House Financial Institutions Committee Interim Charge: Commercial Usury Texas Department of Banking Testimony of: Randall S. James Banking Commissioner June 16, 2004

Offered by: Texas Department of Banking June 16, 2004 House Financial Institutions Committee Page 2  Financial institutions are capable of extending loans and other forms of credit to facilitate business growth and consumer purchases.  Small businesses employ 46% of Texas’ nonfarm workers. (Source: U.S. Small Business Administration)  Banks are a primary source of lending for small and large businesses.  Increases in business activity leads to new employment opportunities.  Cumbersome usury laws can be an impediment to business lending and growth.  Usury laws that only apply to state banks (and other locally based lenders) create a competitive disadvantage for local banks. A Sound Financial System is Important to Texas

Offered by: Texas Department of Banking June 16, 2004 House Financial Institutions Committee Page 3 Profile of Texas Banking *CIT - Chartered in Texas | **COT - Chartered outside Texas Information is from the FDIC Summary of Deposits as of June 30, 2003 and the NCUA Semi-annual report. Numbers are in millions. State Chartered Banks, Savings Banks and Credit Unions represent 22% of total deposits in Texas.

Offered by: Texas Department of Banking June 16, 2004 House Financial Institutions Committee Page 4 Usury Issues for Commercial Lenders  Rate – A maximum rate set too low might benefit borrowers but limit the availability of funds.  Penalties – Harsh penalties for noncompliance discourage lenders to locate their headquarters in Texas and result in lenders paying high legal costs.  Complexity – Overly complex usury laws result in higher costs for training and compliance and encourage lenders to contract under other states’ laws.  Fees – In the current statute, fees are prohibited unless specifically authorized. This occasionally results in violations of the usury laws when disallowed fees are determined to be interest through court decisions. (See Gonzales Savings and Loan Case)  Effectiveness – Out of state lenders are not required to comply with Texas’ usury laws.

Offered by: Texas Department of Banking June 16, 2004 House Financial Institutions Committee Page 5 Most Other States Have No Effective Commercial Usury TexasNorth D.AlabamaNevadaDelawareIllinois Usury Limit Can vary from 18% to 28% No Limit (1) No Practical Limit (2) No Limit No Practical Limit (3) No Limit Penalties Attorney’s fees plus greater of: (i) 3x overage or (ii) $2,000 or 20% of principal, whichever is less N/A (4) Complexity Complex by industry standards Not Complex Complex Fees If not authorized, fees can be interest N/A Effectiveness Other states’ laws are imported (1)Usury laws do not apply to regulated lending institutions, which include banks, credit unions, trust companies, and finance companies. (2)Any person, corporation, trust, partnership, or association may agree to pay such rate or rates of interest for the loan or forbearance of money; provided, that the original principal balance of the loan or forbearance of money or credit sales is not less than $2,000. (3)Usury laws do not apply if the borrower is a corporation, LP, business trust, or LLC, or the loan is > $100,000 and not secured by a mortgage against the principal residence of the borrower. (4)Penalties are not applicable to commercial lending in this state, since there is either no limit or no practical limit.

Offered by: Texas Department of Banking June 16, 2004 House Financial Institutions Committee Page 6 Usury Effectiveness  How effective are our usury laws for commercial lending?  Do they apply to all the players in the market?  Usury rates can be imported from the home state of out-of-state lenders;  Equity participation and options are legal circumventions. (See Chapter 306, Subchapter B)

Offered by: Texas Department of Banking June 16, 2004 House Financial Institutions Committee Page 7 Preemption of Texas Usury  Federal regulators consistently assert that state law restrictions on lending activities of federally chartered institutions are subject to preemption.  Out of state state-chartered banks enjoy these same preemptions.

Offered by: Texas Department of Banking June 16, 2004 House Financial Institutions Committee Page 8 Usury Problems  Lenders headquartered in Texas have additional legal expense to comply with usury statutes.  Texas lenders cannot be absolutely certain about Constitutional usury issues until the Texas Supreme Court has made a ruling.  Lenders headquartered in Texas risk for violations of commercial usury laws: (i) increased litigation costs, (ii) attorney’s fees to the borrower, and (iii) penalties [which can be the greater of three times the amount of overcharge or $2,000 or 20% of the principal amount, whichever is less].

Offered by: Texas Department of Banking June 16, 2004 House Financial Institutions Committee Page 9 Texas as a Host State