SENATE BILL NO. 157 An Act relating to the regulation of small loan and retail installment transactions. Co-chairman Halford directed that SB 157 be brought on for discussion. SHERMAN ERNOUF, aide to Senator Kelly, again came before committee. He referenced CSSB 157 (L&C) and told members that work on the legislation was done in conjunction with the Alaska Consumer Financial Services Association. It attempts to accomplish three goals: 1. Modernize the Alaska Small Loans Act. Present law was drafted in the late 1950s and is outdated. 2. Expand the availability of credit to Alaska consumers. 3. Allow Alaska lenders to compete with out-of-state lenders who import interest-rate structures from their home states. WILLIS KIRKPATRICK, Director, Division of Banking, Securities, and Corporations, again came before committee. He acknowledged that one of the problems the division encounters is deterioration or "obsolescence of some of the laws that we administer." Examiners have been working on areas that should be modernized. One is the Alaska Small Loan Act. In the course of drafting improvements, the division was approached by industry with proposed amendments. An amendment calling for a single license for multiple offices would be extremely beneficial to administration of the act. Other minor changes would increase fees to cover increased costs since statehood. Mr. Kirkpatrick referenced a particular provision under the Installment Retail Sales Act and said that while it is not "necessarily promoted" by the department, it also is not objected to. When queried by Senator Phillips, Mr. Kirkpatrick advised that the department endorses the proposed bill. When further queried concerning the Governor's position, Mr. Kirkpatrick said he had briefed staff on provisions of the bill but had received no specific instructions from the Governor's Office. He further commented on the breaking down of banking barriers between states and the impact of interest-rate provisions on outside financing. JOHN HIGGINS, General Manager, Northland Credit Corporation, (a wholly owned subsidiary of National Bank of Alaska) came before committee advising that he would also be speaking on behalf of the newly formed Alaska Consumer Financial Services Association. He stressed that the end result of proposed changes within the bill would: 1. Create and retain jobs in Alaska's financial industry. 2. Provide more financing to rural communities. 3. Provide credit to a broader base of Alaskan consumers who otherwise might not have access to the credit they deserve. Mr. Higgins next spoke to the following highlights included within the bill: 1. Fee enhancements to the state. 2. Increased bonding requirements. 3. Licensing enhancements which ease licensing requirements for corporations with more than one office. 4. Bookkeeping changes. 5. Inclusion of joint loan provisions. Present law does not allow for two open loans to the same person or an open loan with a spouse. 6. Allowance for payments other than standard 30-day payments. This change will accommodate those with seasonal jobs. 7. Inclusion of NSF fees within the Alaska Small Loan Act. Current statutes do not so provide, and good payers end up subsidizing bad payers. 8. Inclusion of attorneys fees for collection of loans over $5,000.00. 9. Deregulation of financing in dealerships under the Alaska Retail Installment Sales Act to compete with out-of-state lenders that import their rate structures to Alaska. Senator Randy Phillips referenced the zero fiscal note from the Dept. of Commerce and Economic Development and asked why enhanced fees were not included. Willis Kirkpatrick again came before committee and said the department would submit an updated zero note explaining the impact of fee changes. The department does not anticipate "that much fee enhancement." Senator Rieger asked for an explanation of "add-on interest." Mr. Higgins acknowledged inclusion of clean-up language on "how interest should be earned." Current statutes are unclear. Some companies earn under the "rule of 78ths." Others earn under "interest bearing" arrangements. Two different forms are used "under the same type of paper." This should be "more homogeneous"--everyone should be "doing it the same way." However, the annual percentage rate is the same under both methods. The methods differ in how the money is earned internally. Add-on interest refers to "closed-end contracts." The current rate is "ten percent, eight percent add-on." That equates to ten percent up to $1,000 and eight percent thereafter, in an add-on fashion. Lengthy discussion of different methods of calculating interest followed. Mr. Higgins advised that "rule of 78ths" financing has an inherent prepayment penalty. However, it is the best type of loan to have if the payer is delinquent because the interest never changes even if payments are late. An interest-bearing loan is the worst to have, if you are late, because interest is calculated on the outstanding balance. Further comments followed regarding differing legal interpretations of the "rule of 78ths." The proposed bill allows interest earning by either of the above-mentioned methods, but the method must be disclosed to the consumer. Discussion of disclosure requirements and understanding of disclosure by the general public followed. Senator Frank stressed need to clarify existing law to track with requirements for disclosure of the annual percentage rate so that consumers know what rate they are paying. In response to a question from Co-chairman Frank asking why calculation of interest is not restricted to a single method such as simple interest, Mr. Higgins explained that under the Truth in Lending Act the "rule of 78ths" was the preferred method of computing interest. Those involved in drafting the proposed bill did not want to preclude that methodology since it is part of federal law. For high-risk consumer loan portfolios where payments tend to be late and delinquency and charge-offs are higher, interest on "rule 78ths" loans cannot increase. Principal is paid down more quickly since the interest does not change. It is precomputed each month because it is set at the time the loan is written. A borrower who is late on an interest bearing contract "could pay on it forever because . . . your payments just go to interest" and do not cover the principal balance. Further discussion followed regarding computation of interest under the "rule of 78ths." Mr. Higgins acknowledged that it computes to 15% interest for the first month. Co-chairman Halford asked if the proposed bill provides for an increase in the amount of information provided to consumers. He voiced support for deregulation but suggested that greater public awareness is an appropriate balance. Mr. Higgins advised that contracts indicate how interest will be calculated. Requirements for disclosure to the consumer are incorporated within regulation "Z" and truth in lending statutes. Senator Rieger directed attention to page 5, lines 20 through 26, and asked if new language deletes ability to charge for a credit report on a loan of less than $10,000.00. Mr. Higgins concurred. END: SFC-96, #28, Side 1 BEGIN: SFC-96, #28, Side 2 Discussion of title insurance requirements followed. In response to questions from members, Willis Kirkpatrick came back before committee. He advised that if collateral is not perfected, the classification of the loan might be jeopardized. In response to a question from Senator Zharoff regarding Sec. 13 provisions for late-payment fees, Mr. Higgins explained that language relates to retail revolving credit rather than the consumer small loan act. The law is silent on these charges. The proposed bill does not list fees or charges by dollar amounts because they vary from state to state. Sec. 13 provides for information on these costs to be contained in the contract, or agreement, and concurred in by the parties so that everyone understands what the late charges will be. Mr. Higgins advised that his corporation would use "what's already out there as law." That means ten percent up to $15.00. He then referenced language at page 5, subsection (6) which seeks to increase the limit from $15.00 to $25.00. Co-chairman Frank asked if small loan institutions in Alaska would be disadvantaged if limited to simple interest calculations only, since they would be competing against institutions able to use either simple interest or "rule of 78ths" financing. Mr. Higgins agreed that disadvantage could occur if outside institutions import their own individual method of calculating interest to Alaska. He stressed that the goal is not to require that the industry use only one methodology but to clarify that more than one method may be used and that disclosure to the consumer is proper. In response to questions from members, Willis Kirkpatrick again came before committee. He acknowledged confusion and complaints from those who pay off "rule of 78ths" contracts early. At the time a loan is made, the borrow usually has a specific goal in mind. The particulars of the financing arrangement are often not paramount. Co-chairman Halford asked if something could be added to notice requirements to better inform consumers. Mr. Kirkpatrick voiced his belief that present disclosure forms are adequate in presentation of the true rate. Senator Rieger advised of his understanding that unless there is a specific waiver, a consumer credit loan has reasonably equal payment for the life of the loan. "Rule of 78ths" and "simple interest" are merely different schedules for computing how much of each monthly payment is applied to interest and principal. Mr. Kirkpatrick concurred. In the course of further discussion, Mr. Higgins stressed that application of "rule of 78ths" financing relates only to retail contracts. It does not apply to the small loan act. He then recited a listing of institutions and the type of schedules they use. JOHN SHIPE, Executive Vice President, National Bank of Alaska, next came before committee. As background information, he explained that the "rule of 78ths" was developed prior to "the days of sophisticated computing systems." It assumes fixed payments on a fixed bases (such as every thirty days). "Simple interest" financing computes interest based on the principal and the number of days since the last payment. If two hypothetical loans were made for the same amount and at the same interest rate but calculated under "simple interest" and the "rule of 78ths" with timely payments on the due dates carried to maturity, the amount of interest paid on both loans would be identical. The manner in which the interest is recognized internally would be different. Both methods are well established and utilized and fall within regulation "Z" disclosure requirements. Discussion involving examples of both types of interest calculations followed. Mr. Shipe advised that the "rule of 78ths" is the predominant structure used by corporations that import financing to Alaska. Co-chairman Halford inquired concerning the types of retail agreements used by chain stores in Alaska. JERRY REINWAND, representing J. C. Penney; Sears; Safeway; and Fred Meyer, came before committee. He explained that the bill represents an attempt to keep retail business in Alaska. Co-chairman Halford voiced his understanding that a sale through a chain store in Alaska is not necessarily governed by Alaska law. There is nothing to prevent a retail business from making arrangements with an outside bank and consequently complying with the laws of that state. Mr. Kirkpatrick again came before committee and advised of existing provisions that allow transport of credit rates across state lines. The first provides that the focal point (center of gravity) of the transaction is where it is approved and disbursed. More recent case law speaks to the constitutional question that prohibits states from interfering with interstate commerce that allows funds and the cost of funds to flow across state lines. Co-chairman Halford queried members regarding disposition of the bill. Senator Zharoff referenced enhanced ability of Alaskan businesses to compete under the proposed bill and asked why it did not have an effective date. Mr. Higgins acknowledged that the issue was not considered when the legislation was developed. He concurred that an immediate effective date should be included. Mr. Kirkpatrick commented that the crisis created by immediate effectiveness would be manageable. Senator Zharoff MOVED to amend CSSB 157 (L&C) to include an immediate effective date. No objection having been raised, the amendment was ADOPTED for incorporation within a Senate Finance Committee Substitute for the bill. Senator Zharoff then MOVED for passage of the bill. Co-chairman Halford questioned the zero fiscal note in light of bill provisions (Secs. 1 and 2) which increase fees. Mr. Kirkpatrick said there would be a slight positive fiscal impact if there was a lot of activity because of the bill. However, the division does not anticipate much activity. Further, the division will be doing multiple licensing for some entities. That is likely to reduce revenues. The end result is a balance between increased fees and revenue reductions. He said he would provide a new zero fiscal note with an appropriate explanation. No objection to passage of CSSB 157 (Fin) having been raised, CSSB 157 (Fin) was REPORTED OUT of committee with a zero fiscal note from the Dept. of Commerce and Economic Development. Senators Rieger and Zharoff signed the committee report with a "do pass" recommendation. Co- chairmen Halford and Frank and Senators Donley and Phillips signed "no recommendation." ADJOURNMENT The meeting was adjourned at approximately 10:30 a.m.