Expectations are high for marketplace lending in 2020 but, more than any other lending sector, there are legal questions on the horizon that are likely to have an impact going forward.
A Market on the Rise
Marketplace lending deals have been steadily climbing since FinSight started tracking data in 2013. There was a jump from 2018 to 2019 with the number of tracked deals going from 37 in 2018 to 47 in 2019, and the value of those deals rising from $12.3 billion to $15.2 billion. Recently, Kroll Bond Rating Agency predicted a rise in securitized volume of marketplace loans to $17.5 billion in 2020, even though lending guidelines are expected to tighten.
SoFi had the largest consumer loan note offerings in 2019, having expanded from student loans and refinancings to consumer loans in order to better serve a high quality customer pool. Their most recent 2019 consumer loan deals had high FICO scores in the 750s, a weighted average gross income of over $150,000 and a weighted average monthly free cash flow of over $5,000.
TransUnion has reported that, on a broad view, debt consolidation and use of funds for home improvement are driving growth in unsecured personal loans. However, lenders of unsecured personal loans have not pushed further into subprime territory and, in fact, their share of the non-prime market remained steady from 2018 to 2019. Consistently, low delinquency rates for the past few years have also demonstrated the soundness of this approach. TransUnion is predicting lenders will focus more on prime customers going forward in 2020, and expects a slower growth rate for originations because of this risk aversion.
Growth continues despite the uncertainty that has come from Madden v. Midland, which, as we’ve discussed, has disrupted marketplace lending in the Second Circuit. In the past, we’ve noted that regulatory or legislative action is needed to provide clarity to all market participants. And just in the last few months, the OCC and the FDIC proposed new regulations to potentially counterbalance Madden’s upending of the longstanding “valid when made” rule.
The OCC proposes to codify the “valid when made” principle by amending the language of the National Bank Act and Home Owners’ Loan Act. The new language would allow interest that is permissible at the time the loan is made to be unaffected by subsequent events, such as the sale, assignment or other transfer of the loan. The FDIC is proposing a similar amendment to the Federal Deposit Insurance Act.
The proposed rules will not overturn Madden and are not as strong a solution as legislative action might be. But it’s progress. The regulations are still out for public comment and the real test will be, once they are codified, how the courts will interpret them.
True Lender Issues
One area the proposed regulations do not address is the concept of a “true lender,” the other main issue thrown into question by Madden that has been at the center of judicial analyses of usury and loan assignment matters.
The “true lender” issue is playing a controversial role in payday lending in California, where a new law, AB 539, is meant to limit interest rates on installment loans between $2,500 and $10,000. It was reported in late 2019 that several nonbank lenders in California had told their investors during earnings calls that they could avoid the impact of AB 539 by using a “rent-a-bank” structure, which would allow nonbanks to partner with banks out-of-state to get the benefit of a higher interest rate elsewhere. California legislators have sent letters to the lenders, warning them that if they try to avoid this new law, they will face enforcement action.
Reasonable Minds Disagree
We’ve talked about the disparity between Kroll and Fitch’s views of risk in the MPL market, with Kroll more buoyant and Fitch more cautious. At least one lender has pointed out that Kroll’s loss expectations for their securitizations have been consistently and significantly off. Upstart reports that their securitizations have outperformed Kroll’s expectations by 40%-71% on various deals. While this may be an anomaly or unique to this one lender’s portfolio (Kroll has been close to the mark on many others’ deals), it is a good reminder that this is still a relatively nascent sector that is hard to predict.
Because marketplace lending is so algorithm, AI and data driven, and relies on non-traditional means to determine creditworthiness, it’s a space that can change as rapidly as the technology that underlies it. Yet, the speed of evolution is in contrast to the slow path to resolution of the main legal issues facing the market. The market is poised for greater growth once there is more certainty on the legal front.
And, at that point, a new challenge may appear: we still have not seen marketplace lending perform under a recession or real economic pressure. The experience through bad times is what is needed to attract greater investment.
Nicole Serratore, an Attorney, in the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert, contributed to this post and Emily Hatchett, a paralegal in the Insolvency, Creditor’s Rights and Financial Products Group, assisted with this post.