A History of Texas Credit Service Organization Model
Prior to March of 2005, payday lenders existed in several
states that did not have enabling legislation. These lenders would
utilize out-of-state banks to fund loans to customers while the payday lenders
would act as marketer, processor, and servicer of these loans. The FDIC permitted
the out-of-state banks to import the bank's home state interest
rate into the payday lender's state. As these banks were located in Delaware
or South Dakota, which have no usury cap, there were no interest rate caps
on payday loans. Under this arrangement, known as the "Bank Model", the bank
and payday lender would split revenues. Each lending bank was contractually
obligated for the losses on payday cash advances in an amount established
as a percentage of the interest and/or fees charged by the banks to their
Revised FDIC Guidance
On March 1, 2005, the FDIC issued Revised Guidance to FDIC-insured institutions that offered payday cash advances, including the lending banks that acted as an agent. The Revised Guidance significantly restricted payday lending operations and revenues.
However, in Texas, where most payday lenders had significant operations, a work-around
was put into effect, utilizing Section 393 of the Finance Code permitting them
to operate as "Credit Services Organizations" (CSO's). [For the remainder of this discussion, we will refer to the payday lender as a "CSO"].
The requirements for becoming a Texas Credit Service Organization are negligible. One only need fill out an application and obtain a bond.
As for what a Texas Credit Services Organization can do, here is the statute:
"Credit services organization" means a person who
provides, or represents that the person can or will provide, for the
payment of valuable consideration any of the following services
with respect to the extension of consumer credit by others:
(A) improving a consumer's credit history or rating;
(B) obtaining an extension of consumer credit for
a consumer; or
(C) providing advice or assistance to a consumer
with regard to Paragraph (A) or (B).
(4) "Extension of consumer credit" means the right to
defer payment of debt offered or granted primarily for personal,
family, or household purposes or to incur the debt and defer its
A CSO offers a fee-based credit services package to assist customers in trying to improve their credit and in obtaining an extension of credit through a third party lender. The CSO may charge whatever the market will bear for these services, usually $20 per hundred borrowed, although in some remote regions the charges are as high as $28 per hundred.
A CSO third party Lender, not affiliated with the CSO, provides the actual loan. The third party lender is limited by law to only receiving 10% APR on the loan, plus NSF and late fees. In order to mitigate the Lender's risk, the CSO commits to reimburse the Lender for any loans or related fees that are not collected from such customers. This guarantee is usually provided in the form of a Letter of Credit that the Lender may drawn upon at any time. Including fees, the LOC preferably needs to be 125% of principal.
Generally, however, the Texas Credit Services Organization will reimburse the third party lender directly. The cash flow generated by CSO fees is more than sufficient to accomplish this as traditional default rates are 3-5% of principal.
The CSO model was initially a questionable method by which payday lenders continued to operate in Texas. They based their model on a landmark case in the 5th Circuit Court of Appeals, Lovick
v. Ritemoney, which handed an auto title loan company a victory in utilizing the CSO model.
In March of 2006, The Texas Attorney General issued an opinion letter which stated that the Texas CSO model is legal and fees are not limited.
The Lovick case, however, established a key component in the CSO-Third Party Lender relationship: they must be arm's length. Thus, the Third Party Lender may only collect interest as permitted under Texas law, NSF fees, and late fees. Any other fees that the third party lender collects, whether directly from the CSO or indirectly from another party, may be considered disguised
interest and subject the third party lender to usury penalties.
All public and private payday loan chains are using the CSO model, as well as smaller owner-operators.
Payday Lender's Capital is a Third Party Lender for CSO's.