Madden v Midland Funding
Some of you may have heard about this case and that it may/might/could/is already affecting marketplace lenders.
Miss Madden had a Bank of America credit card and defaulted on her payments. Midland Funding is a debt buyer and collection agency based in San Diego. Midland bought the debt of Miss Madden, who is a NY resident, and added additional interest costs to her debt balance and tried to collect the total. Madden thought this was wrong and filed suit.
In May, the Supreme Court declined to hear an appeal of the case maintaining the decision made by the 2nd Circuit which covers the NE including New York.
So what does this (or could this) have to do with peer lending?
Which state controls/presides over the loan?
In peer to peer lending, we have an originating platform like LC or Prosper based in CA, the actual loan originating bank like WebBank based usually in either Utah or NJ, the borrower who lives wherever they live and all of us lenders who live all over the country.
This Bloomberg article has some of the best analysis I’ve seen on what this case is and what it means to all investors big and small.
The 2nd Circuit decided that Midland as a non-bank debt buyer is not subject to the provisions of the National Bank Act. As soon as Midland bought Madden’s debt, they became subject to NY’s usury laws (laws regulating how much interest consumers can be charged for a loan) and could not add additional debts and interest to the loan that went over and above NY’s usury limit, currently at 25% annually.
The impact as stated in the Bloomberg article for marketplace lending platforms is “warehouse and online marketplace lenders like LendingClub and Prosper Marketplace—which arrange loans between an originating bank, borrowers and other investors in an originate-to-distribute model—are unable to export the higher interest rate cap of the originating bank, oftentimes located in Utah or New Jersey, when they sell off the loans to debt purchasers.”
So the borrower’s state of residence means more to the max interest rate they can be charged than where the loan was originated OR where the loan was sold. This could have a huge impact on lending platforms but so far it hasn’t. Just like how some of you are in states where you can't invest your own money. Some institutions and banks and other investors will not be able to buy certain loans at certain interest rates potentially limiting and affecting the supply of money to fund loans.
Lending Club reaction
LC dealt with this decision by renegotiating their deal with WebBank ensuring that WebBank has more of a direct and ongoing involvement with the borrowers. LC's own counsel and other securities attorneys believe this more direct relationship lessens the potential impact of this Madden decision. We shall see if that is true, and LC has other things it needs to work on since its executive shakeup. Their recent hire of Patrick Dunne from BlackRock as Chief Capital Officer should help them get back on course and regain lenders’ confidences.
Prosper on the other hand is standing pat with its current model and moving along with business as usual. They seem unaffected so far.
Will Madden apply to performing loans?
As a debt buyer and collector, Midland focuses on defaulted debt. An important question about this decision is will this apply to performing loans (meaning loans where the borrower is paying on time or slightly late and not in a state of default or collections)?
So far, we don’t know. This is a concern for the entire industry that a loan originated on a platform can’t be sold at the full interest rate charged to the borrower if that borrower’s interest rate is above his/her state’s usury law. This has not been challenged yet from either side and it is something we will be watching. This is the biggest unknown taken from this decision. Institutional buyers and secondary markets for peer loans in particular could be impacted in limiting their ability to buy loans.
This decision is fraught with uncertainty and markets do not like uncertainty. As retail investors, we need to watch how this could affect us and it could by limiting the supply of institutional funds to buy loans or creating limitations and restrictions on interest rates charged to certain borrowers. Without their funds our loans could take longer to get funded.
These two things, especially declines in institutional funding volume, are things I am going to be looking out for and you should too. Even though we don't like admitting it, we need the institutions to help keep funding robust and active on the lending platforms.