North Carolina is a pretty big military state. There's Fort Bragg, home to the 82nd Airborne and Special Operations Command of the Army. There's Camp Lejeune, home to the 2nd Marine Division and a cornerstone of the Marines' East Coast presence. The state is dotted by air stations, bases, and installations from east to west.
That influence has shown itself in an unusual way over the past several years, as top military brass in the state inserted themselves into the political workings of financial regulation, and they did it in the name of national security. Here's how it went down.
The back story -- the big business of subprime personal loans
In 2013, SpringLeaf Financial (NYSE: LEAF), a subprime lender that serves borrowers with poor credit, sold shares in an initial public offering and in doing so opened up their books to the public.
The company's most recent filing with the SEC is as of the quarter ended June 30. SpringLeaf reports a hair over $12 billion in total loans outstanding, the vast majority of which are the small, personal loans to subprime borrowers.
SpringLeaf saw earnings per share rise 12.5% from the third quarter of 2013. Net income was $103 million for the quarter, which works out to about 5% of shareholder equity. Return on assets calculates to 0.73%.
Neither of these metrics is outstanding, and they both fall short of other traditional lenders. The FDIC reports in its Quarterly Banking Profile that the average return on assets for traditional banks was 1.07% in the second quarter. Average return on equity was 9.54%.
Perhaps more telling, though, is the investor response after the company's IPO last year. The stock has nearly doubled over the time, outperforming the broader indices handily. Subprime personal loans are clearly big business.
For banks, it's a fine line between profitability and public perception
The business model of lenders like SpringLeaf presents an interesting look into the intersection of politics, business, and public perception in the world of finance.
On one hand, banks have a fiduciary responsibility to shareholders to maximize profits. On the other hand, though, banks have an ethical obligation not to take advantage of customers who lack a full understanding of financial concepts. The rules that dictate how this balance plays out are drafted through political processes guided by a healthy dose of public perception.
These issues are present in many regulated industries, but in this particular case, the issues spilled over and turned into not just a political debate, but also a national security concern.
At the heart of this are consumer advocacy laws designed to protect individuals with poor credit scores from price gouging. When an individual with poor credit needs a loan to repair an automobile, to pay a medical bill, or for another legitimate need, banks and other lenders are limited on the interest rate they are allowed to charge.
Typically, banks and non-bank lenders charge interest rates dependent on the level of risk in the loan. For a loan that is more likely to default, the bank will charge a higher rate. Lenders argue that interest rate limits in the laws haven't kept up with the cost of doing business and in some cases fail to match the level of risk in a given loan.
The actual interest rate limits vary, but typically an annual rate of 30%-36% is the maximum allowable. In North Carolina, the previous law stipulated a maximum 30% interest rate on the first $1,000 of the loan and a maximum of 18% on the remaining balance up to $6,500.
When consumer advocacy and national security meet
In 2011, a bill proposed to raise those limits was met with outspoken opposition from the state's military leadership. Generals suggested that allowing soldiers to take out these loans with such high rates would make it nearly impossible for the individuals to ever pay off the loan.
The generals worried that under that financial burden, the soldiers could accumulate an unsustainable debt level that could put their security clearances at risk, or, worse yet, it could create an opportunity for a nefarious foreign agent to take advantage of the soldiers' financial troubles to coerce espionage.
The bill in North Carolina was defeated at the time, but a compromise was passed into law that raised the allowable interest rates to 30% on the first $4,000 and 24% on the next $4,000.
Coming full circle
In this case, military leaders stepped in to protect their subordinate soldiers from a very common financial pitfall. The U.S. education system doesn't address personal finance across the board, leaving many Americans without the basic tools needed to avoid predatory loans, save for retirement, or even balance a checkbook.
The issue is complex, to be sure. There are several factors pulling the debate in different directions. These lenders operate in a needed niche; these subprime borrowers have a genuine need for loans when the unexpected happens.
The lenders have a fiduciary responsibility to maximize profit without breaching an ethical responsibility to avoid price gouging and predatory practices. And all the while, lawmakers and regulators have a responsibility to set fair rules for the game.
If nothing else, this example should highlight the need for everyday citizens and investors to work to improve financial education, from the most basic concepts of budgeting and understanding debt to more complicated concepts such as stock investing.
It's up to us all to help the world invest better.
