Regulatory Arbitrage In Usurious Finance Capitalism: The Elevate Case

Among the more interesting trends in modern financial capitalism has been the continuous evolution of financial products designed to charge the highest interest rates possible while evading regulation such as state usury laws.

Long gone are the days of loansharking by mafiosos. More recently, high-risk loans were secured by collateral such as a car title, a pawned watch, or post-dated check. Since 2000, however, two factors have interacted causing lenders to spawn ever more creative offerings: technological advances in lending and regulation. Advances in credit scoring, default prediction software, and securitization, are examples of innovations that have allowed lenders to (very) profitably lend to risky borrowers.

Federal regulations, such as Fair Debt Collection Practices Act, Dodd-Frank, and the Military Lending Act, have resulted in changes in origination practices; for example, rather than expressly charging 150% interest, borrowers pay “monthly minimum advance fees.” Rather than offering payday loans, lenders have created an ever-evolving and shifting pool of options, such as refund anticipation loans, installment loans, and cash advances. Soon thereafter, regulators quash these new options, the industry evolves, and the cycle begins anew.

This essay will primarily focus on one company, Elevate, and its product, Elastic. Elevate is a “FinTech” company that has just finished its IPO process.

From Elevate’s website:

According to Elevate, the firm is NOT a “predatory lender” that charges financially unsophisticated customers egregious interest rates. The firm uses “data” and “innovation” to provide solutions for “non-prime customers.” Why, the firm even has a partnership with Clinton Global Initiative called Commitment to Action – Ending the Cycle of Subprime.

A quick look into Elevate’s recently filed S-1 (the public document required of every major firm going public) gives a deeper look into how the firm uses financial and regulatory legerdemain to make very high interest rate loans. Elevate’s website suggests the firm is a hip start-up complete with a cycling team, but dig into the S-1 and you find that Elevate is spinning out of another high-risk lender, Think Finance.

While the firm could be separating to improve its strategic focus, it seems more likely that Elevate is trying to distance itself from a lawsuit-plagued parent firm. Think Finance was a high-risk lender founded in 2001. Think Finance tried to evade 50-state banking laws by originating its loans using a Native American-owned affiliate called Plain Green, LLC. That particular tactic has been banned, but the management team of Elevate continues on as a new FinTech company backed by Sequoia Capital and Technology Crossover Ventures, two very well-known venture capital firms.

Elevate focuses on three products: “Rise,” “Sunny,” and “Elastic.” Rise is an unsecured installment loan of $500-5000 with an APR of 36-299%. Sunny is a UK unsecured loan of £100 – £2500 with an APR of 238%-1291%. Elevate’s final product, Elastic, appears to be a novel, data-driven cash advance.

It’s even got an app (just kidding, it doesn’t have an app):

Elastic is actually a product tailor-made to avoid usury caps in most states. Approximately half of all U.S. states have usury laws that cap interest rates for personal loans at APRs between 10-30%. Elastic is able to charge ~150% APR by charging a “cash advance fee” that varies based on the total amount borrowed and the time to repayment. This is not “interest,”–it is a “cash advance fee.”

Lawyers and lobbyists have confirmed the two are totally not the same thing.

Complicating matters somewhat, Elevate is technically a FinTech company, not a bank. As a lender, Elevate would be subject to 50-state banking laws, so Elastic is legally an offering of Republic Bank, a Louisville, Kentucky-based bank. As an aside, Republic Bank itself experienced regulatory action after the FDIC shut down its very lucrative Refund Anticipation Loan (RAL) business. RALs were a high-interest (~169% APR) short-term loan made against a borrower’s expected federal income tax refund. On paper, Republic Bank licenses Elevate’s technology, underwriting services, and originates the loan. Upon closer examination, it becomes clear that Elevate engages in the sales and marketing, and immediately after origination, Republic Bank sells a 90% loan participation to Elastic SPV, a Cayman Island entity.

Elastic SPV, a nominally independent entity, in turn funds the loans with borrowed money and purchases credit default swaps from Elevate to guarantee the performance of the loans. The borrowed money costs 13-18% and comes from a Chicago-based private credit fund, Victory Park Capital. Victory Park Capital enjoys some political clout as the chairman of its executive board is former Senator Joseph Lieberman. Interestingly, Sen. Lieberman was against exploitative lending as recently as 1999. As readers who understand credit default swaps will realize, selling a credit default swap against risky debt is tantamount to purchasing that debt with leverage, as the “premium” earned is essentially equal to the spread between the interest on that debt and the base rate (or in this case ~150% APR). In this arrangement, Republic Bank is basically a conduit which earns money by effectively leasing its bank charter to Elevate.

Elevate positions Elastic as a novel credit solution for non-prime customers of any race or background.

However, looking at Elastic’s own marketing materials…

…it’s pretty clear who Elastic’s target demo happens to be:

Again, contrary to its image as a FinTech company, 99.5% of Elastic customers come through the direct mail marketing of pre-approved offers, which is essentially the same method Providian used decades ago to rapidly scale its credit card business. Buy the names and addresses of millions of Americans from the Credit Bureaus. Send out hundreds of thousands of offers to the ones who look desperate but not too desperate, originate millions of dollars of triple-digit interest rate loans, profit.

Despite what at first glance appears to be a very lucrative business, Elevate’s owners are significantly diluting themselves via IPO. A quick look into Elevate’s financials and regulatory environment likely explains why. Most importantly, the entire high-risk consumer credit industry is in the sights of Dodd-Frank’s spawn, the Consumer Financial Protection Bureau. Think Finance, Elevate’s predecessor firm, received a Civil Investigative Demand that has yet to be resolved. Next, state regulators, especially in New York, have started to aggressively pursue firms offering payday loan-like products.

As mentioned before, Think Finance is still facing lawsuits for the tribal lending practices and Elevate’s CEO is named as a defendant in at least one of those lawsuits. Republic Bank, the originator of Elastic loans, is subject to dozens of federal laws including the Equal Credit Opportunity Act and Fair Credit Reporting Act, which effectively prohibit the kind of big data underwriting done by Elevate. Republic and Elevate wish to have it both ways: they want to evade bank regulation by having Elevate do the underwriting, but evade non-bank regulation by having Republic Bank do the origination.

Elevate is certainly not the only firm playing regulatory games in the high-interest lending space.

Indeed, the industry is rife with parasites, con-artists, and scumbags.

History has looked quite dimly on lenders–perhaps an up-close look at a modern usurer sheds light as to why.

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  1. Wow, this is legit investigative reporting. Bravo!

    How do you suggest we, as a society, either meet or eliminate the demand for short-term/high-risk lending?

  2. This is a perfect example of how regulation is a failed idea. The problem was not solved, but driven underground. Better to have left the payday lenders alone so that people could see these practices for what they are without having to look through all of the layers of chicanery described above.

    1. Advocatus Diaboli for the throne and altar neoreactos: This is a perfect example of how insufficient regulation is a failed idea. The problem was not solved, but driven underground. Better to have burned the payday lenders at the stake and ritually mutilated their corpses so that people could see these practices for what they are, and fear to ever engage in the layers of chicanery described above.

      [Please note that I abstain from declaring my endorsement for either thesis or antithesis.]

      1. The problem with that (aside from the mass murder) is that you can kill a man but you cannot kill an idea. Even if you kill everyone who believes in that idea, time will eventually erase the memory of the slaughter and people will start doing the forbidden deeds again.

        1. Did Justinian despair over the 30,000 dead in the Nika Riots? The problem (to the crown, which presumes its own legitimacy) was the rioters’ contentious disposition, not the manner by which a week’s chaos and insubordinate plunder of Constantinople was resolved.

          1. There is quite a difference between a state of riotous rebellion and some people deciding to lend their own money at rates that a ruler happens to dislike.

        2. [Replying to this comment [0], because we have reached maximum reply nesting depth.]

          You are correct, a riot is an acute stress upon the pillars of governance that encourages a swift and obvious corrective feedback loop. Money lending can potentially (in the use case of this article, primarily) accumulate chronic stress where it can less be observed and borne within society more broadly.

          [I reiterate that I merely generate, not necessarily endorse, these views.]


  3. Just to be clear, egregious interest rates are not themselves usurious, though they are immoral. Usury involves the combination of interest – of whatever amount – with personal liability against the borrower. Loans that charge interest rates – of whatever amount – that are instead secured against some real collateral – such as a watch, or a car, or a house – and contain no deficiency agreement requiring the borrower to ‘make up the difference’ between the loan principal and the value of the collateral in case of default are not usurious, whatever their other faults.

    Which doesn’t mean this isn’t horrible. It is.

    1. An interest rate is simply a measure of time preference and risk preference unless governments and central bankers mess with it. You pay more money later because you want less money right now, and how much more depends on how much later and how much default risk you present to the lender. The recognition that there is nothing horrible or immoral about this is a major factor in the economic prosperity of the West compared to most other places.

    2. The predatory principals involved should be named for the general public to know of their deeds. Hiding behind offshore companies or impenetrable corporate structures or similar devices just shows how they seek to avoid the notoriety that their practices would so richly deserve.

      It is one thing to provide legitimate credit where not previously available, and quite another to build in slippery definitions, entrapment, legalese and other schemes to prey on the unsuspecting or credulous. Those debtor protections of yore were put in place to counteract the fundamental imbalances exploited by the ethically challenged and morally deficient.

    3. With modern bankruptcy law, doesn’t all debt (except student) essentially qualify as non-usurious then? If not, you’re talking about limiting debt to non-recourse -> expensive debt -> rather impenetrable barrier between capital-owning and -renting classes -> who knows?

      Even secured, non-recourse debt will still have socially destructive information asymmetry problems. I’m intrigued by Curt Doolittle’s framework for holding the information-holders to a higher moral standard.

      1. No. Modern (and indeed, all) bankruptcy law comes into effect when you BREAK a contract. With non-recourse debt, you don’t have to break the contract to walk away from the agreement.

        But don’t take my word for it. I’m just parroting Zippy here:

        1. I don’t know about this distinction. A contract is made under a legal scheme, and if that legal scheme guarantees an alternative resolution of a liability (bankruptcy), that alternative resolution is part of the contract, no?

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