Financial Industry Alert | September.27.2017
On September 25, the Acting Comptroller of the Currency and leading participants in the online lending industry gathered in Washington, D.C. at the second annual Online Lending Policy Institute (OLPI) Online Lending Policy Summit. Here are a few of the interesting highlights from the panel discussions.
Keith A. Noreika, Acting Comptroller of the Currency remarked that "over the last decade, marketplace lenders have originated about $40 billion in consumer and small business loans in the U.S." and that "online lending has doubled every year since 2010." He noted that some companies that set out to be "bank killers" a few years ago are now "discovering the advantages of being part of the banking system." "Some companies now desire to become a bank and a large number of companies are choosing to partner with banks."
Noreika reported on the work of the OCC's Office of Innovation that has been up and running since January. He explained that the primary purpose of the Office of Innovation "is to make certain that institutions with federal charters have a regulatory framework that is receptive to responsible innovation and supervision that supports it."
As to whether fintechs should be chartered by the OCC, Noreika said that deliberations are ongoing. He emphasized, however, that the OCC continues to believe that it has the power to issue such charters and that it is vigorously opposing the state regulators who have sued arguing to the contrary.
While leaving the fintech charter issue open, Noreika suggested that some fintech companies could obtain a charter, even absent the fintech special purpose national bank initiative: "Companies engaged in the business of banking can seek a national bank charter under the agency's existing authority to charter full-service national banks and federal saving associations, as well as other long-established special purpose national banks, such as trust banks, bankers' banks, and other so-called CEBA banks [under the Competitive Equality Banking Act of 1987]. Many fintech and online lending business models fit well into these categories of national bank charters." He added, "Chartering innovative de novo institutions through these existing authorities enhances the federal banking system, increases choice, promotes economic opportunity, and can improve services to consumers, businesses, and communities."
Noreika expressly endorsed congressional enactment of a "Madden fix," making it clear that if "the rate of interest on a loan made by a bank is valid and lawful when the loan is made, the rate "remains valid after transfer of the loan" to a non-bank entity. Such a fix, he explained, would reduce the current "uncertainty by reestablishing well-settled law and would create a uniform standard eliminating the differences in treatment of loans made in different judicial circuits." Such a fix would promote "economic opportunity" and market liquidity.
In response to questions posed after his prepared remarks, Noreika said that if a Madden fix is not enacted by Congress, the OCC will look into issuing regulations and guidelines that support the rule that non-bank purchasers of loans issued by banks may enforce the original interest rates as long as they were valid when issued.
Noreika took a different view, however, about the need for further regulations and guidelines on the "true lender issue." He said that there is already sufficient guidance from the OCC and federal regulators as to when a bank is to be considered the lender for the purposes of preemption. He remarked that while the guidance from the federal regulators is, in his view, clear, that does not mean that courts and state regulators are always adhering to the regulatory guidance.
Noreika refused to directly speak to the CFPB rules regarding arbitration, but said that the OCC was itself revisiting those issues.
A later panel speaker, Dan Quan from the CFPB, noted that the OCC and the CFPB were working closely on a number of issues, and in the end had the same goals—to set safeguards for consumers and let people innovate to provide much needed affordable credit.
Quan also addressed the recent "no action letter" that the CFPB sent to Upstart, a marketplace lending platform. Upstart requested such a letter regarding its lending platform practice (where "a prospective borrower applies for a loan from Cross River through Upstart's platform," "Cross River relies on Upstart's underwriting methodology to decide whether to offer a loan and, if so, on what terms," and "[a]ccredited investors and certain institutions then have the opportunity to invest in those loans"). The September 14, 2017 CFPB letter stated, upon review of the Upstart submission, that the CFPB "Staff has no present intention to recommend initiation of an enforcement or supervisory action against Upstart with regard to application of the Equal Credit Opportunity Act and its implementing regulation … to Upstart's automated model for underwriting applicants for unsecured non-revolving credit." The letter states that it expires in three years but can be renewed.
Quan used the no action letter to indicate that the CFPB is not hostile to innovative lending models. He said that the CFPB recognizes that there is a major issue regarding access to credit, and that innovation is instrumental to facilitating more widely available credit at lower cost.
In another panel, Alex Bean from Prosper spoke. Answering the question of whether the fintech platforms are regulated, he explained that they are subject to a full panoply of federal and state regulation: Prosper's bank partner is subject to full federal oversight by the FDIC and others, while Prosper itself is subject to oversight by the FDIC, CFPB, and state regulators.
On the same panel, Richard Neiman of Lending Club discussed how its products were filling gaps left by the traditional banks. He cited a study showing that in Chicago and Philadelphia, 75% of the Lending Club loans were made in areas where banks have closed branches. He also discussed the credit card debt consolidation loan, which saves the individual from the high credit card interest rates that quickly enlarge credit card debt. Neiman said that the traditional banks have little interest in such loans, and that Lending Club and the other platforms have filled that gap. He further detailed how the loans being facilitated by the platforms were at lower rates than traditional banks would offer.
The consensus on another panel was that the ability of the platforms to fill the gaps left by traditional banks, and grant individuals the affordable credit they need, is still being impaired, especially within the New York area, by the Second Circuit's Madden v. Midland Funding ruling. In that case, dealing with the enforcement of defaulted debt sold to a collection agency, the Second Circuit held that the interest rate preemption afforded to the issuing bank did not extend to the non-bank collection company.
Ram Ahluwaila of Peer IQ said that the Madden ruling "stunned" the capital markets. He cited a study showing a clear reduction in the availability of credit in the Second Circuit after Madden. That study found that the "pattern is most obvious for the very lowest-quality borrowers—those with FICO scores below 625. Outside the Second Circuit, loan volume for these borrowers after Madden grew by 124% (that is, loan volume in absolute numbers more than doubled)." By contrast, "the same statistic for borrowers in New York and Connecticut was negative 52%—meaning that, in absolute numbers, loan volume to these borrowers declined after Madden." Ahluwaila said that if Madden were to apply nationally as much as 50 percent of responsible online lending volume could disappear.
Jeff Meilier of Marlette said that Madden is still "choking" the availability of credit today. All on the panel supported the current Madden legislative-fix proposals in Congress. Meilier noted that even if a fix is enacted the marketplace lending platforms still need to stay engaged with the state regulators to avoid problems going forward. Alexandra Karram from Affirm concurred and made the point that state regulators need to understand the model and its value in order to avoid "true lender" and other challenges.
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Some of our takeaways:
By: Bob Loeb and Howard Altarescu