Lending Club Tweaks Business Model in Effort to Thwart Legal Challenges
The nation's largest marketplace lender is taking new steps to fend off the threat that it will have to heed state interest-rate caps.
Lending Club announced Friday that it is making changes to its contractual relationship with the bank that issues its loans. The move is designed to protect San Francisco-based Lending Club against legal challenges to its business model.
WebBank, a $327 million-asset institution in Salt Lake City, issues loans on behalf of Lending Club and numerous other online lenders. Lending Club did not name WebBank in its press release. WebBank declined to comment.
The burgeoning industry has been hoping the Supreme Court would overturn a problematic lower-court ruling, but the unexpected passing of a conservative stalwart makes that outcome less likely.
In the worst-case scenario, they'll get state licenses and reprice a portion of their loans, but executives of the highflying industry say they doubt such steps will be necessary.
Because of a regulatory quirk, Lending Club and its competitors depend on banks to issue their loans. The set-up raises questions about the regulatory outlook for the fast-growing marketplace lending sector.
Because banks have the ability to export their interest rates nationwide, online lenders have chosen to partner with banks in order to avoid the hassle of getting licensed in dozens of states. In some cases, consumers end up paying higher rates than would be allowed under state regulations.
Lending Club announced the changes as the online lending industry waits to learn whether the Supreme Court will hear the appeal of a Second Circuit Court of Appeals decision that has dampened investors' interest in the sector.
That case, Madden v. Midland Funding, involves the sale of charged-off credit card debt by a Bank of America subsidiary. The appeals court found that the bank's legal authority to charge an interest rate exceeding state interest rate caps did not transfer to the debt buyer, which limited the amount of money that could be collected from the borrower.
Even though the Madden case does not directly involve online lending, it has scared some investors interested in buying bonds tied to the sector's loans. Their fear is that the courts will force online lenders to reduce the interest rates on some outstanding loans, leading to losses for investors.
More recently, a second federal court decision in Pennsylvania, Kane v. Think Finance, raised related legal questions for the online lending industry. "Those are bound to give some people pause," Jahan Sharifi, a lawyer at Richard Kibbe & Orbe, said in an interview earlier in the week.
The impact of the Second Circuit decision, which was issued in May 2015 and is binding in New York, Vermont and Connecticut, has been building for months.
In August, Lending Club disclosed that approximately 12.5% of its consumer loan volume would exceed state interest rate limits if the company were forced to get state licenses. That disclosure was apparently intended to reassure investors about the scale of any potential losses they might suffer.
In its latest announcement, Lending Club stated that its issuing bank will now maintain an ongoing economic interest in all loans made, and that the bank will only get paid when borrowers make payments on their loans.
"The majority of the bank's revenue is tied to the terms and performance of the loans," Lending Club's press release stated.
The issuing bank also maintains an "ongoing contractual relationship with borrowers," the press release stated.
In the press release, Lending Club Chief Executive Renaud Laplanche said that the Madden v. Midland case "did not pose an immediate threat to our business."
Still, he added that "we believe this new structure will strengthen the foundation of our program to provide borrowers the ability to access affordable credit on a nationwide basis and to provide investors with greater certainty."
The press release was short on details about the revised contractual relationship. But the changes seem likely to be more substantial for WebBank than they are for Lending Club, said Alex Johnson, an analyst at Mercator Advisory Group.
Previously, Lending Club paid WebBank a service fee based on the number of loans the bank issued each month, according to a 2014 regulatory disclosure. WebBank held onto the loans for just two business days, according to a separate disclosure.
Under the revised agreement, WebBank appears to have much more stake in the performance of the loans.
"If you think about WebBank's business model, they've had incredibly low risk and low costs in that model for so long," Johnson said. "This is definitely going to be a change for them."