Garnet Capital Advisors Blog

August 19, 2015

Court ruling could have widespread impact on marketplace lenders

On May 22, a federal appeals court ruled on a case that involved a charged-off credit card debt sale, according to American Banker. In that broad ruling was the decision that a bank's right to charge an interest rate higher than state usury caps didn't transfer to the buyer during a debt sale.

While this ruling was related to credit card debt, the language is broad enough that it could have an impact on marketplace lenders. This led to a chain of events including an appeal to a full appeals court in June, with the decision being handed down in August.

How could this impact marketplace lenders?
Regarding marketplace lenders, this case may have an impact in several key ways. 

According to American Banker, the issue at hand is that marketplace lenders typically issue their loans through banks, who end up holding the loans for just short time spans. By doing so, the marketplace lenders can use the national banks' exemptions from state-level interest rate caps. LendingClub and Prosper, for example, use Utah-based WebBank for this purpose. 

The ruling from the appeals court could challenge this ability, which would in turn cause marketplace lenders to reevaluate their current system. It could also change loan pricing in certain states, depending on interest rates, it could change compliance requirements, and it could alter licensing. One of the biggest issues, however, is the potential for a drastic change in the industry that could revise profitability projections for marketplace lenders.

What happened in the ruling
The ruling was broken down into two main steps. The first was at a smaller appeals court. There, the decision was that banks' rights related to interest rate caps weren't transferrable to debt buyers. 

That decision was also appealed to a full court. The ruling for that came down in early August. And the final decision is that the ruling was upheld, which means marketplace lenders are left in a precarious predicament. They could petition the U.S. Supreme Court for another appeal hearing, or they can accept the ruling and hope that nothing changes.

As for now, it appears that they'll do the latter. The reasoning is that the ruling may not have as big of an effect on the industry as some predict. The initial decision only applies to three states: Vermont, Connecticut and New York, according to American Banker. But the concern is that this will set a precedent moving forward.

"I think it's raised a lot of questions," Rob Lavet, Social Finance, Inc.'s general counsel, told American Banker. "I know there's been much concern about it. That said, I don't know if it will really directly affect the market."

On a similar note, Lending Club's CEO Renaud Laplanche explained to American Banker that the worst-case scenario - exceeding state interest rate caps - could be handled in various ways. Marketplace lenders could end up having to get licensed at the state level to account for the ruling, but that is unlikely.

Right now, all that's left - outside of a long-shot U.S. Supreme Court hearing - is to wait and see. If you have any questions about the current state of loan sales in the marketplace lending arena, don't hesitate to contact loan sale advisory firm Garnet Capital Advisors.