Preemption put to a new test
A pair of lawsuits targeting entities that JPMorgan Chase & Co. and Capital One Financial Corp. use to bundle credit-card loans into bonds could threaten the future of the $563 billion market for debt backed by consumer obligations.
At issue is whether credit card interest rates can be considered usurious. A Civil War-era piece of legislation has long shielded national banks from having to comply with state regulations, some of which cap the maximum rate on loans at as little as 5%. But borrowers are arguing that the packaging of credit-card debt into notes to sell to investors removes it so far from a bank that the shield shouldn’t apply.
The defendants say the suits are baseless because banks still maintain customer relationships and charge interest - even if they’ve bundled rights to receive the interest into securities.
Should the plaintiffs prevail, the ruling would chill the market for bonds tied to consumer loans, industry groups say, forcing banks to keep more risk on their balance sheets and stifling their ability to extend credit. The fallout could ultimately extended to the $9 trillion mortgage-backed securities market, causing home loans to fall under a patchwork of state regulations, they warn.
“Is it something that people worry about? Absolutely,” said Scott Cammarn, co-chair of the financial services group at Cadwalader, Wickersham & Taft in Charlotte, North Carolina. “It’s worried about by originators. It’s worried about in the secondary market.”
The plaintiffs - a group of New York credit-card users paying interest rates on their balances in excess of the state usury limit of 16% - are seeking class-action status for the cases. U.S. consumers pay an average interest rate of 17.1% on their credit-card debt, according to the Federal Reserve.
In 2015, the Second Circuit Court of Appeals - which hears cases from New York, Connecticut and Vermont, ruled that banks’ shield from usury laws doesn’t apply if a lender writes off bad credit card loans and sells the accounts to a non-bank debt collector.
The cardholders are arguing that the process of bundling credit card loans into bonds - which requires a bank to sell the debt into a separate bankruptcy remote vehicle - is effectively the same type of transfer, making the credit-card rates usurious under state law and therefore uncollectable. A favorable ruling for the plaintiffs would apply to securitized bonds containing credit-card loans made to borrowers residing within the Second Circuit’s jurisdiction. But market participants say it would likely only be a matter of time before similar cases popped up elsewhere, tied to other types of debt. Credit-card and other asset-backed securities make up about $563 billion of the broader market for securitized bonds.