager to provide financing.

The principal owners of personal loan businesses seem reluctant to lend their names to these enterprises, so Blackstone, Citigroup and Fortress don’t appear on the neon signs in your neighborhood shopping center. Abetted by legislators, including our representatives in Raleigh, these companies have a license to mint money. The rest of us seem content with a bit of the gold dust that’s available from lending to these enterprises. Meanwhile, the working poor and our military are paying a terrible price.

Andrew Silton’s Meditations on Money columns can be found twice a month in The N&O’s Work&Money section. He is a retired money manager living in Chapel Hill. He was CIO for the North Carolina Retirement System from 2002-2005. He writes the blog

Previous versions of this column originally mentioned bank BB&T along with Citigroup and Fortress. That was incorrect, as Blackstone had purchased BB&T's assets. All references were modified Monday, Nov. 3, 2014.