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The Bank Partnership Model Affirmed in Settlement With Colorado

This groundbreaking settlement resolves the "true lender" issue in Colorado and could be used as a regulatory framework across the country

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The issue of “true lender” has been one that has dogged the marketplace lending industry virtually since its inception. When a borrower takes out a loan from most marketplace lenders the loan is often originated by a partner bank then held on their balance sheet for a short time before being sold to the lending platform. There has been debate about who is the true lender in these circumstances.

In 2017, the Colorado Attorney General filed two separate lawsuits against Marlette Funding and Avant alleging violations of the state’s Uniform Consumer Credit Code by charging interest rates in excess of those allowed under Colorado law. These loans were originated by out of state banks, Cross River Bank and WebBank, who were also party to these lawsuits. These banks are allowed to export higher interest rate caps across state lines but Colorado was saying that this was all a scheme to lend above Colorado’s usury rate limited.

The upshot of these lawsuits was that Colorado consumers had less choice as both Avant and Marlette, along with WebBank, started excluding Colorado consumers from their loan offerings. And it even called into question the business models of Cross River Bank and WebBank as both banks have established long running partnerships with many marketplace lenders.

After years of back and forth, and much time and expense, today the Colorado Attorney General announced a settlement with all parties. It is hard to overstate how important this is for the industry. These lawsuits have been hanging over the industry for years and even though the OCC recently proposed a new true lender rule there was still a great deal of uncertainty.

With this settlement, which amounts to $1.55 million in total, the companies have “committed that they will not lend to Colorado consumers at rates above 36% and will provide consumers with other protections required by Colorado law. In addition, non-bank partners will maintain a Colorado lending license.” There are also certain oversight requirements and they laid out a model for successful bank-fintech partnerships in Colorado. It is this model that could be adopted by other states and become a de facto national standard. Which is why this is big news today.

The industry was clearly pleased with this settlement. I reached out to several parties to get their commentary on what this means. First, Nat Hoopes from the Marketplace Lending Association: [Read more…]

The Ten Biggest News Stories of the Decade in Marketplace Lending

We take a look back at the news stories that shaped marketplace lending in the 2010s

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I started writing about marketplace lending back in 2010, so I have spent almost the entire decade immersed in this space. While we have expanded our coverage on Lend Academy today beyond marketplace lending this remains a major focus.

We have certainly come a long way in the past ten years and the industry is almost unrecognizable from where it was in 2010. Back then there were just two notable companies in the space, LendingClub and Prosper, originating just a few million dollars a month in loans. No one could have predicted that by the end of the decade marketplace lending would have led to a resurgence in personal loans and changed expectations for customer experience across all lending verticals.

As I look back at the past decade here are, in my opinion, the top ten most important news stories in chronological order.

Prosper Recapitalizes and Brings in a New Management Team
(January 2013)

At the time this was a huge story. The number two marketplace lender had been struggling for some time and was in serious danger of running out of money. This new funding round was small by today’s standards at $20 million but it ensured that Prosper would remain a going concern. The deal was architected by, the now fintech legend, Ron Suber as he brought in a new management team and a new board to guide Prosper on to their future growth path. It helped set the industry up for success over the next several years.

LendingClub Becomes First Marketplace Lender to go Public
(December 2014)

This was a momentous day for marketplace lending as market leader LendingClub became the industry’s first company to go public. The IPO was a huge success by any measure. By the end of the first day of trading LendingClub was valued at $8.46 billion and they had raised $870 million in cash. Of course, at the time we had no idea what would happen to the stock but there was a sense a real optimism that this company was going to change the world.

Second Circuit Rules on The Madden Decision
(August 2015)

The biggest legal issue the industry dealt with this decade was the ramifications of the Madden v Midland decision. We have been following this case since the Second Circuit ruling in 2015 and it has had far reaching consequences for the industry. It has led to a reduction in lending activity in Second Circuit states (NY, CT and VT) but the bigger concern was that this kind of ruling would spread nationally. That has not happened and there have been multiple regulatory fixes proposed plus the OCC and FDIC have weighed in as well. But as of this writing nothing concrete has changed since the 2015 decision.

SoFi Raises $1 Billion Led by SoftBank
(September 2015) [Read more…]

The OCC and FDIC Both Propose a Madden Fix

The two banking regulators have each put forward proposal to fix the Madden issue, we cover that as well as the varied reactions to this news

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The Madden saga has been plaguing the marketplace lending industry for years now. We have covered this issue on Lend Academy more than any other regulatory topic. Ever since the 2015 Madden v. Midland decision by the Second Circuit the industry has been weighed down by uncertainty.

There is finally some real light at the end of the tunnel. In the last two days we have heard from both the OCC and the FDIC on the Madden issue, something they called unfathomable in a joint amicus brief in Colorado a couple of months ago. They have each given notice of their proposal that would clarify the “valid when made” doctrine once and for all.

At the core of the issue is the ambiguity created by the Madden decision. A loan can be valid when it is made but if it is sold or transferred can suddenly become invalid in the Second Circuit states of NY, CT and VT. This has led to reduced consumer lending to these states and also concern that, given no regulatory clarity, this could expand to other states.

Here are links to the OCC and FDIC proposals. There will be a 60-day comment period where interested parties can weigh in. Given the high profile nature of this case many public comments have already been made from several interested parties.

Reaction to the OCC and FDIC Proposals

[Read more…]

FDIC and OCC Weigh in on Madden Decision

The FDIC and OCC file a joint amicus brief with a Colorado court calling the Madden decision "unfathomable"

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There were some new developments in the Madden case, something we have been following for many years here on Lend Academy (see here, here and here).

Law360 is reporting (subscription required) about a bankruptcy case in Colorado that involved a high interest small business loan that was originated by a bank in Wisconsin and then acquired by New Jersey-based World Business Lenders LLC. The Colorado company that is currently in bankruptcy proceedings claimed the loan was no longer valid because the interest rate exceeded Colorado usury laws. The judge disagreed and disallowed the exclusion of the loan stating that the loan’s interest rate was “permissible as a matter of federal law.”

What is most interesting about this case is that the FDIC and OCC jointly filed a 34-page amicus brief with the court. It contains some pretty damning language about the Second Circuit 2015 decision in the Madden case. Here is an excerpt from the brief:

Madden failed to consider the valid-when-made rule and the stand-in-the-shoes rule, either of which defeats the debtor’s usury claim. Madden’s disregard of two centuries of established law — without even addressing such law — is not just wrong: it is unfathomable. And it is doubly disconcerting given its negative impact on the credit markets and the banking system.

This is pretty damning language from the two banking regulators. They make it crystal clear that the Madden decision was wrongfully decided in their opinion and should be overturned. Last year there was a “Madden Fix” bill that passed the house with bipartisan support but it failed to progress in the senate.

I reached out to Nat Hoopes of the Marketplace Lending Association and this is what he had to say about this news from Colorado:

There is near total consensus in the legal and regulatory community that the original Madden case was wrongly decided. The FDIC-OCC joint brief in Colorado this week is a key development – it rebuffs Madden as precedent and again confirms the sanctity of the 200-year-old valid when made doctrine. But there is a human element here as well. Research produced by multiple independent academics has documented the many harms Madden produced – including a rise in personal bankruptcies and a sharp decline in available credit in the 2nd Circuit states. So the FDIC – OCC amicus brief in Colorado is also a strong defense of consumers and small businesses that seek to access more transparent, affordable credit options.

This last point that Nat makes is something that does not get enough attention. Because few lenders want to lend in second circuit states above the state usury rates (for consumers it is 12% in CT, 16% in NY and 12% in VT) many consumers find themselves unable to get a loan. So, they resort to payday loans or another form of expensive credit and fall into a debt trap that often leads to bankruptcy.

A legislative fix is still needed and the MLA as well as many other organizations are still pushing hard for it. This amicus brief should make the argument for this fix a little stronger now.

Marketplace Lending & Personal Bankruptcy: Cause and Effect

We highlight an interesting academic paper released last summer that studies the link between personal bankruptcies and marketplace lending

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Perhaps it’s true that money can’t guarantee a lifetime of happiness, but one thing that is fairly certain, personal bankruptcy can guarantee a slew of negative emotions including sadness, grief and shame.

A national wave of personal bankruptcies that began in 2008 reached a peak in the year ending September 2010, when nearly 1.6 million bankruptcies were filed. So traumatic was the emotional impact of all these bankruptcies an entirely new field emerged – financial therapy – to provide counseling to people in need of emotional support due to a monetary crisis.

While the numbers have dropped significantly since the 2010 peak, personal bankruptcy is still a significant issue in the U.S. Filings fell by 1.8 percent for the 12-month period ending March 31, 2018, compared with the year ending March 31, 2017. The data continues a national trend of declining bankruptcy filings since 2010-2011. The March 2018 annual bankruptcy filings totaled 779,828, compared with 794,492 cases in the previous year, according to statistics released by the Administrative Office of the U.S. Courts.

However, the numbers are still substantial and the rate of people 65 and older filing for bankruptcy has tripled according to a recent study from the Consumer Bankruptcy Project. According to the study, the median wealth for over 65 bankruptcy filers is -$17,390. Non-bankrupt Americans of the same age recorded a median wealth of more than $250,000.

Fintech: A Way Out or Gateway to Deeper Debt?

An interesting white paper (The Real Effects of Financial Technology: Marketplace Lending and Personal Bankruptcy) co-authored by Dr. Piotr Danisewicz, University of Bristol and Ilaf Elard, Assistant Professor of Finance at Shanghai University of International Business and Economics was released last summer. It examines how today’s financial technology is affecting household hardship when it comes to personal bankruptcy.

The paper explores how the advancements in fintech are making it much easier to control finances and provide more access to funding, but also suggests that little is known about the risks vs benefits regarding the long-term effects on household financial health. The main question the white paper examines: is the increasing availability of credit pushing individuals to over-indebtedness, default and bankruptcy?

Citing  a number of landmark court cases, the co-authors explore both the risks and benefits of fintech lending, claiming, “To the extent that individuals prefer to avoid bankruptcy, rather than default strategically to discharge debt, marketplace lending has the potential to lower debt refinancing costs and provide households with liquidity in the face of income or expenses shocks, thus reducing the incidence of bankruptcy.”

However, Danisewicz and Elard also suggest that the rapid expansion of marketplace credit could increase the number of bankruptcy cases by increasing consumer debt.

“Besides marketplace lending possibly throwing borrowers into a debt-trap of over-borrowing, the concern is that marketplace loans worsen the risk-composition of borrowers by providing credit to less creditworthy households,” the co-authors point out.

The Madden/Midland Effect

Perhaps the case that has garnered the most attention regarding the yin and yang of the fintech lending world, and the case Danisewicz and Elard spend the most time on in their research, is Madden vs Midland Funding LLC. We have covered this ruling extensively on Lend Academy – see articles here, here and here.

The white paper documents a persistent rise in personal bankruptcies following the Madden ruling and a severe decline in marketplace lending, particularly among low-income households. Danisewicz and Elard also document that marketplace loan defaults and consumer credit by banks and finance companies have remained unaffected, suggesting that increases in personal bankruptcy arise principally from reversing access to new lending technology.

Among the many additional conclusions Danisewicz and Elard reach in the white paper are:

  • The Madden win triggered Lending Club and Prosper, the two largest U.S. marketplace lenders, to reduce lending in the states affected by the verdict.
  • Using monthly data from the U.S. Courts Administrative Office, the paper cites that there are 8% more personal bankruptcy filings in Connecticut and New York relative to other states following Madden.
  • The co-authors attribute the increase in the incidence of personal bankruptcy following Madden to the reduction in marketplace lending. This hypothesis is supported by a number of further results.
  • The consequences of Madden are limited to the enforceability of marketplace loans and suggest that the increase in bankruptcy rates following Madden arises predominantly from changes in marketplace lending.
  • Danisewicz and Elard also rule out that the rise in bankruptcy following the verdict could be the result of an increase in defaults by marketplace borrowers in the affected states. This may occur if marketplace borrowers are over-indebted and default after being unable to obtain additional marketplace loans in the affected states.

Danisewicz/Elard Conclusions

The research in the Danisewicz and Elard white paper suggest in the absence of a clear regulatory framework for fintech lending, the Madden vs Midland verdict also had the unintended consequence of raising personal bankruptcies.

As the co-authors conclude, “Understanding the real effects of financial technology helps to inform the intense regulatory deliberations on the wider fintech industry currently taking place at the OCC, FDIC, Federal Reserve, Treasury, and the Basel Committee on Banking Supervision.”

The Danisewicz/Elard research ultimately concludes that restricting marketplace lending increases personal bankruptcy filings persistently.

“Our findings have urgent policy implications,” the co-authors summarize. “While this paper does not imply that marketplace lending or the fintech industry is void of risks and should be left unregulated, our findings suggest that improving fintech lending regulations may improve access to marketplace funding and help alleviate financial hardship in terms of personal bankruptcy among low-income households.”

There has been bipartisan support in Congress for a Madden fix bill but as yet nothing has moved to a full vote. With a new Congress in place, we hope this legislation can be passed in 2019. As the white paper points out this will be a good thing for consumers.

Bipartisan “Madden Fix” Bill Passes the House

The Protecting Consumers’ Access to Credit Act of 2017 was passed by the US House of Representatives

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We have been covering the Madden issue for several years here on Lend Academy (the full list of coverage is here). Today, marked an important day on this issue as the United States Congress passed the Protecting Consumers’ Access to Credit Act of 2017 (HR 3299), otherwise known as the “Madden Fix” bill.

This is a bipartisan bill that was introduced by Congressman Patrick McHenry (R-NC) and co-sponsored by Congressman Gregory Meeks (D-NY). It passed the house this evening by a margin of 245 – 171 meaning it picked up some support from Democrats (16 votes to be precise).

This bill would restore the “Valid when Made” doctrine meaning that if a loan was valid when it was made it does not become invalid when assigned to another party regardless of state usury laws. The Second Circuit Court of Appeals ruled on a case that meant loans made in Second Circuit states (NY, CT, VT) are exempt from this Valid when Made doctrine and theoretically, loans that are to be transferred from originating banks to non-banks would need to adhere to Second Circuit state interest rate caps. This has led to a significant drop in lending activity in those three states as investors and online lending platforms shy away from making and invest in loans there. This is why a fix is needed.

To get more perspective on what the vote today means we reached out to Nat Hoopes, the Executive Director of the Marketplace Lending Association who had this to say about the bill’s passage:

Over the past decade, borrowers across America have used marketplace loans to start new businesses and save billions of dollars through lower interest rates and more transparent products. Today’s action by the House will help ensure that small businesses and consumers can continue to access these affordable credit products online. This legislation simply restores the law of the land as it stood as recently as 2015, providing greater certainty for responsible, well-regulated and supervised partnerships between traditional banks and their fintech partners.

Gilles Gade, the CEO of Cross River Bank, also gave his perspective:

As a partner to many marketplace lending platforms, Cross River combines the trust, security and established expertise of a community bank with cutting edge technology to facilitate innovation, making responsible credit more accessible and affordable. Today’s bipartisan passage in the House is a positive step towards restoring confidence in the secondary markets and promoting lower cost, more efficient access to credit, particularly in communities who have had more limited access to traditional banking services. We look forward to working with Senators Warner (D-Virginia) and Toomey (R-Pennsylvania) to ensure this access continues while appropriate borrower protection is maintained.

Of course, this bill is still a long way from becoming law and it would need 60 votes in the Senate and then the President’s signature before that happens. Many people view that as unlikely but there are other ways it could become law by attaching it to another bill for example. But that is a story for another day. Today, is a positive first step in the legislative process for the Madden fix.

Why Congress Needs to Act Now to Fix the “Madden Issue”

The new CEO of the Innovative Lending Platform Association has written an op-ed focused on the Madden decision and how it could be fixed by Congress to better serve small businesses.

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[Editor’s Note: This is a guest post from Scott Stewart, CEO of the Innovative Lending Platform Association. ]

Courts are distorting credit markets in a way that hurts Main Street small businesses, and Congress now has an opportunity to fix it.

Imagine you opened a salon two years ago with a chair for both you and your business partner.  Over the years, you built a small clientele and grew steady revenues.  Your business is profitable, and you want to add two more chairs to your shop.  You estimate that the expansion will cost $20,000 but will yield $40,000 annually in new revenue.

Together, you discuss taking out a small business loan with both large and small banks, but they turn you down citing your 640 personal credit score and the lack of two years of business tax returns as the reason for the decline.  So, you reach out to online lenders in the hopes of securing the capital you need to expand and grow your business.

After reviewing your application, an online lender offers your business a $20,000 loan that can be funded in a day and paid back in weekly installments over a six-month period.  The APR seems high – it’s about 40% – but the total cost of capital is only $2,115.  That means you’ll pay $2,115 to borrow $20,000 to fuel your expansion, and that expansion is expected to yield a $40,000 return on your investment.  You and your partner decide to seize the opportunity.

Unfortunately, a recent decision by the Second Circuit Court of Appeals in Madden vs. Midland Funding, is making it difficult for online lenders to offer businesses the funds they need to grow and succeed.  The Madden decision undermined the legal doctrine known as “valid when made,” which has been a cornerstone of banking law for over 100 years.  The principle is simple.  If a loan is legal with respect to its interest rate, then it does not become invalid or unenforceable when sold to another party.  Numerous bi-partisan and non-partisan groups have come out in opposition to the Madden decision, in part because of the dangerous uncertainty it has inserted into the financial markets that are critical to supplying credit to individuals and small businesses.

[Read more…]

The Second Annual Online Lending Policy Summit in Washington

The online lending industry gathers in Washington to hear from lawmakers and regulators

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The Acting head of the OCC, Keith Noreika, takes the stage at the Online Lending Policy Summit

Yesterday, I attended the second annual Online Lending Policy Summit in Washington DC. It was headlined by the Acting head of the OCC, Keith Noreika, Congressman Greg Meeks (D-NY), Congressman Tom Emmer (R-MN) and William Isaac, the former head of the FDIC.

The event was opened by Cornelius Hurley, Executive Director of the Online Lending Policy Institute (OLPI). He then introduced the first speaker, Phil Goldfeder, head of Government Affairs at Cross River Bank, who laid out an overview of where we are today with online lending. Following that we had a panel focused on the Madden issue. There was a long discussion about the impact that this decision has had on borrowers in Second Circuit states: NY, VT and CT. Research has been done by Columbia University and others that show lending is down significantly in the three states and one panelist noted that “no marketplace lending platform is issuing loans in these states to borrowers under a 625 FICO.” If for some reason the Madden decision was to be expanded to all states then lending platform volume could drop as much as 50%. But there was some optimism that a legislative fix would be successful here.

William Isaac was the head of the FDIC under President Reagan and he painted a stark picture of the US today where 60% of the population cannot get a bank loan. He said that we have to do better and figure out a way to lend to a broader cross section of the population.

Acting Comptroller of the Currency, Keith Noreika, struck a surprising upbeat tone in his remarks. He began his speech by saying that online lending was a natural evolution of banking. This caught the attention of American Banker as well as everyone in the audience. He also cautioned that one of the problems with the industry today was a lack of profitability and the fact that the loan books have not been tested in a downturn. These are concerns we have all heard before. Not surprisingly he argued that online lending platforms should consider directly entering the banking industry. But what was interesting was that he did not mention the OCC fintech charter, instead pointing out other the various other types of banking charters that might be suitable for fintech companies.

[Read more…]

Bills Being Introduced to “Fix” Decision in Madden v. Midland

We report on the updates to the Madden v. Midland case and get perspectives from a top law firm and the Marketplace Lending Association.

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The Madden v. Midland case has been a topic many lenders have been following closely for over two years. Our last update was in June 2016 when the Supreme Court denied a petition to hear the case which left the case unresolved. Now bills are being introduced in hopes to fix the ambiguity around this case.

For a historical perspective you can read our coverage of the case at the below links:

An article in American Banker this week from Adam Levitin, professor of law at Georgetown University, provides his perspective on what the bills mean for the case. Levitin expresses concern over the bills, believing that the bills being introduced are overly broad and will facilitate predatory lending.

Nat Hoopes, Executive Director of the Marketplace Lending Association disagreed with Levitin’s assessment. Here is what he had to say:

These bills are strongly pro-consumer. They will help ensure that consumers can continue to refinance their higher interest rate debts, saving consumers significant amounts of money through lower interest costs.  Furthermore, these bills clearly cannot facilitate predatory lending because they do not change the rate or terms on which any entity in this country (regulated at the state or federal level) can lawfully lend money.  The language of the bills simply reaffirms one of the fundamental principles of contract law — that valid loan contracts can be sold on the secondary market.

[Read more…]

Supreme Court Denies Petition to Hear Madden v Midland

Brian Korn, an expert in marketplace lending regulation gives us the latest on Madden v Midland.

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Supreme_Court_Madden_Midland

[Editor’s Note: We recently covered in depth what is going on with marketplace lending and regulation in a podcast with Brian Korn, but this morning we learned that the Supreme Court denied the petition to hear the Madden v Midland case. We got in touch with Brian Korn, Capital Markets Partner at Manatt, Phelps & Phillips, LLP to share with us exactly what this means for marketplace lenders.]

In somewhat of a surprise move, the U.S. Supreme Court denied the petition by Midland Funding to hear the case Madden v. Midland Funding.  The decision leaves in place the decision of the U.S. Court of the Appeals for the Second Circuit that the National Bank Act (NBA) does not provide a shield against state law (namely, the charging of usurious interest under state law).  A national bank cannot sell a loan to a non-bank with that non-bank exempt from state law.  This is what is known as the “preemption argument.”  Despite the strong objections of industry lobbying forces and the U.S. Solicitor General, the Supreme Court denied hearing the case.  By not hearing the case, the precedent of the appeals court stands.  But it does not stand for a wider approval or precedent in any other circuit other than the Second Circuit (NY, CT & VT).  Here are the implications for marketplace lenders:

  1. Non-bank purchasers cannot buy loans from banks operating under the NBA in the Second Circuit that exceed applicable state usury caps.  In New York, by far the largest state of the Second Circuit, the usury cap is 16% without a state lending license, and 25% with a license.
    1. Such loans may be deemed uncollectible.
    2. This is a major problem for securitization of Second Circuit loans, as many securitization trusts purchase loan assets from national banks.
  2. Marketplace lenders generally do not purchase loans from banks operating under the NBA, so Madden technically does not apply to them.  Both Madden and Midland made this argument in their briefs to the Court.  However, the factual analogy is compelling enough to spook investors and therefore platforms away from originating loans in the Second Circuit.
  3. Credit for the over 16% borrower in the Second Circuit will continue to be tight from originators that rely on loan sales or securitization.  This includes subprime consumer and auto loans.
  4. Small business and real estate platforms should not be impacted by the decision.
  5. The case is now remanded to the District Court to decide the two remaining claims:
    1. That both parties elected Delaware choice of law, which recognizes the “valid when made” doctrine and therefore does not rely on the preemption ruling.  Valid when made means if the loan was valid when made, it doesn’t not matter in whose hands it is sold or assigned, the borrower is still bound by the contract.
    2. Even if New York law governs (i.e., the District Court rejects, as is somewhat common, a consumer’s election of law in a fine print credit card agreement), the “valid when made” doctrine is still the law of New York.
    3. The big unanswered question is how the court will apply two competing state laws: valid when made vs. usury.  The judges involved will play a critical role here.
    4. If choice of law is honored or if the home state law honors valid when made, the preemption case will become somewhat of a troubling academic exercise.
  6. Platforms have already started reshaping their legal relationships with banks to be factually distinct from the facts in Madden.  This may mean keeping more loans on bank balance sheets, appointing the bank the master servicer, adding “skin in the game” by banks investing in loans or deferring compensation to banks until the borrower performs on the loan for some or all of the term.
  7. Platforms have also pursued the alternative or complementary strategy of becoming licensed in various states so as to not need to rely on a bank funding partner.
  8. Future challenges to the Madden case are likely to come out of the Second Circuit given the strong negative view of the Solicitor General and the importance of the case to the industry.
  9. We are keeping an eye on the Bethune v. LendingClub, WebBank et. al case and its implications on the “true lender” doctrine.  Unlike Madden which deals with the power of a bank to sell its assets, the true lender cases have the view that there never really was a bank involved.  This case will also be a test of the platforms’ mandatory arbitration clauses contained in every consumer loan agreement.

In some respects this is a positive for platforms which might have faced the prospect of a Supreme Court siding with Madden and effectively “nationalizing” the case.  By denying cert, the Court has localized the damage caused.  Platforms will begin to mitigate the effects of Madden, but in the short term, credit availability in the affected areas to the affected borrowers will be relatively scarce.

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