Subscribe to our InfoBytes Blog weekly newsletter for news affecting the financial services industry.
Governor’s Proposed NY State Executive Budget Includes More Online Lending Supervision; State Assembly Budget “Rejects” Proposed Change
Article 7 of the New York State Constitution requires the Governor to submit an executive budget each year, which contains, among other things, recommendations as to proposed legislation. On February 16, New York Governor Andrew Cuomo released a proposed 2017-18 Executive Budget that includes a proposed amendment to the New York Banking Law that would provide the New York Department of Financial Services (“NYDFS” or “DFS”) expanded licensing authority over online and marketplace lenders. (See Part EE (at pages 243-44) of the Transportation, Economic Development and Environmental Conservation Bill portion of the Executive Budget).
According to a Memorandum in Support of the Governor’s Budget, the proposed amendment would (i) address “[g]aps in the State’s current regulatory authority [that] create opportunities for predatory online lending,” and (ii) “ensure that all types of online lenders are appropriately regulated,” by (a) “increase[ing] DFS’ enforcement capabilities,” and (b) “expand[ing] the definition of ‘making loans’ in New York to not only apply to online lenders who solicit loans, but also online lenders who arrange or otherwise facilitate funding of loans, and making, acquisition or facilitation of the loan to individuals in New York.” If enacted, the NYDFS’s new authority would, under the Governor’s current proposal, become effective January 1, 2018.
This proposal in the Governor’s Executive Budget has, however, been challenged by the New York State Legislature. On March 13, after several hearings on the Governor’s proposed budget, the New York State Assembly released its own 2017-18 Assembly Budget Proposal (“Assembly Budget”), which, among other things, expressly rejected the aforementioned proposed amendment to the banking law found in “Part EE.” The Senate is now expected to release its own budget proposal shortly. And, once it is released, the two house of the State Legislature will reconcile the two bills in committees and pass legislation that stakes out the House’s position on the Governor’s proposals. From there, negotiations will begin in earnest between the Legislature and the Executive, with the goal of reaching a budget agreement on or before March 31, 2017.
 See also N.Y. Banking Law § 340; N.Y. Gen. Oblig. Law § 5-501(1); N.Y. Banking Law § 14-a(1); N.Y. Gen. Oblig. Law § 5-521(3); N.Y. Ltd. Liab. Co. Law § 1104(a).
On September 27, the CFPB entered into a consent agreement with a California-based online lender for allegedly misrepresenting, among other things, the fees charged, the loan products that were available to consumers, and whether the loans would be reported to credit reporting companies. As part of the agreement, the CFPB indicated that the lender would be required to include the correct finance charge and annual percentage rate in all of its online disclosures, and must test those disclosures annually to ensure accuracy and compliance with the Truth in Lending Act. As a result, the lender will be required to pay $1.83 million in consumer redress as well as $1.8 million as a civil penalty.
On July 29, the FDIC issued FIL-50-2016 to request comments on the agency’s proposed Guidance for Third-Party Lending, which aims to “set forth safety and soundness and consumer compliance measures FDIC-supervised institutions should follow when lending through a business relationship with a third party.” Pursuant to the proposed guidance, third-party lending would be defined as “a lending arrangement that relies on a third party to perform a significant aspect of the lending process.” Intended to supplement the FDIC’s 2008 Guidance for Managing Third-Party Risk, the proposed guidance seeks to establish specific expectations for third-party lending arrangements. FIL-50-2016 includes 10 questions related to (i) the proposed definition of third-party lending and the scope of the guidance; (ii) the potential risks arising from the use of third parties, with a particular emphasis on risks associated with third-party lending programs; (iii) the proposed expectations for establishing a third-party lending risk management program, including expectations around strategic planning policy development, risk assessment, due diligence and ongoing oversight, model risk management, vendor oversight, and contract structuring and review; (iv) supervisory considerations, including, but not limited to, credit underwriting and administration, loss recognition practices, and consumer compliance; and (v) the proposed examination procedures, which would establish “a 12-month examination cycle for institutions with significant third-party lending programs, including for those institutions that may otherwise qualify for an 18-month examination cycle.” Comments on the proposed guidance, with a particular emphasis on the questions posed in FIL-50-2016, are due by October 27, 2016.
On June 21, North Carolina AG Roy Cooper, together with Commissioner of Banks Ray Grace, announced a $9,375,000 settlement with two online lenders to resolve allegations that they violated state usury laws. According to the complaint, the lenders offered North Carolina consumers personal loans of $850 to $10,000 and charged annual interest rates of approximately 89 to 342 percent, significantly exceeding the rates allowed under state law. In 2015, Special Superior Court Judge Gregory P. McGuire issued a preliminary injunction to ban the companies from making or collecting loans in North Carolina. In addition to permanently barring the companies from collecting on loans made to North Carolina borrowers, the consent judgment requires the companies to (i) cancel all loans owed by North Carolina consumers; (ii) have the credit bureaus remove negative information on consumers’ credit reports related to the loans; (iii) pay $9,025,000 in refunds to North Carolina consumers, with the remaining $350,000 of the settlement allocated to covering the costs of the investigation, lawsuit, and administering the settlement; and (iv) cease unlicensed lending in North Carolina. The settlement represents North Carolina’s first successful action to ban an online payday-type lender that used affiliation with an Indian tribe in an effort to evade state usury laws.
Nebraska AG Peterson and Department of Banking Announce Settlement with Loan Companies for Alleged Deceptive Practices
Recently, Nebraska AG Doug Peterson, in conjunction with the Director of the Department of Banking and Finance, Mark Quandahl, announced a settlement with four loan companies and their owners for alleged violations of three state laws, the Consumer Protection Act (CPA), the Uniform Deceptive Trade Practices (UDTPA), and the Nebraska Installment Loan Act (NILA). According to AG Peterson, three of the companies “managed and facilitated almost every aspect” of the fourth company’s business. The complaint alleged that the fourth company acted as an unlicensed lender to originate usury-based internet loans to Nebraska consumers by way of electronic transfer. In violation of the CPA and the UDTPA, AG Peterson alleged that the fourth company’s loan agreements deceptively stated that it was a “tribal entity subject to the exclusive jurisdiction of Cheyenne River Sioux Tribe, Cheyenne River Indian Reservation” when it was not; rather, according to the complaint, it is a limited liability company whose profits were distributed directly to its owner. Pursuant to the Department of Banking and Finance’s authority to enforce the NILA, Director Quandahl alleged that the defendants “charged loan origination fees in excess of the state’s maximum origination fee permitted for installment loan licensees and non-licensed lenders.” Under the terms of the settlement, the companies and their owners will pay $150,000 to the state and establish a restitution fund of $950,000 to repay, pro rata, excess interest and fees paid by Nebraska consumers. In addition, more than $557,000 in loans taken out by Nebraska consumers and held by one of the four companies will be forgiven, and credit reporting agencies will be notified to remove the history of the loans. The companies and their owners are prohibited from originating loans in Nebraska until they comply with state law.
On May 10, the U.S. Department of the Treasury (hereafter, Department or Treasury) released a report on “Opportunities and Challenges in Online Marketplace Lending.” The result of Treasury’s July 20, 2015 Request for Information (RFI) on Expanding Access to Credit through Online Marketplace Lending, the report summarizes the Department’s understanding of the online marketplace lending industry, including the potential benefits and risks of the growing industry in relation to consumers’ financial needs. Treasury’s key observations and findings are discussed in sections three through six of the report – Background and Definitions; Treasury Research Efforts and Themes from (RFI) Responses; Recommendations; Looking Forward.
Background and Definitions
The report provides a high-level overview of the two primary business models in online marketplace lending: (i) direct lenders originating loans to hold in their own portfolios (or balance sheet lenders); and (ii) platform lenders that partner with an issuing depository institution to originate loans, subsequently purchasing the loans and reselling them to whole-loan investors or issuing securities tied to the performance of the loans. Commenting on the various types of consumer loans offered through marketplace lending, the report identifies the unsecured consumer credit market (debt consolidation, credit card repayment, and home improvement), small business credit market, and student loan market as constituting the majority of the industry’s business. The report also notes that the industry is moving into the mortgage lending and auto loan markets. According to the report, while both direct lenders and platform lenders have altered their frameworks to allow for “flexibility in varying economic environments,” neither has demonstrated an ability to perform well in a less than favorable economic environment: “[o]nline marketplace lenders have demonstrated their ability to improve operational efficiencies, but neither the durability of technology-driven operations and credit underwriting, nor the sustainability of investor demand for loans, have yet been tested during a downturn in the credit cycle.”
Treasury Research Efforts and Themes from RFI Responses
The report summarizes approximately 100 industry responses to the RFI. According to Treasury, the overarching topics that emerged from the comments included:
- Data and Modeling Techniques for Underwriting: While the industry’s use of data as an underwriting tool to provide loans in targeted market areas expedites credit assessment and reduces cost, the report suggests that it also poses disparate impact risk in credit outcomes and could lead to fair lending violations. Many commenters highlighted the efficiency benefits of automated data sources, while others expressed concern for the lack of transparency when using “big data.”
- Access to Credit: Industry stakeholders maintain that online marketplace lending is expanding access to credit by lending to borrowers who otherwise might not qualify for loans from traditional financial institutions.
- Operational Challenges: According to commenters, a gap in lenders’ servicing and collection capabilities exist. In addition to concern that new underwriting models have not been tested through a full credit cycle, consumer advocates expressed concern for the industry’s reliance on servicing and collections firms: “[w]here depository institutions have tended [to] perform most functions internally, many online marketplace lenders are choosing to specialize in certain core functions while outsourcing other services.” Since new underwriting models and underlying operations of the industry have not been tested in deteriorated credit conditions, commenters’ main concern in relation to the “heavy” reliance on outsourcing services to collections and servicing firms lies in the possibility of a rise in delinquencies and defaults.
- Consumer Protection: RFI commenters addressed a need for “uniform consumer protections across financial institutions and online marketplace lenders,” with many consumer advocates arguing for enhanced safeguards for small business borrowers: “[s]mall business loans do not currently operate under all of the same consumer protection laws and regulations as personal loans, but may receive protection only under contract law or the enforcement of fair lending laws under ECOA. Consumer advocates argued that many small business borrowers should be treated as consumers.”
- Transparency: Most commenters agreed that greater transparency in disclosure forms would benefit industry participants, borrowers and investors alike.
- Secondary Market Activity: Commenters acknowledged that the secondary market for whole loans is underdeveloped, noting that although trading platforms for online marketplace securities have emerged, they’re not widely used. Generally, commenters agreed that the industry would benefit from a transparent and “well-functioning securitization market with active repeat issuance.”
- Regulation: Commenters’ views regarding the regulatory regime surrounding the industry varied. Some argued for a uniform regulatory regime, others recommended an ongoing interagency working group, and several argued that existing regulations sufficiently address industry risk. A need for greater regulatory clarity was expressed in many comments, with commenters drawing attention to the following areas: (i) consumer protection; (ii) small business protection; (iii) cybersecurity and fraud; (iv) true lender designation in the platform business model; (v) BSA/AML requirements; and (vi) risk retention.
Based on its understanding of the marketplace lending industry and review of responses to the RFI, Treasury makes the following policy recommendations in the report: (i) support greater small business borrower protections and effective oversight; (ii) adopt industry servicing standards that ensure sound borrower experience from customer acquisition through collections in the event a loan becomes delinquent; (iii) promote a transparent marketplace by, among other things, creating a “private sector driven registry for tracking data on transactions, including the issuance of notes and securitizations, and loan-level performance”; (iv) expand access to credit through sound partnerships with traditional financial institutions and Community Development Financial Institutions; (v) support the expansion of safe and affordable credit through government held data by promoting the use of smart disclosures (the release of information in standard machine readable formats that third-party software can easily process) and data verification sources; and (vi) facilitate interagency coordination by creating a standing working group to include the Treasury, CFPB, FDIC, Federal Reserve, FTC, OCC, Small Business Administration, and SEC that would, among other things, identify areas where additional regulatory clarity could benefit consumers.
In its final section, the report addresses trends and developments that Treasury believes “should be closely watched.” Regarding evolving credit scoring models, the report expressed concern on behalf of consumer advocates that increased automation and accuracy of credit scoring may “create a vicious cycle where those already disadvantaged will pay more for credit, and therefore be more likely to become financially fragile and default, and the cycle will repeat itself.” Referencing an increase in delinquency rates from January to December 2015, as well as an increase in charge off rates from October 2015 to December 2015, Treasury further stresses the need to monitor how the industry tests and adapts models in an unfavorable credit environment. Additional areas to monitor highlighted in the final section include: (i) the investment community, noting that as securitization activity increases, “[p]rudent loan underwriting, securitization transaction pricing, and robust governance and disclosures are necessary to ensure market soundness”; (ii) cybersecurity, encouraging financial sector firms to develop sufficient baseline protections and best practices to mitigate the risk of cyber incidents and to protect consumers; (iii) Bank Secrecy Act requirements, emphasizing that FinCEN will continue to monitor the industry for money laundering and terrorist financing risks; and (iv) mortgage and auto loan markets, with Treasury continuing to monitor the origination volumes and loan performance as these sectors within the industry develop.
CFPB Issues Report on Payday and Installment Loans; Director Cordray Weighs in on Online Lending Industry
On April 20, the CFPB issued a report titled “Online Payday Loan Payments,” which covers an 18-month period in 2011 and 2012 and examines how online lenders’ attempts to recover debts are affecting consumers. Also on April 20, the CFPB held a press call during which Director Cordray delivered remarks regarding the small-dollar lending market, specifically focusing on findings included in the simultaneously released report. According to Director Cordray, online payday lenders have considerable power over consumers’ bank accounts because they use automated networks to deposit loans and collect payments, which often results in banks or credit unions charging consumers overdraft and non-sufficient funds fees. Director Cordray further summarized key findings from the report, including, but not limited to: (i) half of online consumers incurring an average of $185 in bank penalties – in addition to the penalties imposed by the lenders and the average annualized interest rate of 300% to 500% – as a result of reoccurring failed debits made by online payday lenders; (ii) one-third of online consumers losing their checking or savings accounts due to overdraft and non-sufficient funds fees; and (iii) consumers facing “hefty bank fee[s]” due to lenders’ repeated debit requests, despite the fact that second payment requests have a 70% failure rate, with third or subsequent payment attempts failing at an even higher rate. Director Cordray concluded by emphasizing that the CFPB’s “process of reforming the market for small-dollar loans” is ongoing, and that the CFPB will consider the data from the report as it prepares new regulations to address the industry.
On April 18, Senators Sherrod Brown (D-OH), Jeffrey Merkley (D-OR), and Jeanne Shaheen (D-NH) sent a letter to the Government Accountability Office (GAO) requesting that it complete a study on the fintech industry. Under the Dodd-Frank Act, the GAO is required to examine the regulatory structure of person-to-person (P2P) lending. While the letter recognizes that the GAO issued a report on P2P lending in 2011, the senators urged the GAO to recognize that the lending platforms of financial technology firms (often called fintech) “has changed dramatically and evolved beyond consumer lending,” and that “P2P lending, now generally called marketplace lending, is not the only form of fintech that has developed over the last several years.” The letter further cautions that, “gaps in understanding and regulation of emerging financial products may result in predatory lending, consumer abuse, or systemic issues.” Finally, Senators Brown, Merkley, and Shaheen urged the GAO to provide responses to questions relating to, among other things, (i) the size and structure of the loan portfolios maintained by privately owned fintech lenders; (ii) how fintech lenders’ relationships with financial institutions impact both the financial system at large and regulatory framework; (ii) whether the risks that may arise from the investor base shifting from individual investor to institutional investor have grown since this issue was first noted in the GAO’s 2011 report; and (iii) the anti-money laundering, data security, and privacy requirements fintech companies are subject to.
On April 14, the FTC announced the first of a series of events intended to examine consumer protection across several areas of emerging financial technology. Scheduled to take place in Washington, D.C. on June 9, the first forum will focus on marketplace lending, bringing together industry participants, consumer groups, researchers, and government representatives to examine (i) the different models used by companies in the industry; (ii) potential consumer benefits; (iii) potential consumer protection concerns; and (iv) how existing consumer protection laws may apply to companies in the industry.
On April 12, CFPB Assistant Director for Installment Lending and Collections Markets Jeffrey Langer delivered remarks at the San Francisco LendIt USA Conference on the marketplace lending industry. Langer began his remarks by summarizing the CFPB’s Project Catalyst initiative, which was designed to support and encourage consumer-friendly innovation pertaining to financial products and services, such as marketplace lending. Langer, referencing the CFPB’s recently released consumer bulletin on online marketplace lending, commented that marketplace lending is a “young” industry with both potential benefits and potential risks. For example, Langer explained that marketplace lenders may be able to offer consumers faster and more convenient methods of obtaining credit, and may also have fewer overhead costs to pass along to consumers as compared to brick-and-mortar institutions. However, Langer also expressed concerns about the industry’s agility in changing markets, opining that, “[i]t is unclear whether marketplace lenders’ have adequate loan servicing infrastructure or the ability to scale infrastructure quickly and effectively in the event of [an economic] downturn.” According to Langer, “it is simply too soon to know whether marketplace lending will be able to realize its potential as a means of delivering credit at a lower cost to consumers (and small businesses) who have the ability to repay the loans they obtain or whether the marketplace lending business model will prove unable to sustain itself through a full business cycle.” Langer additionally noted that marketplace lenders could face fair lending risk as a result of introducing new types of data and/or analytics in making credit decisions.