Marketplace lenders: The law of agency
WebBank of Salt Lake City, Utah; Cross River Bank of Teaneck, New Jersey; NBT Bank of Norwich, New York and Comenity Capital Bank of Columbus, Ohio: these are hardly household names. But their involvement with the new breed of online marketplace lenders has arguably been far more important than that of the likes of JPMorgan and Citi.
These are so-called agent or issuer banks, through which marketplace lenders have channelled loans to get around the fact that they do not have banking licences. When a borrower qualifies on an MPL platform, a loan note is issued from the issuer bank and the proceeds of the loan (minus a fee) passed on to the borrower. The platform then matches the loan with an investor in a process that usually takes 24 to 48 hours. Once the loan has been funded, the platform buys the loan note back from the issuer bank.
In effect, the online lending platforms rent the regulatory capital and licences of these banks for 48 hours.
They are doing it a lot.
Taking a small cut of each loan it processes, WebBank, owned by ex-hedge fund investor Warren Lichtenstein, generated net income of $31 million last year – a return on equity of 59%. It has just 52 employees. Cross River Bank was launched by Gilles Gade, a veteran of Barclays and Bear Stearns, in 2008 and had done enough business by October last year to launch a $100 million securitization of MPL loans originated by Marlette Funding via Deutsche Bank.
This cosy arrangement has served the sector well. However, when the Department of the Treasury launched a request for information on the online lending industry in July last year, it became clear the good times may be running out. If there is one thing the regulators learned from the financial crisis it was that the originate-to-distribute model in the mortgage industry encouraged lax underwriting because the originator had little incentive to maintain borrower quality on loans that it would sell on in their entirety – exactly what has been going on in the MPL industry ever since.
Unsurprisingly, the issuer banks have been at pains to play down any risks in the current arrangement. “From a regulatory perspective, the origination of [marketplace] loans does not break new ground,” insisted WebBank in its response to the Treasury RFI. “Indeed, this is a business in which WebBank (and other banks) have been engaged for many years. It is a model used for credit-card lending, mortgage lending, student lending, private-label financing and other credit platforms.” This rather Canutian claim has, however, been shaken by a recent decision in the courts that has big implications for marketplace lenders.
Last June, a case was brought against a debt collection firm Midland Funding by a New York-based plaintiff, Saliha Madden, who claimed that its attempt to collect her debt (which carried interest at 27%) breached the Fair Debt Collection Practices Act. This was because New York usury law caps annual interest rates at 16%. The outcome of the case, which has been referred to the US Court of Appeal, found that while banks can collect interest above usury rates thanks to protections from the National Bank Act, non-bank lenders can’t and are subject to the usury law of the borrower’s domicile. Utah, where WebBank is domiciled, does not have a cap on usury rates.
That is a problem for MPLs as their rates often breach these limits. Indeed, in a 2014 earnings call, Lending Club revealed that more than one in 10 of its loans may exceed them. It therefore has an urgent need to tie its non-bank loans more closely to the bank that is issuing them. It will do that by forcing WebBank to have skin in the game through its contractual relationship with Lending Club. In future the issuing banks it works with will maintain a continuing interest in all Lending Club loans after they are sold on and will maintain a contractual relationship with the borrowers.
This will be achieved by Lending Club paying its fees to WebBank in instalments that terminate if the loan stops being repaid.
In its fourth-quarter earnings call Lending Club CEO Renaud Laplanche stated: “As a note of caution we are rolling out this quarter a number of operational and contractual changes to our relationship with our issuing banks that give us a high level of confidence that our issuance framework would meet the tests used in the Madden case if a similar action was ever brought against us.”
He must hope that confidence is not misplaced following a complaint filed by New York-based Ronald Bethune in early April over the 29.97% interest rate on his loan from Lending Club. According to the complaint more than 100 borrowers, many from other states, are joining a proposed class action lawsuit against the marketplace lender.
To soften the blow to the issuing banks on which it relies Lending Club will increase the performance fee it pays to them in return for tying them in to the loan’s performance. The Midland decision only applies to loans originated in Connecticut, New York and Vermont, but it could be applied elsewhere.