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This article was written by the Consumers Union Southwest Regional Office.
Throughout Texas, many working people turn to pawn shops, finance companies, and check cashing outlets for basic financial services. While check cashers primarily sell people high priced access to their own money,1 pawn shops and finance companies specialize in high interest loans that often cost more than borrowers can afford to pay. |
The so-called "fringe banks"2 advance money to poor and working class people who have little or no traditional collateral and may not meet strict bank underwriting standards. They make home equity loans, small personal loans, and auto loans (you can pawn your car at a pawn shop,3 borrow against it at a finance company, or your auto dealer can go to a finance company to fund your original car note). Some finance companies also fund retail installment purchases by buying the notes from furniture, appliance, and department stores.
Pawnshops specialize in very small loans secured by personal items which they turn around and sell at a profit if the consumer cannot repay the loan. Some pawn shops have also expanded into other financial services for the poor, like Cash America's rent-to-own tire and check cashing kiosk businesses. 4 For these services consumers of both pawn and finance companies pay interest rates and fees many times higher than those charged by banks, credit unions, or major credit card companies.
This report examines pawnshops and finance companies in Texas (with emphasis on the small, personal loan market). While low income lending has its roots in the charitable activities of the Catholic church, today's booming market for small loans and the rapid proliferation of pawns and finance companies is about profit. Fringe lenders locate in low income and minority communities, and charge very high interest rates and fees for their services. While low income consumers represent a somewhat higher risk to lenders, these lenders return solid and sometimes spectacular profits to parent companies-in some cases banking institutions who in their mainstream operations generally shy away from the inner cities and higher risk loan markets.
Pawn shops and finance companies are booming these days, especially in Texas. According to the National Pawnbrokers Association, pawnshops now serve 10 percent of the U.S. adult population,5 and a disproportionate number of pawnshops in the United States are located in Texas. Texas is second only to Florida in the number of pawnshops statewide.6 Of the four publicly traded national pawnshop chains, three are Texas-based companies: EZPawn, Cash America Pawn, and First Cash Pawn. The number of pawn shops in this state swelled in the mid- to late-1980s, but leveled off after the Legislature passed a 1991 law limiting new pawnshop licenses in certain cities.7 Today there are 1244 licensed pawnshops statewide, 430 more than in 1985.8
Finance companies are also spreading across the state. From 1992 to 1996, the number of regulated lenders in Texas (non-bank lenders, largely finance companies) increased 42 percent to 2,068 statewide.9 Along with this growth, the volume of loans (the total dollar amount loaned in a calendar year) increased by almost 50 percent between 1992 and 1995.10
Historically, lending to the poor was a charitable practice. Pawnbrokers evolved in the 15th century as philanthropic, not-for-profit operations run by the Franciscans of the Catholic Church (called the "monti di pieta," or "banks that take pity"). The church hoped to combat usury by providing low-cost collateralized loans to artisans and the poor. In the centuries that followed, the government and other organizations in urban centers of Western and Central Europe opened similar charitable pawnshops. These municipal pawns lent money and returned any surplus from the sale of pawned goods to the borrower. In the U.S., similar philanthropic pawns were established in the 19th century, and grew to prominence alongside their higher priced commercial counterparts.11
By contrast, the modern finance company is a distinctly profit oriented phenomenon dating to the early 20th century. A number of today's large commercial finance companies can be traced back to the 1920s and earlier. Of the ten largest located in Texas, for example, at least six were founded, or are successors of corporations founded in the first two decades of this century.12
The 1920s was marked by a sudden surge in the production of consumer goods. Easy credit provided by finance companies allowed consumption to keep up with the growth of consumer goods.13 While mass production encouraged the growth of finance companies, it stifled pawnshops. Mass-produced goods were less valuable than their individually crafted counterparts and, therefore, not easily pawned. For this reason, the surge in low-income lending alternatives was accompanied by a marked decline in pawnbroking. Between the 1930s and the 1970s low income borrowers increasingly turned to lending alternatives such as finance companies, credit unions, and other commercial lenders.14
It was not until the 1980s that pawnshops began to thrive again. During the late-1980s when the mainstream credit market faltered and many lending institutions failed, alternative lenders flourished. Since then, this growth as been remarkably stable. A Federal Reserve Board study of consumer finances found that finance and other loan companies are growing faster than every other category of consumer debtholders. "The finance companies are picking up the slack left from the savings and loans," explains Arthur B. Kennickell, a Fed economist and co-author of the study in an interview with American Banker. "It is part of the continuing restructuring of the industry."15
For a significant segment of the population, the combination of failing mainstream financial institutions and thriving fringe lenders completely altered the financial landscape. While pawnshops and finance companies have always catered to lower income borrowers, they once co-existed with with other mainstream lending alternatives. But, as banks and savings institutions collapsed, merged, closed branches and increased fees during the past decade, low income individuals' credit options became increasingly restricted.
Thirty-six percent of all bank failures nationwide during the 1980s occurred in Texas,16 and low income neighborhoods were disproportionately affected by the closures. A study from Texas A&M on the availability of banking facilities between 1985 and 1993 found that low income, high poverty, and high minority areas all experienced a decline in the availability of bank branches during this time span.
Specifically, the study revealed that the average number of branches for zip codes in the highest income quartile stayed roughly the same while zip codes in the lowest income quartile experienced a decline of 11 percent. For below poverty zip codes, this decline was an even more dramatic 13 percent. In addition, while predominately white zip codes actually saw their number of branches increase by 4 percent, minority zip codes saw theirs decline by 10 percent.17
The lack of physical access to banks has been compounded by bank lending practices. Commercial banks do not usually make loans for less than $1,000, and bank borrowers typically take more than a year to repay a loan.18 The unwillingness of banks to make small loans tends to exclude individuals of more modest means from bank borrowing. In addition, low-income individuals whose income and credit history earn them the label of "high-risk borrower" may be turned down for a bank loan.
Throughout the 1970s and 1980s the number of households without bank accounts, and therefore without direct access to the payment and credit services of mainstream financial institutions, increased. In 1977, 9.5 percent of families did not have a bank account. By 1989, the share of households without a bank account had increased to at least 13.5 percent.19
Other studies found an even larger portion of the population evicted from the mainstream financial market. According to a 1988 GAO study, as many as 17 percent of families did not have a bank account by the end of the eighties.20 Data from the most recent Survey of Consumer Finances shows that more than half of families without checking accounts are nonwhite or Hispanic, while 85 percent have incomes less than $25,000,21 and also indicates that the portion of families without any type of bank account (checking, savings, money market) peaked in the late 80's and has now begun to decline again.
Instead of forming traditional banking relationships, these consumers were turning to "fringe" lenders. In the early 1990s, the number of small "last resort" loans grew dramatically. In the three years between 1992 and 1995, for example, the number of loans from finance companies in Texas increased by 24 percent.22 By contrast, the state's population increased only 10.2 percent between 1990 and 1995.23
The dual forces of bank closures in low-income areas and the proliferation of "last resort" alternatives has worked to turn low income borrowers almost exclusively to fringe lenders. In this way, a large segment of the population no longer has a typical borrowing relationship with a mainstream financial institution.
While banks withdrew from low income Texas neighborhoods, fringe banks in growing numbers located there. Consumers Union maps on the following pages show that finance companies and pawnshops primarily locate in neighborhoods below median household income and in minority areas.
Finance companies claim to serve a broad swath of working class middle-America. Household Finance Company explains that its "primary target customer for consumer lending is generally between 25 and 50 years of age with a household income of $15,000 to $50,000."24 Similarly, Great Western Consumer Finance Group's "average loan customer is 43 years old with an annual gross household income of $36,570 and has a 10-year history with his or her current job."25
According to a 1992 national survey sponsored by the Federal Reserve, finance company customers are generally younger, less likely to be white, and more financially insecure than their bank-borrowing counterparts. More than half of finance company borrowers are between 25 and 44 years old, while just 37 percent of this age group borrow from commercial banks; only 15 percent of those who borrow from finance companies are between 55 and 74 years of age, while 28 percent of this age group borrows from banks. In addition, 33 percent of those who patronize finance companies are either black or Hispanic, a dramatic contrast to the 6 percent of black and Hispanic bank borrowers. The survey also found less financial security among finance company customers. In comparison to bank borrowers, finance company clients hold fewer financial assets, are less likely to pay their credit cards in-full, and have shorter planning horizons.26
The Consumers Union maps (see map insert) confirm previous findings about the demographic characteristics of those who borrow from fringe lenders. They suggest that in addition to serving predominantly young, non-white, and low to middle income clients, they physically locate near populations with many of these characteristics. A majority of the fringe lenders in three Texas cities we examined locate in neighborhoods below the median household income.
The Consumers Union maps also found a relationship between race and fringe lender location that echoes the findings of the survey. In Harris County, for example, most finance companies and pawnshops locate in neighborhoods in which minorities comprise a majority of the population. In Dallas County, most pawnshops locate in minority neighborhoods, while about half of all finance companies are in minority neighborhoods and half are in the surrounding area. In Austin, most finance companies are located in or at the border of non-Anglo neighborhoods, as well as about a third of pawn shops.
Pawn and finance company loans are quick and convenient, but costly-borrowers may pay many times the interest rates charged by mainstream banks. Gloria S. of El Paso received a loan from Teresa Finance Company for $361.19 with an APR of 82.9 percent. She signed a one page document which served as both the loan application and the loan contract. Without filling in credit history, salary information, or even a home phone number, Ms. S. left the company with a loan that would cost her almost $200 in interest.27
Low income borrowers using pawnshops or finance companies pay substantially higher interest rates than their counterparts who borrow from banks. Pawns charge 20 percent of the amount of a pawn loan each month for loans up to $132 (equivalent to 240 percent APR),28 and most loans are small. EZ Pawn, a chain with 149 stores in Texas, reports that its pawn loans averaged $67 in FY 1996. Cash America, with 145 Texas stores, loans an average of $70 to each customer for a typical loan term of fifty days.29
Pawn borrowers must pay the finance charge on the loan every 30 days to keep the pledged item from becoming the pawnshop's property. When the borrower reclaims the belonging, he or she must pay the finance charge plus the amount of the original loan. The borrower also has the option of never repaying the loan by forfeiting the pledged good to the pawnshop. For its part, the pawnshop must hold the pawned item for 60 days before reselling it.
For example, a $40 loan on a ring, requires an $8 monthly payment to the pawnshop. When the borrower reclaims the ring at the end of one month, he or she pays $48: the $40 loan plus that month's $8 fee. In this example, a borrower who returns for the item early still pays $8 because the fee, up to the first $15, is fully earned the minute the pawn broker makes the loan.
Pawn fees account for a large share of pawn revenues and profits. Cash America, Inc. for example, earned 57 percent of its gross revenues from pawn service charges in 1996, and 43 percent from merchandise sales.30
For personal loans, finance companies typically charge the highest interest rates allowed under the Texas Credit Code. According to Beneficial, for example, "generally, loans under the consumer finance acts are made at the maximum rates allowable."31 World Acceptance Corporation, a small-loan chain with 131 offices in Texas notes that "pricing is not an important competitive factor in the industry because most small loan consumer finance companies charge the maximum interest rates and fees allowable under applicable state laws."32
In Texas, this amounts to an interest rate of about 30 percent or 90 percent APR, depending on the size of the loan-much higher than credit card cash advance rates or the average 15.51 percent APR charged in Texas for a personal loan by a commercial bank.33
Two statutes control the cost of a finance company loan, and define two different but overlapping markets and types of loan lenders. Loans under $440 fall under Texas Credit Code, Article 3.16, which allows lenders to charge a $10 flat fee plus $4 each month for every $100 borrowed. This creates a total finance charge equivalent to between 85 percent and 95 percent APR for most very small loans. These loans typically have short terms (a loan of $100 must be repaid within 6 months by law) and are frequently refinanced. Chains like World Acceptance and Security Finance Corporation dominate the very small loan market in Texas, along with many independently owned "signature loan" companies. (See Texans Take Out Millions of Very Small Loans Annually.).
Article 3.15 of the Credit Code applies an 18 percent "add-on" rate to loans of more than $440 and less than $1,320. Designed to simplify the calculation of interest before the use of computers, add-on interest is determined at the outset of the loan on the full amount for the full term. It differs from other interest calculations in that it is not based on a principal that declines over the course of the loan.34
So, for example, a $1,000 loan payable in 24 months will cost $360, whereas this same loan at 18 percent APR with a simple interest calculation will cost $198.35 The precomputed add-on finance charge, added to the loan and divided into equal monthly installments is equivalent to an effective rate of 31 percent APR (Truth in Lending laws require all loan documents to disclose the effective annual rate to the borrower). According to the National Consumer Law Center,"add-on rates always dramatically understate" the effective interest rate.36 As the loan size increases above $1,320 the maximum interest rate allowed by statute slowly decreases. Lenders may loan up to about $11,000 under this statute.
But, Article 3.15 loans tend to be small, qualifying for the highest rates. In Texas, the average size of an Article 3.15 loan was $2,053 in 1995, the most recent year for which the Texas Office of the Consumer Credit Commissioner (OCCC) has released data. Article 3.16 loans average $279 per loan. There are far more of the smaller "3.16 loans" made in Texas each year. In 1995, lenders made 3.5 million Article 3.16 loans, compared to 400,000 Article 3.15 loans. Because there are many more smaller loans, the highest interest rates apply to a majority of the finance company loans made in the state of Texas.37
Although federal Truth in Lending laws require finance companies to disclose their interest rate, many consumers close the transaction without realizing the actual cost of the loan. Antonio R. of Mathis, Texas wrote the OCCC to complain about his 36 percent APR, asking "if this lender is overcharging." But, according to his contract his loan actually carried a far higher interest rate of 88.66 percent APR, legal under Texas law.38
In some cases finance company staff may mislead borrowers by quoting a lower rate verbally than appears in the final contract. When Kathy G. of Dallas called Amicable Finance Company to inquire about a loan offer sent to her by mail, an employee allegedly quoted an interest rate of 21 percent over the phone. However, once her payments came due she realized that the lender charged her 84.94 percent APR, a fact she said she failed to notice on her contract because she "took the company at its word." When an OCCC investigator called this same finance company to ask about interest charges, an employee also gave him an erroneous rate, according to OCCC correspondence. The employee described a similar loan as "twenty two percent. That's APR of course. Like annual rate."39
Finance company loans also have added costs which make them more expensive than many consumers expect. This year, the legislature added an additional application fee to the cost of small loans. For loans between $440 and $1000, finance companies will soon begin to charge $10 up front, and for larger loans they may charge $25. For a 12 month $1,250, loan the new fee is equivalent to an increase in the maximum allowable interest rate from 31.7 percent APR to 35 percent APR.40
Several different allowable insurance charges further inflate the cost of a small loan.
Many contracts for secured loans in Texas include a charge for non-filing insurance. Purchased by the consumer to benefit only the lender, non-filing insurance pays the lender in the event that the consumer disposes of the collateral and defaults on the loan.41 Typically in Texas, non-filing insurance costs $10 regardless of loan size.
In 1995, borrowers in Alabama sued several lenders, retailers and insurance companies, charging that the non-filing insurance coverage they bought was not true insurance, and that the lenders' practice of charging a non-filing fee constitutes a violation of federal truth-in-lending law. Some of the defendants in the case, now certified as a class action, settled and agreed to change their non-filing practices.42
The credit insurance provided by finance companies pays off the loan or makes loan payments for a period of time if a borrower gets sick, loses a job, or dies. Although in some types of borrowing, the presence of insurance actually reduces the interest rate charged by decreasing the risk of a loan, credit insurance has no such affect. According to the Consumer Federation of America, credit insurance is "the nation's worst insurance rip-off."43 Consumer Reports consistently calls it a "bad buy."44 Major studies of credit insurance generally find that consumers pay a high premium and receive little benefit.45 "Because the lender receives commissions at a specified percentage of each premium dollar, sometimes as much as 40-50%, the lender has a strong financial incentive to sell the most expensive insurance to borrowers, rather than the cheapest," says Kathleen Keest of the National Consumer Law Center.46
Some finance companies have insurance subsidiaries specializing in credit insurance. Of the ten largest finance companies doing business in Texas over half have prominent affiliated insurance operations, including Beneficial, Household Finance Company and Commercial Credit Corporation. For example, in addition to high-interest loans, Texas-based American General Finance offers credit insurance through wholly-owned subsidiaries Merit Life Insurance Co. and Yosemite Insurance Company as part of the company's consumer finance business. When pressed by Prime Time Live for a 1997 segment on Associates, a spokesperson for the company admitted that it sells its own (subsidiary) credit insurance to a large number of its customers. 47
Finance companies profit from their credit insurance operations largely because the insurers collect far more premiums than they ever pay in losses. A typical health insurance company pays about 76 cents in claims for every premium dollar (called the insurance loss ratio).48 By contrast, in 1996, Associates Financial Life Insurance Company paid out only 30 cents on the premium dollar. Similarly, Texas borrowers paid Associates Insurance Company $497,473 for credit insurance and received only $26,061-a mere 5 percent of the total premiums collected.49 Accruing a comfortable profit on their nationwide insurance sales, the two insurers together dividended $80 million in profit up to the parent finance company in 1996, and $200 million in profits to Associates in 1995.50
While consumers can choose not to purchase credit insurance, the loan transaction may obscure this choice. Loan agreements presented to potential borrowers are sometimes complex and bury the insurance information.51
Numerous consumers have filed complaints with the OCCC because they found that their loans included charges for credit insurance they did not want or thought they were required to buy.52
Fringe lenders justify their high interest rates by emphasizing the "high risk" of their borrowers. For pawn shops this argument is inherently flawed. Unlike the unsecured loans often provided by finance companies, pawn loans are fully secured by the personal belongings people leave with the pawn broker. Even when pawnshop borrowers never repay their loans, the pawnshop can recover the cost of the loan and make a profit from the sale of the forfeited merchandise.
To obtain a loan from a pawnshop a borrower presents the shop with a personal belonging, oftentimes a piece of jewelry or electronic equipment. The pawnbroker assesses the item and gives the borrower an amount less than what he or she thinks the pawned item would sell for under the worst economic conditions.
Merchandise sales are lucrative because pawns generally loan far less than the value of the items people bring in. According to EZ Pawn, its stores will loan a customer between 20 percent and 65 percent of the pledged property's estimated resale value, as determined by the pawn shop.53 Thus, if the consumer fails to redeem the pawned item the store is sure to sell it for much more than it loaned out.
Loans from finance companies are frequently unsecured and, therefore, the issue of risk is an important one. But, while finance companies generally have higher delinquency rates than do banks, the difference is relatively minor when compared to the discrepancy in the interest rates charged by finance companies and banks.
According to the American Bankers Association, in 1995 and 1996 respectively, 2.98 and 3.38 percent of bank personal loan borrowers fell at least 30 days behind on loan payments. Of all credit card holders, 3.34 percent and 3.72 percent fell into delinquency in 1995 and 1996 respectively.54 While the consumer credit delinquency of finance companies tends to be higher than the delinquency reported by banks, it varies tremendously according to individual companies. Generally, the rates are lower than one would expect.
Some finance companies report delinquencies of roughly one or two percentage points above the average personal loan bank rate and similar to credit card delinquency rates. For example, Household Finance Company, which specializes in unsecured personal loans, reported that 3.46 percent and 4.15 percent of all their borrowers became delinquent on their loans in 1995 and 1996 respectively.
Bank delinquency rates for all consumer loans combined (home equity, home improvement, auto, personal, etc) were 2.12 and 2.34 percent in 1995 and 1996 respectively, according to American Bankers Association. These rates compare favorably to delinquency rates for finance companies that offer many types of consumer loans. Blazer Financial Services, reported a consumer credit delinquency of 2.87 percent and 3.03 percent in 1995 and 1996 respectively.
Similarly, the largest finance company in Texas, Commercial Credit Corporation showed that 2.14 percent and 2.38 percent of their loans fell into delinquency in 1995 and 1996 respectively. Commercial explains that the rise in 1996 "reflects industry trends," indicating that increased default rates are more a product of the economy than they are the characteristics of their particular borrowers.55
Finance companies trust the creditworthiness of their customers enough to return to them again and again. Many finance companies generate a majority of their new loans by refinancing existing loans and adding new money to the balance. For example, of 910,000 Norwest Financial loans nationwide in 1996, 421,000 were refinanced loans with additional funds added. In particular, Norwest Financial notes that it primarily finds new borrowers for personal loans from among its existing retail installment contract borrowers.56
For example, Norwest Financial rerouted Mary Ann R. of Devine, Texas from its retail installment business into a personal loan. Ms. R. purchased a mattress from a furniture store, which she financed through a retail installment contract provided by the store. The transaction grew more complicated when the store delivered the wrong mattress. Upon exchanging it for the correct one, the store asked her to sign a second retail installment contract for the extra cost of the correct bed and then gave her a "Request for Consolidation." The consolidation converted the two sales accounts into a personal loan with Norwest Financial. The Request itself did not disclose the full terms of her new loan, but instead contained a statement that "holder will furnish to the undersigned, prior to one month from the date thereof, a memorandum setting forth the details of this consolidation." As a result of the quick consolidation, Norwest earned $66.89 in interest (the first two months interest on retail installment contracts are earned the first day of the loan). They also offered to increase the repayment period from 24 months to 30 months, but Ms. R. refused when she became suspicious of the higher finance charges. She paid off the loan in full soon thereafter by taking out a loan at her credit union.57
According to Norwest management, the company generally encourages refinancings and loan consolidations, and avoids multiple contracts with one customer. "Generally, Norwest Financial carries only one loan with a borrower at any one time," management states in its 1996 annual report to the SEC. "When a borrower wishes to obtain additional money from Norwest Financial before the loan is fully repaid, a new loan is made sufficient to pay the balance on the old loan and supply the new money, provided the borrowers credit is satisfactory. Of the total amount of loans made during 1996, 63.8 percent represented funds lent to borrowers who requested additional money while still owing Norwest Financial."58
A refinanced loan may cost the consumer more than a new loan with the same lender. According to its 1995 financial statements, more than 30 Alabama consumers have sued Commercial Credit Corporation alleging that they were misled or induced to refinance existing loans rather than receive a new loan, and that the refinancings carried extensive and/or unnecessary fees and charges that were not fully disclosed to the borrower.59
Verna Emery of Illinois sued American General Finance in 1995 after accepting a "$750.00 Cash Coupon" mailed to her home that turned out to be an offer to refinance her existing debt. She received $200 in additional cash from the transaction, at roughly three times the cost she would have paid had she borrowed $200 in a separate loan at the same interest rate. According to the appeals court, "while the letter sent to Emery and other customers of American General Finance implies that the customer is being offered a separate loan, when the customer shows up to take advantage of the offer the company presents him with papers for refinancing the customer's existing loan with additional funds being advanced and does not disclose, indeed conceals the fact, that this method of obtaining additional funds is much more costly than taking out a new loan." 60
In Texas, lenders profit from refinancing in part because loans "earn" interest more quickly in the early months and the new, non-refundable "administrative" fee of $10 or $25 may be charged on refinancing once every six months.61
At the time a consumer refinances an existing loan, the finance company must refund the unearned interest and typically deducts this refund from the previous balance to calculate the new loan amount. However, the refund favors lenders because they use a refund calculation (called the "Rule of 78s" or the sum of the digits method) that "earns" the interest rapidly in the early months.62
For a 12 month loan, lenders earn 12/78ths of the total interest in the first month, 11/78ths in the second month, 10/78ths in the third month and so on. This formula "earns" 15.4 percent of the total finance charge in the first month. By the final month, the borrower's payment includes a small final interest charge of only 1.3 percent of the total interest. If a consumer refinances often, the repeated application of the refund calculation may substantially increase the effective interest rate on the loan over time.
Historically, the rule of 78s emerged as an easily calculated alternative to amortization. Designed to approximate the results of actuarial amortization with a simple formula, it actually produces a result substantially more favorable to the lender for loans at higher than standard interest rates or longer terms. In 1992, Congress prohibited the use of this calculation in loans with terms longer than 61 months, and in 1994 banned its use in certain home equity loans defined in the Home Owners and Equity Protection Act.63 The Texas Credit Code specifically authorizes lenders to use a variant of the Rule of 78s called the sum of the balances method for Article 3.15 and 3.16 loans.64 The sum of the balances method produces an identical result to the Rule of 78s method for any loan repaid in equal monthly installments.
With the exception of a few high profile, "troubled" companies, most publicly held finance companies increased their profits throughout the nineties.65 The top finance companies that dominate the Texas market increased their combined net income nationally 82.6 percent between 1992 and 1996. In 1996 alone, combined net income grew by 18 percent.66 This sort of profit growth outpaces many of the most successful corporations in other industries. By comparison, the pharmaceutical companies that made the Fortune 500 saw a combined profit growth of 14.2 percent in 1996 and the Fortune 500 telecommunications companies saw their profits rise by 3.8 percent.67 The large publicly traded pawn chains also have seen higher profits in the nineties. Combined net income for the three chains that dominate the Texas pawn market (Cash America, First Cash Inc. and EZCorp.) increased 47 percent between 1992 and 1996.68
Among the more notable profit makers in the industry is Ford Motor Corporation's Associates First Capital, which more than doubled net income over this period. Household finance reported increases in net income of 23 percent in both 1994 and 1995, growth which contributed to its being ranked 41 in the Fortune 500 1996 list of companies with "Highest Total Return to Investors."69 Nationscredit increased net income 61percent since 1994. Beneficial's net income almost doubled in 1996 alone.70
While the major banks appear to be skittish about serving low income consumers, some are more than ready to accept the profits that finance companies make serving these same customers at substantially higher rates. Norwest reports that its Consumer Finance division accounts for only 11 percent of assets but 23 percent of total earnings. Norwest investors profit from the good returns of Norwest Financial, which gave them a 29.7 percent return on their investment.71 This compares favorably to the Fortune 500 median return to investors of 20.9 percent.72 Even companies in the risk averse insurance industry like Travellers own finance company subsidiaries.73
Although many of the larger finance companies combine personal lending with other business, these loans often contribute disproportionately to profits. According to Household, unsecured loans in particular account for the company's good financial performance.74 Travellers attributed 1995 increases in net income for consumer finance business primarily to increases in personal loans outstanding, the highest margin product line.75
According to Household's 1996 annual report, the company shed its sales, transportation and manufacturing businesses in the 1980s in order to focus on the "higher return consumer finance business." More recently, the company shed its banking, life insurance and mortgage business-but retained its "higher returning" credit life insurance business.76
Finance companies profit from the sale of insurance-from both the increased interest charges on a higher amount financed and from the commissions. Insurance charges are often responsible for a substantial portion of finance company net income. For example, Norwest Financial's consumer finance business netted $98 million in insurance sales in 1996, a substantial contribution to the company's $276 million overall profit.77
Competition among finance companies has not served the low income consumer by lowering the cost of loans. Instead, consumers with limited financial resources, consumers who live in low income or minority neighborhoods, and those with glitches in their credit history can get loans, but pay much more in interest, fees, and other charges than their credit risk warrants. Finance companies profit handsomely from the difference between the increased rates they charge and the rates they actually need to offset somewhat higher delinquencies. At the same time, unfair marketing practices often hide the additional costs of loans (the extra cost of a refinancing, or the additional charges for credit life insurance). With fewer options, consumers are seldom able to shop a loan for the best rates.
In order for lower income consumers to have equal access to fairly priced financial services, Consumers Union recommends stronger usury laws, increased oversight and market analysis by state regulators, and initiatives to bring mainstream banking back into low income neighborhoods.
1. Consumers Union SWRO, A Poor Choice: Check Cashing in Texas (March 1995).
2. John P. Caskey, Fringe Banking: Check-Cashing Outlets, Pawnshops, and the Poor (New York: Russell Sage Foundation, 1994). Casky used the term "fringe banks" to refer to check cashing outlets and pawnshops, the subject of his study. We believe the term can also describe the finance companies that offer small secured and unsecured loans to low income consumers at high interest rates.
3. Consumer Complaints, Office of Consumer Credit Commissioner, received 7/25/95, 11/20/95.
4. Cash America's wholly owned subsidiary, Mr. Payroll, is a franchiser of check-cashing kiosks and service centers. Cash America International Inc. Annual Report, 1996, p. 22. Express Rent A Tire Ltd. is a subsidiary of Cash America International Inc. Cash America, Form 10-Q, Sept. 30, 1996, p. 5. According to the National Consumer Law center, "perhaps the most important example of the use of leases to conceal consumer credit sales is the "Rent-to-Own" (RTO) leasing industry." Kathleen Keest, The Cost of Credit: Regulation and Legal Challenges (Boston: National Consumer Law Center, 1996) p. 234.
5. National Pawnbrokers Association Web Page (HTTP://WWW.PIC.NET/BUSINESS/NPA/NAP8.HTML), 6/18/97.
6. Tim Gray, "Welcome to Florida, Where Pawn is King," St. Petersberg Times (January 15, 1996), p. 10.
7. Tex. Civ. Stat. Ann. 5069 Chapter 51 Sec. 5(b)(3). Effective Sept. 1, 1997. There were 814 pawn shops in Texas in 1985, which increased to 1140 by 1991.
8. Office of Consumer Credit Commission, Regulated Loan Licenses and Pawnshop Licenses, 3/12/97.
10. Office of Consumer Credit Commissioner, 10 Year Comparison Annual Report of Regulated Licensees, 1997.
11. Caskey, Fringe Banking, pp. 13-14, 22-25.
12. American General Finance Company Form 10-K, 1995; TransAmerica Form 10-K, 1996; Beneficial Corporation Form 10-K, 1996; Commercial Credit Company Form 10-K, 1995; Norwest Financial, Inc. Form 10-K, 1995; Household Finance Corporation Form 10-K, 1996. Comparative size in Texas is based on the number of loan licenses issued to each company.
13. George Soule, "Hoover's Task at Home," New Republic (LVIII, February 27, 1929), pp. 34-36. "One of the puzzles the economic statisticians have faced in recent years is, where the popular purchasing power to supply the market for generally used commodities has come from.It may also lie partly in the expansion of instalment [sic] credit."
14. Caskey, Fringe Banking, p. 29.
15. Janet Seiberg, "Fed: Nonbanks Making More Inroads in the Retail Market," American Banker (January 16, 1997), pp. 1-2.
16. Kenneth J. Robinson, "The Performance of Eleventh District Financial Institutions in the 1980s: A Broader Perspective," Financial Industry Studies, Federal Reserve Bank of Dallas (May 1990), pp. 20-21. More accurately, 36 percent occurred in the Eleventh Federal Reserve District, which is primarily Texas but also includes portions of New Mexico and Louisiana.
17. Leonard Bierman, Donald R. Fraser, Javier Gimeno, and Lucio Fuentelsaz, "Regulatory Change and the Availability of Banking Facilities in Low-Income Areas: A Texas Empirical Study," SMU Law Review (Volume 49, Number 5, July-August 1996), pp. 1438-1439.
18. Stephens Inc., Company Report, World Acceptance Corporation, September 6, 1996, The Small Loan Industry.
19. Caskey, Fringe Banking, p. 86. Citing Caskey and Peterson (1994) based on the Federal Reserve Board's 1977 and 1989 Survey of Consumer Finances. Because the two survey's treat wealthy families differently, the percentages cited are a percent of families earning less than $35,000 in 1976, or less than the equivalent of $83,780 in 1991 dollars. Fewer than 10 percent of U.S. families had incomes above $80,000 in 1991.
20. United States General Accounting Office, Government Check Cashing Issues (Washington, DC: U.S. Government Printing Office, 1988). Based on 1985 Bureau of Census data.
21. Kennickell, Arthur B. et al, "Family Finances in the U.S.: Recent Evidence from the Survey of Consumer Finances," Federal Reserve Bulletin (January 1997), p. 7.
22. Office of Consumer Credit Commissioner, 10 Year Comparison Annual Report of Regulated Licensees, combined loan totals for 3.15 and 3.16 loans.
23. State Profiles, Bureau of the Census Web Page (http://www.census.gov/statab/www/states/tx.txt). Between 1990 and 1995, the Texas population grew from 16,986,000 to 18,724,000.
24. Household Finance Corporation, Form 10-K, 1996.
25. Great Western Financial Corporation, 1995 Annual Report/10K, p. 18. Also American Finance Company Form 10-K, 1995; TransAmerica Form 10-K, 1996.
26. Robert W. Johnson and Kent L. Claussen, "Who Borrows From Finance Companies?," American Financial Services Association, (Special Report), pp. 15-16.
27. Consumer Complaint, Office of Consumer Credit Commissioner, received 8/17/95.
28. Tex. Civ. Stat. Ann. 5069 Chapter 51. The maximum allowable pawn finance charges were established in 1971 when the Texas Pawn Shop Act was enacted and have not been revised since. However, the stratified loan amounts have been adjusted upward nominally each year since 1981. Loan brackets continue to be reviewed and subjected to annual revision every July 1st in relation to the Consumer Price Index.
29. EZCorp Inc, Form 10-K, 1996, Item 1, Business. Cash America International, 1996 Annual Report, p. 1, 6. Texas is both the home state and the primary focus of activity for both of these chains. Cash America has only 51 stores in Florida, the next largest state in which it does business. EZCorp has 24 stores in Colorado, its next largest jurisdiction.
30. Cash America, Inc. Annual Report, 1996, p. 17.
31. Beneficial Corporation, Form 10-K, 1995.
32. World Acceptance Corporation, Form 10-K, 1996.
33. "Home equity and personal loans: State averages for Texas," Bank Rate Monitor Web Page (HTTP://WWW.BANKRATE.COM/BRMRATES/BRMTX.HTM), 5/22/97.
34. Keest, The Cost of Credit, p. 106.
35. Texas Civ. Stat. Ann. Art. 5069-3.16(1), 3.15(1). The bracket amounts are adjusted annually. Under Art. 3.15, any amount borrowed exceeding $1,320 (1996 limit) is calculated at a slightly lower rate: (remaining balance x .08) , (12 x number of installments).
36. Keest, The Cost of Credit, p. 107.
37. Office of Consumer Credit Commissioner, 10 Year Comparison Annual Report of Regulated Licensees, 3/5/97.
38. Consumer Complaint, Office of Consumer Credit Commissioner, received 2/26/96.
40. Section (8), Article 3.15, Title 79, Revised Statutes (Article 5069-3.15, Vernon's Texas Civil Statutes), effective 9/1/97.
41. In order to repossess goods used to secure a loan if the borrower sells them, a lender must have a valid lien on file at the Secretary of State. Many lenders never file a lien on small items like furniture or appliances. Instead, they require the consumer to purchase a form of insurance that pays them the value of the collateral if the consumer defaults after selling the property to someone else. If a lender charges Art. 3.16 interest rates for a small loan, Texas law prohibits lenders from passing the cost of non-filing insurance on to the consumer. Although the $10 fee is legal in Texas, it is unlikely that non-filing insurance losses justify this charge. See also Keest, The Cost of Credit, p. 284-5.
42. World Acceptance Corporation, Form 10-K, 1997, Item 3. Legal Proceedings. World Acceptance, one of the defendents, has not settled the case against it or agreed to amend its practice of charging for non-filing insurance. [In re-Consolidated "Non-filing Insurance" Fee Litigation (Multidistrict Litigation Docket No. 1130, U.S. District Court, Middle District of Alabama, Northern Division).]
43. Michael Hudson, Merchants of Misery: How Corporate America Profits >From Poverty (Monroe: Common Courage Press, 1996), p. 29.
44. Consumer Reports, (Volume 55, Number 10, October 1990), p. 642; cial, Form 10-K, 1996, Business Methods, p. 9.
57. Office of Consumer Credit Commissioner, Finance Company Consumer Complaint, 8/30/95.
58. Norwest Financial, Form 10-K, 1996, Business Methods. Although this example focuses on Norwest, other finance companies cite similar business methods. Beneficial notes that 60 percent of its new loan customers originated as sales finance customers.
59. Commercial Credit Corporation, Form 10-K, 1995, Legal Proceedings.
60. Emery v. American General Finance, 71 F.3d 1343 (7th Cir. 1995). Reversed and remanded.
61. Section (8), Article 3.15, Title 79, Revised Statutes (Article 5069-3.15, Vernon's Texas Civil Statutes), Section 1. "on a loan made under this chapter, an administrative fee not to exceed $25 for a loan of more than $1,000 or $10 for a loan of $1,000 or less which is considered earned at the time the loan is made or refinanced, which is not subject to refund, which may not be contracted for or received by the lender refinancing the loan more than once in any 180-day period if the loan is refinanced."
62. Sample loan documents from consumer complaints.
64. Tex. Civ. Stat. Ann. 5069 Art. 3.15 (6)(a) and Art. 3.16(4).
65. Barnaby Feder, "A Risky Business Gets Even Riskier," New York Times (February 12, 1997). Mercury Finance, one of the top ten auto and personal loan companies in Texas, shocked its shareholders with the announcement this year that financial reporting "inaccuracies" dating back to 1993 would revise profit estimates downward. New estimates were not yet available at press time.
66. Net income for Beneficial, Household, Associates, Norwest, and Commercial Credit increased from $1.18 billion in 1992 to $2.15 billion in 1996, an overall 82.6percent increase according to five year financial data summarized in the companies' Form 10-K, 1996. We were unable to include Great Western Financial, parent to Blazer Financial Services because recent merger/acquision activity delayed 1996 financial reporting until after this report went to press.
67. "Fortune 5 Hundred Medians," Fortune Magazine (April 28, 1997), p. F-25.
68. Cash America International, Inc. Fact Sheet included in Annual Report with Five Year net income statement, adjusted to amend all results to incorporate accounting changes instituted in 1995. EZCorp. Form 10-K, 1996, Item 6. First Cash Inc., Form 10-K, 1996, Item 6.
69. "Fortune 5 Hundred Ranked By Performance," Fortune Magazine (April 28, 1997), p. F-30.
70. NationsBank, Annual Report, 1996; Beneficial Corporation, Form 10-K, 1996.
71. Norwest Investment Profile, 1996.
72. "Fortune 5 Hundred Medians," Fortune Magazine (April 28, 1997), p. F-30.
73. Travellers Group, Annual Report, 1996, p. 1.
74. Household Finance Corporation, Form 10-K,Developments and Results, 1996.
75. Travellers Group, Annual Report, 1996, p. 35.
76. Household Finance Corporation, Form 10-K,Developments and Results, 1996.
