LendingClub Corp. and other companies that arrange consumer loans over the Internet are running out of options in avoiding a legal blow that may force them to lower interest rates they charge certain borrowers.
The U.S. Court of Appeals in Manhattan refused this week to reconsider its decision that effectively restricts the so-called marketplace lenders from bypassing state usury laws by partnering with banks in states where there are no such rules. The ruling effectively would stop a practice whereby the lenders can make a loan to a borrower in, say, New York—where interest rates are capped at 16 percent for most loans—by originating it in Utah, which has no usury limits.
Firms like LendingClub and Prosper Marketplace Inc., also known as peer-to-peer lenders because they started out by directly linking borrowers and funders over the Internet, match up people seeking consumer or small-business loans with investors such as hedge funds.
Barring a successful request for review by the U.S. Supreme Court, the lower court's May ruling means some of these firms' existing loans may suddenly be deemed in violation of state interest-rate caps, Moody's Investors Service said in June. That poses a risk to loans already sold into securities that are helping to finance the industry's growth, and it presents an obstacle to future originations of the highest-yielding credits, which are receiving the most investor demand.
The decision “may create a catastrophe” for companies and investors trying to trade in the debt, Richard Eckman, a partner at Pepper Hamilton LLP wrote in June on the firm's website.
LendingClub, the largest marketplace lender, estimated in an Aug. 4 presentation to investors that 12.5 percent of its consumer-loan portfolio may be affected by the court decision. LendingClub has originated $11.2 billion in loans since 2011, it said. It may have to lower the interest it charges on those loans in order to comply with state laws, or face the prospect of the loans being considered null. Beth Haiken, a spokeswoman for LendingClub, declined to comment.
That's also unwelcome news for debt investors like RiverNorth Capital Management LLC and others that seek high returns for their investors. Moody's warned last month that the ruling poses a credit risk to existing securities tied to the debt, as investment firms like BlackRock Inc. pool loans into bundles to be sold as bonds. Carissa Felger, a spokeswoman for RiverNorth at Sard Verbinnen & Co., declined to comment.
“If interpreted broadly, interest rates on some loans backing marketplace lending asset-backed securities transactions could be reduced, or the loans themselves be void,” Moody's analysts Alan Birnbaum and Matias Langer wrote in a report.
Some investors have warned they may simply shun loans to borrowers in certain states, because they either don't yield as much or could be affected by the decision, Gilles Gade, chief executive officer of Cross River Bank, said by phone last month. The New Jersey-based bank is an origination partner for more than a dozen lending platforms.
The case itself is binding only in New York, Connecticut, and Vermont, but may have broader implications as market participants “begin to question” marketplace lenders' origination frameworks, said Isaac Boltansky, an analyst at Compass Point Research & Trading LLC.
The case is Madden v. Midland Funding, LLC, No. 14-2131, U.S. Court of Appeals for the Second Circuit (New York).
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