Lewis Roca Blog

In 1980, Congress passed Public Law 96-221, called the Depository Institutions Deregulation and Monetary Control Act (“DIDMCA”), which, in part, allowed federally insured state banks, state credit unions, and state savings institutions the ability to export the “interest” permitted under their home state laws to customers/borrowers in other states without regard to any “interest” limitations in the customer’s/borrower’s home or domiciled state. This put state-chartered banks on equal footing with national banks and federal credit unions, which already could lend across the nation at any interest rate allowed in their respective home states. DIDMCA, under Section 525, also permitted states to opt-out of allowing this kind of interest rate exportation (Sections 521-523 of DIDMCA). As referenced above, federal interest rate exportation authority of national banks or federal credit unions is not based on DIDMCA and will therefore not apply to the following discussion.

Initially, Massachusetts, Maine, Nebraska North Carolina, Wisconsin, Colorado, Iowa, and Puerto Rico all opted out. Subsequently, all but Iowa and Puerto Rico have rescinded their opt-outs, with Colorado scheduled to soon rejoin the two opt-outs with passage of H.B. 1229. The practical implication of a state opting out is that applicable loans made in these states are subject to that state’s specific interest rate and fee restrictions for consumer loans. The stated goals by proponents of the current opt-out is to prevent out-of-state lenders from charging interest rates to Colorado consumers in excess of Colorado’s usury limits.

However, there are several wide-ranging consequences that an opt-out would have on state-chartered banks, out-of-state lenders, buyers of loans from depository institutions located outside the state, and consumers located in that state. Many of the consequences of opting out pertain to any state that elects to do so, including Colorado.

Opting Out Will Disadvantage State-Chartered Banks

The first major issue created by opting out of DIDMCA is that it will directly and negatively impact state-chartered banks lending in the state that opted out. DIDMCA was put in place to provide a level and competitive playing field between state-chartered and federally chartered financial institutions with respect to interstate transfer of interest rates. An opt-out would return that state to the pre-1980 market, when state banks could not export their interest rates, putting them at a distinct disadvantage to federal banks. An opt-out today would have the added twist of disadvantaging opt-out state banks with respect to the state-chartered banks in the other 48 states that can continue to utilize rate exportation under DIDMCA.

Another major effect of an opt-out is that it would create great confusion in the market, as it is not abundantly clear how the decision of where a loan is made would be verified because the provisions that are determinative under DIDMCA would not apply since the opt-out would negate the interpreted provisions for said determinative requirements (i.e. Section 521). Further, there are FDIC Interpretive Letters and FDIC General Counsel Opinions that would call into question how a determination would be made.

Some interpretations from the FDIC regarding sections 521 and 525 have alluded to the fact that a loan is not necessarily made based solely on where the borrower is located but rather a larger factual inquiry into several facets of the loan transaction would need to be considered. This could include an examination of non-ministerial functions including: (i) the decision to extend credit, (ii) the extension of credit itself, and (iii) the disbursal of the proceeds of a loan. If this interpretation is adopted, then it would be possible for out-of-state lenders to continue to export rates from their home states.

If out-of-state (non-opt-out state) lenders appropriately structure their loans to address the question of how the determination of “made in” will be decided, the opt-out would not restrict loans “made” out of state. Loans from institutions located in the state would still be covered by the opt-out restrictions and would be disadvantaged as a result.

Additionally, an opt-out will prevent state banks domiciled in the opt-out state from exporting the opt-out state rates to other jurisdictions, directly shrinking the base of potential customers outside their political boundaries. This would put an opt-out state’s state-chartered banks in a uniquely disadvantaged position. Opt-out state-chartered banks could find themselves not able to export their rates while banks chartered in non-opt-out states bring in their rates to opt-out state customers. In a digital age, where consumers will look to an expanded market, this could have disastrous effects upon the opt-out state’s abilities to source customers outside its political jurisdiction.

Furthermore, due to the negation of Section 521 and the therefore subsequent inapplicability of the FDIC’s rule to address the issue raised in Madden v. Midland Funding (12 C.F.R. Section 160.110(d)), future buyers of applicable loans made in an opt-out state by state-charted banks would lack clarity as to what contract rates they could charge on those loans, particularly if such rates were higher than the rates in the borrower’s state. This would lead to confusion in the market and likely hesitancy for buyers to enter the market of opt-out state’s loans due to concerns over potential legal risk.

Opting Out Will Reduce Credit Options and Competition in the Marketplace For Consumers

The credit offerings and delivery channels available to consumers in today’s marketplace were never contemplated when DIDMCA was passed in 1980 but rather, the market has evolved with DIDMCA as a constant. Data shows that more and more consumers are seeking the growing options available online to comparatively shop and find the best financial offering available to them, regardless of where they live.

In addition to installment loans, other credit product offerings will likely be impacted by an opt-out. Consumers have elected to use the increasing number of Buy Now, Pay Later and point of sale offerings to finance a growing array of purchases, including household staples and essential needs. These products offer an alternative financing option to consumers with and without credit cards. Ultimately, partnering relationships with opt-out state-chartered banks will be significantly restricted if not abandoned. These offerings that are connected to a partner bank in another state could be subject to the restrictions if the loan is deemed to be made in the opt-out state. If such a determination is made, the offerings will now be subject to the restrictions imposed by the state opting out, and consumers will likely expect fewer credit choices and options. There are some who argue that there are certain offerings in Colorado that exceed the state’s existing usury cap of 36%. However, opt-out states’ officials have the ability to use the judicial process to pursue lenders who offer higher-cost products deemed to be in contravention of state law. Furthermore, other states have addressed this dynamic through other measures that don’t use the blunt instrument of opting out of DIDMCA. If a state opts out the legislature has elected to play nanny and decide that it has a right to further restrict the type of credit that citizens receive rather than allowing the market to dictate, pursuant to the rules already in place.

An opt-out would require out-of-state banks and credit unions to follow the opt-out state’s interest rate and fee restrictions on consumer loans made in the state which could drastically restrict their ability to lend there and reach more customers. For example, the existing interest rate cap for consumer loans in Colorado currently is a calculation of 36 percent per year for loans of $1,000 or less - dropping to 21% for loans between $1,001 and $3,000 - and 15% for anything above (lenders can also bypass the calculation and charge a uniform 21%). These limits would apply to all applicable loans deemed to be “made in” Colorado. In a recent letter, six national bank trade associations stipulate that even a 36% cap on loans lessens access to credit:

A 36 percent annual percentage rate (APR) cap, however calculated, will mean financial institutions will be unable to profitably offer affordable small-dollar loans to consumers. For a loan product to be sustainable, lenders must be able to recover costs. Costs include not only the cost of funds availability, but also costs related to compliance, customer service, IT, underwriting, administration, defaults, and, most notably– losses.¹

If out-of-state banks are deterred from lending in an opt-out state due to the financial and legal risk an opt-out of DIDMCA would create, it would drastically reduce financial options and competition, leaving many consumers worse off. We have yet to see a state with a large population and diversified economy (Iowa’s economy and population is not as robust as Colorado’s) fully undertake the opt-out and the effects are yet unknown. North Carolina, Massachusetts, and Wisconsin, all with larger populations and better or similar GDPs, rescinded their opt-outs. Colorado is once again opting out despite opting back in before. Further, Jennifer Waller, the president of the Colorado Bankers Association, told the Denver Business Journal that returning to an opt-out could have lasting repercussions and make Colorado a less efficient place for out-of-state banks to do business.²

Moreover, the findings from Colorado’s recent study on credit access in the state should be given proper attention. In 2021, the Colorado General Assembly appropriated funds to the Colorado Department of Law, Consumer Protection Section, Consumer Credit Unit for use on a study on “the availability of safe and affordable credit” in Colorado. This study was conducted by the Financial Health Network. The study speaks for itself, but among the key findings was the following:

Comparing the share of borrowers in Colorado who obtain reported small-dollar loans with the share in two states without usury limits (Missouri and Utah), we find that for subprime and deep subprime consumers and those with insufficient credit history to generate a credit score, reported small-dollar loans appear to be less available for such consumers in Colorado than in these other states.³

These findings were a byproduct of the state’s 36% APR cap, and it only stands to reason that additional restrictions in the form of an opt-out will yield more of the same results. Furthermore, the study also compares lending data with Iowa (which also opted out of DIDMCA) and finds that credit was even less available in that state:

The Iowa penetration rate lags all the other states in all tiers; Indeed, on an overall basis, the penetration rate in Iowa for reported small-dollar loans is just 0.16%.⁴

The old adage, “if all your friends jumped off a bridge would you do the same?” comes to mind. In the case of an opt out, the opt-out state is following Iowa off a bridge. While the stated intention of opting out is to protect consumers, this blunt approach will more broadly hurt consumers by restricting their available sources of credit. This may also have broader effects of stunting development and investment in an opt-out state because it would be a less desirable place to lend which could impact economic growth and development. This could in turn affect businesses’ decisions and partnerships and ultimately jobs that come into an opt-out state or that would have been created in such a state. In a growing and more interconnected and global market, this action will directly limit any state that elects to opt out uniquely among 48 other markets. Oftentimes it pays to be unique and innovative, but, in the case of an opt-out, it quite literally turns the clock back and leaves those unfortunate opt-out state consumers in the pre-internet dark ages.

Other Considerations

The opt-out provision of DIDMCA may no longer exist. There is an argument that Section 407 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) repealed the opt-out provision. There have been two cases (notably one in Colorado, Stoorman v. Greenwood Trust Co., 888 P.2d 289 (1994)) that have said as much. Conflictingly, the FDIC, in one of its recent rulemakings, referenced Section 525 of DIDMCA as if it had not been limited or repealed. This confusion will only lead to further litigation and more uncertainty in the market.

The impacts of an opt-out have the potential to be much wider than anticipated. Many financial institutions utilize state-chartered banks for various aspects of their businesses, including credit cards and vehicle financing. In the event of an opt-out, the rates on other credit products, which may already fall below the usury limits within the state, may be impacted due to other allowable fees. Lawmakers have seemingly anticipated some of these problems and have exempted one credit product.

While not as a direct effect of the opt-out, Colorado HB 1229, also repeals provisions specifying that lender or seller credit cards issued by a credit card bank or financial institution are subject to limitations on finance charges in statute and instead specifies that “General Purpose Credit Cards” (defined below) are not subject to limits on finance charges and fees applicable to consumer credit transactions specified in state law. The provisions that “General Purpose Credit Cards” will be exempted from are portions of the Colorado Consumer Credit Code, specifically C.R.S. 5-2-201 through 203. “General-Purpose Credit Cards” are defined as any card, plate or other single credit device that may be used from time to time to obtain consumer credit under an open-end credit plan offered by a supervised financial organization that: (i) is accepted by any merchant that participates in a widely accepted payment card network and is accepted upon presentation at multiple unaffiliated merchants for goods and services; (ii) does not charge fees, including pre-account opening fees, which exceed fifteen percent of the credit line; and (iii) does not include an overdraft line of credit that is accessed by a debit or prepaid card or an account number. Rather than having a robust, competitive market for consumer lending options and offerings, the exemption for general-purpose credit cards may also distort the market by picking winners and losers, rather than allowing consumers to choose which options work best for them in a competitive marketplace.

Conclusion

The aim of a free-market system is to allow for competition which will give the consumer the best deal regardless of where they are located. By opting out of DIDMCA, the legislature has decided to not allow the competitors in the market provide additional choices for consumers.

As the state ponders the policy of opting out and how to address the impact of this blunt policy, policymakers should keep in mind that states have used new licensing regimes and new criteria to establish the true lender of loans as ways to address concerns being raised. Furthermore, Colorado happens to have a novel agreement in place with a group of banks and fintechs, which could be codified, and thereby reinforcing the rules around financial institutions lending to Coloradoans.

The Colorado DIDMCA opt-out of the bill will go into effect starting July 1, 2024. Other changes prescribed by the bill relating to small-dollar loans will take effect January 1, 2024.

¹ Consumer Bankers Association, American Financial Services Association, Bank Policy Institute, Independent Community Bankers of America, Association of Military Banks of America, American Bankers Association, and Mid-Sized Bank Coalition of America, September 26, 2023, [Letter to Sen. Jack Reed and Sen. Jeff Merkley, 2023]. Retrieved from https://www.consumerbankers.com/sites/default/files/Joint%20Trades%20Opposition%20Letter%20to%20Rate%2 0Cap%20Amendment.pdf

² Romano, Analisa. “Colorado lawmakers drop higher dollar loans from lending bill: Lawmakers said they anticipate more talks to address alternative charge loans, which can circumvent state interest rate caps.” Denver Business Journal, April 7, 2023, https://www.bixjournals.com/denver/news/2023/04/07/colorado-alternative-chare- loans.html

³ Financial Health Network. The Availability of Safe and Affordable Credit From Non-Depositories in Colorado, 2023, https://finhealthnetwork.org/wp-content/uploads/2023/01/The-Availability-of-Safe-and-Affordable-Credit-From- Non-Depositories-in-Colorado.pdf

⁴ Id.