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For Ed Gallagly, it was just one more distressing story of a credit union Ul member caught in the catch-22 world of fringe banking.

Mr. Hernandez, who barely speaks English, is a member of Gallagly's Florida Central Credit Union in Tampa. In a meeting with the credit union loan manager, Hernandez was clearly beside himself. He borrowed $1,000 from a local pawnbroker that was licensed to make "title" loans. In exchange, he signed over the title to his car. He paid the shop $220 each month for five months-$1,100-and then returned to get his car title back.

"You're not done paying yet," he was told. "The payments you made covered the service fees. Now you owe the principal. That's another $1,000."

Fortunately, Hernandez turned to his credit union for help, and Florida Central loaned him the $1,000 he needed. But sadly, many customers who use the services of fringe bankers-check cashers, pawnbrokers, payday lenders, and rent-to-own shops-can't turn away. They don't understand the high price of the deals they make, and they don't think they have any other options.

Title loans, payday loans are big business

Fringe banking outlets far outnumber U.S. credit unions. In fact, pawnbrokers and check cashers alone total more than 20,000, according to their respective trade associations. The industry has been around since the early part of the century, but expansion boomed with bank deregulation in the 1980s. When traditional banking left unprofitable communities, fringe bankers moved in.

The automobile title pawn business is a relatively new development in the industry. They're legal in only a handful of states, but where they exist, they've grown rapidly and command a large share of the market. With these loans, the borrower uses a car for collateral and, in some instances, gives the lender the title along with power of attorney. This lets the lender transfer the title to itself if the borrower defaults.

The business is controversial, and those who get into it do so for different reasons, according to a Filene Research Institute report, "Lower Income Americans, Higher Cost Financial Services," written by Prof. John Caskey of Swarthmore (Pa.) College.

Some fringe bankers are in this business strictly for the finance and service charges. In Georgia, a pawnbroker can charge 5% interest on outstanding principal each month plus a 20% monthly service charge. Others are in the business to acquire used cars at bargain prices. These lenders typically won't notify borrowers who become delinquent. Instead, they wait for the grace period to expire and then seize the cars.

Check cashers process some $60 billion worth of personal, payroll, and government checks annually. They've grown beyond mom-and-pop neighborhood centers, and many have become sophisticated, customer-oriented businesses. The largest check casher is publicly traded Ace Cash Express, based in Irving, Texas. It operates 725 companyowned stores and 100 franchise stores in 29 states. Other larger companies, such as General Electric Capital, Chase Manhattan, and Citibank, also are getting into the business through investing in or partnering with large check cashers.

States pay some attention to regulating the industry: Nearly half require either a license or registration. Generally, fees for cashing low-risk checks, such as payroll or government checks, are 2% to 3%. But a growing portion of check cashers' business is payday loans: Ace Cash Express' 1997 payday loan revenue of $10.1 million was double the volume of business in 1996, according to the Consumer Federation of America (CFA).

In a payday loan transaction, the check-cashing operation holds a customer's check for deposit at a later date for a prearranged fee. The check casher then advances the funds.

When the loan is due, the customer has three options: Redeem the check with cash or a money order, allow the check to be deposited, or renew the loan by paying an additional fee.

Some states have banned these loans altogether while others allow them under a separate approval process, according to a survey by the American Association of Retired Persons. Few states require fee caps. But these businesses are finding ways to circumvent state usury laws and other lending statutes, too. State consumer protection laws aren't preventing rate gouging nor are they promoting informed decisions, according to CFA. Companies generally assess fees per $100 borrowed, or a percentage of the check's face value. Under Iowa's law, for example, the annual percentage rate (APR) is 780% for a $100 loan issued for seven days; for five days, it's 1,034%. CampusCash serves Midwestern university communities exclusively and will advance amounts from $50 to $300 at 467% APR. The company will extend loans up to 28 days.

Payday lenders must disclose APR as part of the Truth in Lending Act, but people desperate for money don't care. "These businesses do a very good job of selling the payment, and all the rest is just paperwork," says Chet Luney, chief executive officer of Tampa (Fla.) Hillsborough Action Plan (THAP)-a nonprofit agency that provides housing, social, and medical services to inner-city residents.

Payday lenders fill the small-loan market that the majority of mainstream lenders have abandoned, CFA says.

A 1998 CFA report shows what a booming service payday loans have become: Missouri licenses about 450 payday lenders. Oklahoma estimates 900 of 1,400 licensed small lenders are in the payday loan business. Idaho, which had two payday lenders in 1993, now has 74. Iowa's payday lenders increased from two to 64 in two years. Louisiana licenses 345.

Inside fringe banking

The least affluent one-third of consumers are the primary users of fringe banking services, according to Stephen Brobeck, CFA's executive director. "These businesses are meeting consumer demand. They're convenient. And many of them are no more expensive than some banks that charge consumers repeatedly for bouncing checks."

In his landmark book about the industry-"Fringe Banking: Check Cashing Outlets, Pawnshops, and the Poor"-Caskey concludes that alternative banking options are poorly understood by the general public and by most traditional financial institutions. Lower-income households turn to check cashers and pawnshops because they provide products, services, and overall convenience that banks, thrifts, and credit unions don't, Caskey says.

But it's not just low-income consumers who use these services. "Consumers who have maxed out their credit cards are turning to payday loans for quick cash," says Jean Ann Fox, CFA's director of consumer protection. "People who aren't being served by traditional banking outlets use fringe bankers. These people are working folks who are doing what they can to keep up."

Florida Central's Callagly agrees. "Any major disruptions to their budgets, such as car repairs that must be done immediately, will throw them for a loop. They get desperate and they see no other sources for unsecured loand."

In Caskey's Filene study, he looked at who provides what services to lower-income households, how these businesses operate, why they charge such high fees, and what opportunities exist for credit unions seeking to expand their services into this market. Some of his findings:

One-third of households that used fringe bankers were members of credit unions.

One of five households that used fringe bankers had no deposit accounts in mainstream financial institutions. The main reason for not having these accounts was that they had little or no saving.

A significant minority of households surveyed use check-cashing outlets, but those that do are heavy users of their services.

Money orders are a very popular payment mechanism among modest-income huseholds.

About half of households that used fringe bankers had credit cards.

One of 20 lower-income households took out personal loans from credit unions within the past year, compared with one of 10 who have personal bank loans and one of 10 with finance company loans.

One of 10 lower-income households used either pawnbrokers within the past year or rent-to-own shops within the past two to three years.

Where permitted by regulation, about one of 25 lower-income households used check-cashing outlets for payday loans.

"Most people turn to the alternative financial sector because their financial characteristics exclude them from the services of depository institutions, not because they lack physical access to banks and credit unions," Caskey points out.

One of the largest markets for check-cashing outlets is the "unbanked" consumer, which is made up of 10 million to 12 million consumers. Many of these people currently cash government or payroll checks and pay bills with cash or money orders. The federal government's push to issue all its benefits electronically-EFT '99-has also had an impact on the check-cashing industry's marketing and partnership strategies.