A federal appeals court ruling against a debt collection agency could spell trouble for marketplace lenders.
In late May, the 2nd U.S. Circuit Court of Appeals in New York said that two units of Encore Capital Group did not qualify as national banks, and did not deserve protections such banks get against claims brought under state usury laws.
Moody’s Investors Service is concerned that other courts could apply the ruling to securities backed by consumer debt that is originated on marketplace lending platforms.
Encore’s Midland Funding and Midland Credit Management acquire debt from banks at a discount, hoping to collect a higher amount. In this case, the borrower, Saliha Madden, objected to a 27% interest rate that Midland sought to impose on a roughly $5,000 debt it had bought, and which she had incurred on a credit card account opened years earlier at Bank of America.
The decision revolves around a federal law that allows national banks to charge interest on loans at the rate allowed by the laws of the state where the bank is located, without regard to the laws of the states where the borrowers reside. The 2nd U.S. Circuit Court of Appeals in New York said that Midland did not deserve such protections.
Moody’s believes that the case has implications for marketplace lenders that rely on third-party bank relationships to originate loans, which the banks typically sell to the marketplace lenders a few days after origination. In some cases, these loans carry interest rates that exceed usury limits in the states where the borrowers reside. However, the interest rates are permissible because a bank that benefits from federal preemption of state usury laws originates the loans.
“Applying the court’s reasoning in the Madden decision, a non-bank entity buying a loan from a bank would be subject to applicable state usury limits and the loan buyer might not be able to charge and collect interest at the contract interest rate,” the rating agency wrote in report dated Friday and distributed this morning. “In a worst case, some of the loans could be void or unenforceable.”
The Madden decision adds to the legal uncertainty for securitizations of marketplace loans. Last week the Treasury Department launched an inquiry into the industry, asking for information about the impact of broader securitization of these loans and whether marketplace lenders should be required to keep a stake in loans that they sell.
Moody’s said that, because of the potentially far-reaching implications of the Madden decision, there is likely to be clarification on its impact, either by judicial decisions or through bank regulatory guidance. On 19 June, the Madden defendants petitioned the Second Circuit for a rehearing. If the Second Circuit declines, the defendants can ask the US Supreme Court to review the case.
“The defendants contend that the Second Circuit’s decision conflicts with prior judicial decisions, arguing that it is a fundamental principal of usury law that if a loan was valid when made, it will continue to be valid when it is subsequently sold,” the report states.