July 20 — The volume of loans provided through marketplace lender LendingClub hasn't substantially changed since a federal appeals court held that maximum interest rates are determined by the borrower's—not the lender's—state, a Bloomberg BNA analysis has found.
The finding suggests that the marketplace lender has been able to sidestep the impact of a May 2015 decision by the U.S. Court of Appeals for the 2nd Circuit in Midland Funding, LLC v. Madden, in part by renegotiating terms with its originating bank (Midland Funding, LLC, et al. v. Saliha Madden, Docket No. 15-00610).
The court held that debt-purchasing companies don’t necessarily qualify as national banks under the National Bank Act and are therefore not exempt from usury laws in the borrower’s home state.
As a result, warehouse and online marketplace lenders like LendingClub and Prosper Marketplace—which arrange loans between an originating bank, borrowers and other investors in an originate-to-distribute model—are unable to export the higher interest rate cap of the originating bank, oftentimes located in Utah or New Jersey, when they sell off the loans to debt purchasers.
The Supreme Court in June declined to hear an appeal of the case, letting the decision stand throughout the 2nd Circuit, which covers New York, Connecticut and Vermont (124 BBD, 6/28/16).
So far, LendingClub loans haven’t changed in average interest rate or risk, either in the 2nd Circuit or nationwide.
Both the total number and value of loans and the amounts arranged through the company have only grown, not diminished, while average FICO scores measuring a borrower's credit rating remain consistent, and internal loan grades have remained the same. One exception is that the average value of borrowers' previously requested FICO score did increase steadily since the decision, even though FICO scores at the time of loan issuance did not.
LendingClub has also continued to arrange loans to borrowers in the 2nd Circuit that surpass the interest rate caps in those states. The Madden decision does not prevent national banks from providing loans above a state’s interest rate cap. Instead, it applies to debt collection agencies that purchase those loans.
As a result of the court’s decision, LendingClub in February renegotiated terms with WebBank—the Utah bank that originates all of the loans through the online service (40 BBD, 3/1/16)
The new terms were set to comply with precedents set by other cases cited in Madden and give the originating bank vested interests by ensuring an ongoing relationship with borrowers.
Under the new arrangement, WebBank maintains ongoing accounts for the borrowers and receives regular payments from LendingClub—called “loan-trailing fees”—rather than a single lump sum fee on every loan it originates. The loan trailing fee is based on the total amount serviced by the bank and a “loan fee factor.”
A LendingClub representative told Bloomberg BNA that the company does not publicly disclose the amount of the loan fee agreement with WebBank.
While LendingClub didn’t think the Madden decision applied to its business model, LendingClub Founder and former CEO Renaud Laplanche stated in Securities and Exchange Commission filings that the new arrangement with WebBank would strengthen its ability to lend.
Kevin Petrasic, partner with White & Case, told Bloomberg BNA that LendingClub's restructuring ensured that WebBank had “skin in the game” and dampened the potential impact of the Madden decision.
The FDIC did not respond to a request for comment on whether the agency maintains rules to determine whether an originating bank has an ongoing relationship with borrowers.
In March, the number of loans arranged by another marketplace lender, Prosper Marketplace, dropped by 40 percent. Around the same time, Moody’s downgraded bonds backed by Prosper loans. Moody’s removed the warning in July.
Representative for Prosper attributed any changes in lending to general market fluctuations but would not comment further for this story.
In 2015, the state of Vermont cited Prosper for offering loans without a lender license, after the company let its previous license lapse. Prosper has since obtained a new license from the state.
Ram Ahluwalia, CEO of PeerIQ, a peer-to-peer investment analysis company, told Bloomberg BNA that Prosper had ceased to lend to borrowers in Vermont.
LendingClub has not been cited in Vermont but has a pending application with the state.
Ahluwalia added that some lenders like SoFi are not experiencing struggles over originating banks because they have taken a state-by-state licensing approach.
“There is no ambiguity as to the lender of record since there is no intermediating agent bank,” he told Bloomberg BNA.
In the Madden case, the solicitor general filed a brief amicus curiae calling the decision “incorrect” and contending that the analysis was a misunderstanding of precedent.
LendingClub spokeswoman Deborah Solomon said in a statement that the company supported the solicitor general’s view, believing that the decision was “at odds with the ‘valid-when-made’ doctrine.”
“While we are confident that the facts of the case do not directly apply to our business, we look forward to a decision by the lower courts which will reduce unnecessary uncertainty for investors on our platform,” the company told Bloomberg BNA in a statement.
Since the fallout from the subprime mortgage crisis, numerous academic papers have criticized the originate-to-distribute model—in which a national bank originates loans, then soon sells them off—employed by both online lenders and some mortgage brokers.
A 2009 paper from the Federal Reserve Bank of Atlanta said that loans sold into the secondary market through originate-to-distribute underperformed other loans by 9 percent. A 2010 academic paper funded by the FDIC’s Center for Financial Research also implicated the originate-to-distribute model in the subprime crisis.
According to the paper, “lack of screening incentive created by the separation of origination from the ultimate bearer of the default risk has been a contributing factor to the current mortgage crisis.”
Author and University of Michigan Finance Professor Amiyatosh Purnanandam told Bloomberg BNA that part of the problem with the originate-to-distribute model is that once the debt is sold, the originating bank has nothing at risk and the debt buyers don’t always have the skill in evaluating good borrowers as national banks do.
“[Debt buyers] are not always tied in to the community of banks, and some of them are insurance companies,” he said. “Without the originating bank, online lending is dependent on data and models to assess risk. But appraised values can be inflated and models can be inaccurate.”
To contact the reporter on this story: Llewellyn Hinkes-Jones in Washington at email@example.com
To contact the editor responsible for this story: Heather Rothman at firstname.lastname@example.org
The 2nd Circuit decision is available at https://www.bloomberglaw.com/s/opinion/57c384fb6a0e3e777ca8dcc4ab7a3637/document/X19C0QKP0000N
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