A tiny Brentwood bank is caught in the middle of a showdown between federal regulators and payday lenders – one that could hold up plans to sell the bank.
Publicly traded NCAL Bancorp, the holding company of National Bank of California, is one of a few dozen banks under investigation for possible fraud by the Justice Department over processing of payments for high-interest payday lenders.
Though National Bank is a relatively small bank, it’s a major processor of the kinds of electronic payments favored by such lenders. The bank has assets of only $342 million, and last year processed more of those payments than a bank nearly 200 times its size – San Francisco’s Bank of the West. Last year, National Bank was among the nation’s top 40 processors of such payments.
While industry groups say about 50 banks and payment processing firms are under investigation by the Justice Department, NCAL is the only company that has publicly announced it is under federal scrutiny. Bank executives declined to comment beyond that disclosure for this article.
The Justice Department and other federal authorities have said they are trying to protect consumers from scam artists and unlicensed lenders, but payday lending and payment processing industry groups say the feds are trying to choke off payday lenders by scaring away the banks they work with.
NCAL executives first mentioned the federal investigation in a September announcement about a plan to recapitalize the bank. They said an unnamed investor plans to buy millions of new shares, essentially taking over the holding company and bank. But NCAL noted that the Justice Department inquiry and other loose ends must be tied up before that can happen.
It’s NCAL’s second recent attempt at a sale. Downtown L.A. bank holding company Grandpoint Capital announced a plan last year to buy NCAL, but the two institutions walked away from the deal in January.
At the time, Henry Homsher, NCAL’s chief executive officer, said that the deal was canceled because Grandpoint couldn’t close the acquisition by the end of the year and because of problems in NCAL’s loan portfolio.
It’s unclear whether the Justice Department’s inquiry helped to kill the Grandpoint deal. However, federal scrutiny of banks that process electronic payments has been ramping up for years.
Homsher and Don Griffith, chief executive of Grandpoint, declined to comment for this article. A Justice Department spokeswoman also declined to comment.
Some other banks under investigation by the department have moved to curtail their payments business, cutting ties with payment processors who work with online lenders, said Marsha Jones, director of the Third Party Payment Processors Association, a Washington trade group formed this year.
NCAL could follow suit, but that could cut into the struggling bank’s business. Payment processing is a source of fee income and cheap deposits, both of which NCAL needs. The bank has been losing money since 2009 and its assets have shrunk by nearly $100 million since peaking that year.
“There’s a big opportunity for a bank with a third-party payment processor,” Jones said. “For every transaction on behalf of the processor, they receive income for that. And the processor has deposits with the bank. We’re talking about a lot of money.”
Niche market
Headquartered in Brentwood, National Bank has branches in Sherman Oaks, the Fairfax District and Costa Mesa after selling off two others. It ranks 36th largest among the 60 banks based in Los Angeles County.
The bank, founded in 1982, has long promoted its electronic payment services. It works with merchant services companies to process credit card payments and is one of a few small banks that can originate payments through the Automated Clearing House system, or ACH.
Through that system, banks can pull money directly out of an individual’s account at any other bank without using a check or a debit card. Those payments are often used for recurring bills, such as mortgage payments.
But they are also used by payday lenders: companies that make short-term, high-interest loans, mostly to the working poor. For example, a customer gets a loan of a few hundred dollars, and the payday lender automatically deducts the amount owed from the customer’s bank account on the next payday.
Only federally insured banks can use the ACH system. Most ACH payments go through the nation’s biggest banks. Last year, San Francisco’s Wells Fargo & Co. processed $3.5 billion in ACH payments, according to Herndon, Va., trade group Nacha, formerly the National ACH Association.
That group publishes an annual list of the nation’s top 50 ACH originators. NCAL has made the list in each of the past two years, ranking 37th last year. It’s one of four banks on the list with assets of less than $1 billion and the only Los Angeles County bank on the list.
Processing ACH and credit card payments are niche services that many banks don’t offer directly. Jack Wilson, chief executive of Orem, Utah, merchant services firm Complete Merchant Solutions, said those services require their own kind of underwriting and specially trained bankers who know the business.
“When National Bank of California decided they wanted to get into the business, they recruited talent,” Wilson said. “They have to oversee things. The bank has five folks over there just dedicated to merchant services business.”
NCAL gets tiny fees for every transaction – perhaps just tenths or hundredths of a percent of a transaction amount – but also gets low-cost deposits as processors must park some money at the bank.
However, federal officials have said they are examining banks that that work with payday lenders in part because many lenders that operate online might be violating various state laws. Payment processors that work with payday lenders might also be targeted because they often have higher rates of returned payments – a red flag for regulators – than other types of merchants.
But higher return rates are a predictable part of the payday lending business, said Peter Barden, a spokesman for the Online Lenders Alliance, a trade group in Alexandria, Va. Customers who use payday loans often have bad credit and might not be able to pay a loan when it is due, leading to payments returned because of insufficient funds.
“You tend to see some higher return numbers,” Barden said. “That is not an indication of fraud on behalf of the lender or the customer.”
He said federal authorities should focus their efforts on unlicensed lenders and other bad actors, not on the payday lending industry generally.
Cutting ties
NCAL executives have not said how they plan to resolve the Justice Department’s inquiry. But in announcing the recapitalization plan, NCAL executives said they anticipate closing the deal early next year.
That time line suggests that the likely outcome is a settlement, rather than a lengthy battle.
A settlement could require NCAL to curtail its payment processing activities. The bank’s filings with the Federal Deposit Insurance Corp. do not detail the source of its deposits or the amount of income received from processing payments. And though its stock is traded over the counter, the bank is small enough – and has so few shareholders – that it does not have to file reports with the Securities and Exchange Commission.
But in the bank’s 2010 annual report, executives noted: “National Bank of California is a leader in ACH services, and our electronic payments processing and merchant card services continue to grow and contribute to the bank’s profitability through fee income and deposit balances.”
Of course, things could be worse. Federal officials have said banks that process fraudulent payments could face civil and criminal penalties. Last year, the Justice Department and other regulators fined Wilmington’s First Bank of Delaware $15 million for originating fraudulent payments. The bank was stripped of its charter and shut down.
