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Bank Challenge: Collaborating with Online Lenders PDF Print E-mail

Bankers are facing increasing regulatory challenges to collaborating with online marketplace lenders.

 

Bank Administration Institute

Executive Report


May 2015

 

 

By Robert Stowe England

 

 

The success of online marketplace lenders is motivating

banks to find ways to partner with these companies,

acquire them, or duplicate what they see happening in

this new industry. However, as banks look to initiate that

collaboration, the task has been made more difficult

by last November’s advisory letter from the Federal

Deposit Insurance Corp. (FDIC) on how to manage the

risk of purchased loans from third parties.

 

The letter “basically says that banks getting into

investing in marketplace loans will need to have

processes in place to make sure that they can do

due diligence on the loans and the underwriting

appropriately,” says Tom Nolan, practice leader for

global finance at K&L Gates LLP, Washington, D.C. In

effect, bankers will have to evaluate the marketplace

platforms and how they operate to make sure that

all relevant banking and consumer regulations are

followed, Nolan explains. They will even want to know

about the vendors to the platform, such as loan

servicers, to make sure there are no hidden risks

there for the bank.

 

The new FDIC guidance raises the prospect that loans

originated by online marketplace lenders will have to

be underwritten a second time by the bank, which is

making matters far more complicated than they need to

be, according to Linda McGreevey, president and CEO

of the Online Lenders Alliance, based in Alexandria, VA.

“You’re supposed to be able, as a bank, to manage your

risk – not avoid all risk,” McGreevey says.

 

Regulators have been concerned for some time about

the increasing reliance of banks on outsourcing to cut

costs and they have issued guidance they say should

help make sure those relationships have been managed

properly. During 2012 and 2013, for example, the FDIC,

the Office of the Comptroller of the Currency (OCC), the

Consumer Financial Protection Bureau (CFPB) and the

Federal Reserve System all issued either guidance or

bulletins on mitigating third-party risk.

 

The compliance task facing both banks and their

lending partners is extremely complicated, “a Gordian

knot that has to be unwound,” and not to be taken

lightly, according to Todd Baker, managing director at

Broadmoor Consulting LLC, based in San Francisco. To

hammer home the point, regulators have made third

party and counterparty risks “a big focus” of compliance

examinations in recent years, Baker says.

 

Third party due diligence now has to focus on how

loans are originated, how they are serviced and how

collections are handled, according to Baker. Banks must

also look at how the automated underwriting works

and be comfortable with its ability to properly evaluate

the sophisticated analysis based on data that goes into

determining the credit worthiness of borrowers.

 

Usury Preemption Threatened

 

Just as bankers look to online marketplace lenders

to grow their consumer and small business lending,

the online companies look to banks such as WebBank

of Salt Lake City, UT and Cross River Bank of Teaneck,

NJ, for compliance help. “The banks take care of making

sure the loans are originated properly so anyone that

buys them can feel comfortable the compliance side

is a go,” says Baker. Importantly, the banking partner

provides the online lender with preemption from many

laws, including state usury laws that set caps on

interest rates.

 

The problem is that the ability of banks to give

marketplace lenders preemption on usury rates was

thrown into question last year in a ruling by the U.S.

Circuit Court of Appeals for the Second Circuit in the

case of Madden v. Midland Funding. The court ruled

that federal exemption protections given to credit card

companies that use higher interest rates than those

limited by state usury laws do not apply to buyers of

credit card debt. The case was appealed to the U.S.

Supreme Court.

 

In a surprising move on March 18, the Supreme Court

asked the U.S. Solicitor General for his views on the

case and how he thought the court should rule before

deciding to hear the case. “It is likely the Solicitor

General will reach out to various banking agencies, the

Fed and probably CFPB and get their views and how

they think the federal government should respond,”

says Richard Eckman, a partner at Pepper Hamilton in

Wilmington, DE. A response from the Solicitor General

was due in May.

 

If, based on the Solicitor General’s response, the

Supreme Court decides to take the case, and ultimately

decides to uphold the circuit court decision, “it could

spawn a host of class action lawsuits challenging the

rights of holders of such loans to collect interest at the

rates made by the originating bank,” Eckman says

 

Despite significant third party compliance issues,

banks are moving ahead to meet the competitive

challenge from online marketplace lenders by “giving a

lot of thought to how they can best participate in the

market,” Nolan says, noting that some banks will want

to partner with a marketplace lending platform on a

white labeling basis, in which the bank’s name appears

in all communications with the borrower. Others may

want to develop their own technology in-house. Or, it

may be less expensive to acquire an online lender with

the required capability, especially given the decline in

valuations for those companies, according to Nolan.

 

Banks and marketplace lenders have already set up a

number of strategic alliances. WSFS Bank of Wilmington,

DE, agreed in 2013 to originate and refinance

student loans using LendKey, a New York-based

marketplace lender. San Diego, CA-based Union Bank

in 2014 decided it would buy loans originated by San

Francisco’s LendingClub, a major online marketplace

lender. In 2015, Premier Community Bank of Hillsboro,

OR, agreed to originate loans using the marketplace

platform of Portland-based Mirador Financial

 

Perhaps the most significant partnership to date is the

one announced last year between New York City-based

JPMorgan Chase & Co. and OnDeck Capital Inc., a New

York-based marketplace lender specializing in small

business loans. Working together, the two partners

were able to incorporate Chase’s underwriting protocols

Compliance Challenge of Collaborating with Online Lenders

into OnDeck’s technology, according to Julie Chen

Kimmerling, executive director of Chase Business

Banking, based in New York. “The credit risk appetite is

entirely determined by Chase and, frankly, is within our

current risk appetite” in small business lending at the

bank, she says.

 

Importantly, OnDeck’s credit evaluation and

underwriting of Chase customers for offers from the

bank “is not a duplication of efforts,” says Brian Geary,

head of bank partnerships at OnDeck. “What we bring

to the table is innovation in both customer experience

and credit scoring.”

 

The partnering companies have also worked to

make sure the customer experience meets Chase’s

requirements. “This is a Chase product for Chase

customers and no matter which part of the experience

is handled by OnDeck or Chase, the entire experience

end-to-end is vetted as a Chase experience,”

Kimmerling says. After completing the current pilot

phase, Chase expects to offer loans up to $250,000

by invitation only to small businesses that are already

clients of the bank. Borrowers who receive offers will be

able to apply and receive funding the same or next day.

 

Another way for banks to address third-party

compliance issues is to build an in-house marketplace

platform, the approach taken by Boston-based

Eastern Bank, New England’s largest small business

lender, to profitably make more loans under $100,000.

 

Copyright (C) 2016 Bank Administration Institute

 

Mr. England is a contributing writer to BAI Banking Strategies

and the author of Black Box Casino: How Wall Street’s Risky

Shadow Banking Crashed Global Finance.

 

 

 

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