MINUTES SENATE FINANCE COMMITTEE February 21, 1996 9:10 a.m. TAPES SFC-96, #28, Side 1 (000-575) SFC-96, #28, Side 2 (575-158) CALL TO ORDER Senator Rick Halford, Co-chairman, convened the meeting at approximately 9:10 a.m. PRESENT In addition to Co-chairman Halford, Senators Donley, Phillips, and Rieger were present. Co-chairman Frank and Senator Zharoff arrived soon after the meeting began. Senator Sharp did not attend. ALSO ATTENDING: Willis Kirkpatrick, Director, Division of Banking, Securities, and Corporations, Dept. of Commerce and Economic Development; John Higgins, General Manager, Northland Credit Corporation; John Shipe, Executive Vice President, National Bank of Alaska; Jerry Reinwand representing Fred Meyer, J.C. Penney, and Sears; Sherman Ernouf, aide to Senator Kelly; and aides to committee members and other members of the legislature. ALSO PARTICIPATING VIA TELECONFERENCE FROM ANCHORAGE: Ron Kukis, First Interstate Bank of Alaska; and Jerry Weaver, National Bank of Alaska. SUMMARY INFORMATION SB 157 - SMALL LOANS & RETAIL INSTALLMENT SALES Testimony was presented by Willis Kirkpatrick, John Higgins, John Shipe, Jerry Reinwand, and Sherman Ernouf. An amendment by Senator Zharoff adding an immediate effective date to the bill was adopted. CSSB 157 (Fin) was REPORTED OUT of committee with a zero fiscal note from the Dept. of Commerce and Economic Development. SB 168 - FINANCIAL INSTITUTIONS Discussion was had with Willis Kirkpatrick and Sherman Ernouf. Ron Kukis and Jerry Weaver were available to respond to questions via teleconference from Anchorage. SB 168 was REPORTED OUT of committee with a zero fiscal note from the Dept. of Commerce and Economic Development. SENATE BILL NO. 168 An Act relating to financial institutions. Co-chairman Halford directed that SB 168 be brought on for discussion. SHERMAN ERNOUF, aide to Senator Kelly, came before committee. He advised that the legislation was introduced at the request of the Division of Banking, Securities, and Corporations. As background information, Mr. Ernouf explained that congressional passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 overrides state law in a number of areas. It also allows states to address provisions in the Act and effect remedies before the 1996 deadline. Alaska anticipated most of the federal changes in recent recodification of Alaska banking law. SB 168 contains provisions needed to correct state law before the congressional act goes into effect. Changes relate to: 1. Agency activities between Alaska banks and banks in other states. 2. Examination sharing agreements between state bank regulators. 3. Deposit concentration limits on mergers and purchases of Alaska banks by outside banks. The Alaska Bankers' Association endorses the legislation. All banks within the state have "passed" on the language and the intent of the bill. WILLIS KIRKPATRICK, Director, Division of Banking, Securities, and Corporations, Dept. of Commerce and Economic Development, came before committee. He explained that 1994 recodification of state banking law showed that "state barriers/boundaries were falling down." There was a massive push by large national and international banks for congressional action on interstate branching. The large banks wanted branches across state lines. The congressional act allows states until 1997 to decide whether or not they wish to opt in or out of interstate branching. Alaska's recodification provides for that type of branching. A bank from another state could buy an existing bank or existing branch. Alaska opted in before Congress made specific determinations. However, federal law contains other optional provisions upon which the state must act by 1997. One of those provisions relates to agency powers. The Division of Banking, Securities, and Corporations has determined that full agency powers would be appropriate in Alaska. That means that if a large international or interstate bank locates in Alaska and imports many of its services and becomes aggressive in the marketplace, the local community bank may enter an agreement with a bank outside the state to serve as an agent for the outside bank and thus compete with the large national or international bank. Federal law also allows states to address the question of concentration (the outside purchase of deposits in Alaska). A limit of 50% is proposed. Mr. Kirkpatrick cited, as an example, the fact that National Bank of Alaska has insured deposits of 24 to 30%. Federal law also allows states to share agreements and examinations across state lines. Under that provision, the Division of Banking, Securities, and Corporations would cooperate with other states and jurisdictions in sharing bank examination information. Senator Randy Phillips asked if consumers would experience any side effects as a result of proposed law. Mr. Kirkpatrick responded, "Not that I know of." Senator Rieger directed attention to page 3, line 7, and inquired regarding a definition for "financial institution." Mr. Kirkpatrick explained that "depository institution" is defined in Title 6, Chapter 1. Financial institutions are included within that definition. It refers to financial institutions whose deposits are insured by an agency of the federal government. Senator Rieger next referenced page 1, Section 1, and noted that subsections (a) through (f) speak to state banks acting as agents for other entities. Subsection (g) appears to reverse the process and allow state banks to contract with other entities to render services. The Senator pointed specifically to language at page 2, line 19, and asked for an explanation of "by itself through an agent." Mr. Kirkpatrick said that wording prevents a state bank, acting as an agent for an outside bank, from conducting activities prohibited by applicable state or federal laws. Senator Rieger expressed continuing concern that language might impact situations where a state bank might be using an agent rather than serving as an agent. Co-chairman Halford acknowledged a teleconference connection to Anchorage and asked if individuals wished to testify. RON KUKIS, First Interstate Bank of Alaska, advised that he and Jerry Weaver, National Bank of Alaska, were available to answer questions. Co-chairman Frank asked if federal law establishes a limit on concentration. Willis Kirkpatrick said that under the Riegle-Neal Act, Congress would set the limit at 37% if the state does not take alternative action. Most states presently rely on antitrust provisions. Co-chairman Frank voiced his understanding that the state would preempt imposition of 37% by enacting 50%. Mr. Kirkpatrick concurred. Senator Rieger MOVED that SB 168 pass from committee with individual recommendations. No objection having been raised, SB 168 was REPORTED OUT of committee with a zero fiscal note from the Dept. of Commerce and Economic Development. Co-chairmen Halford and Frank and Senators Rieger and Phillips signed the committee report with a "do pass" recommendation. Senators Donley and Zharoff signed "no recommendation." 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.