Banks, marketplace lenders, and other nonbank lenders were dealt a setback when a federal appeals court declined to reconsider a ruling that has set off alarm bells across the consumer finance industry.
The May 22 decision involved the sale of charged-off credit-card debt by a Bank of America subsidiary. A three-judge appeals panel in New York found that the bank's legal authority to charge an interest rate that exceeds state usury caps did not transfer to the debt buyer.
In June, the defendants in the lawsuit petitioned the full appeals court to reconsider the ruling, and they were joined by a slew of industry trade groups, including the American Bankers Association, the Consumer Bankers Association, and the Financial Services Roundtable. In friend-of-the-court briefs, these lobbyists argued that the decision would have dire consequences for numerous financial firms.
Some financial industry lawyers who were following the case closely had predicted that the request for a rehearing would be granted, but on Wednesday the Second Circuit Court of Appeals denied it.
The case can still be appealed to the U.S. Supreme Court, but analysts at Compass Point Research & Trading noted Thursday that only 1% of Supreme Court petitions are granted.
The court's decision has sparked widespread concern because its reasoning is broad and would seem to apply to certain marketplace lenders, including industry pacesetters Lending Club and Prosper Marketplace, as well as other nonbanks that also issue their loans through banks. Those relationships allow the nonbank firms to avoid complying with state-level interest rate caps, since banks can apply their home states' rules on loans made across the country.
Lending Club and Prosper, both headquartered in San Francisco, issue their personal loans through the $236 million-asset WebBank, which is based in Utah, a state that does not cap interest rates.
Lending Club Chief Executive Renaud Laplanche has argued that even if the court decision is upheld, his company still has adequate legal authority to rely on Utah law.
But during an Aug. 4 earnings call, Laplanche also disclosed that approximately 12.5% of Lending Club's consumer loan volume would exceed state interest rate limits if the company were forced to obtain state licenses.
Compass Point analysts, who have a "sell" rating on Lending Club, called Wednesday's ruling a "surprise" and a "negative policy development" for Lending Club and other marketplace lenders.
"The Second Circuit decision is only binding in New York, Connecticut, and Vermont but it could have broader implications as market participants begin to question marketplace lending issuance frameworks," the analysts wrote.
The ruling's potential implications go well beyond marketplace lending, also known as peer-to-peer lending.
The decision could affect the sale of charged-off debt by banks, the private-label credit card industry and other nonbank lenders such as PayPal, which partners with Comenity Capital Bank on its PayPal Credit product.