Companies such as LendingClub Corp. that arrange Internet loans to consumers seem destined to be forced into lowering interest rates for certain borrowers following a U.S. Court of Appeals ruling.
The U.S. Court of Appeals in Manhattan, New York, has refused to reconsider its earlier decision that restricts "marketplace lenders" for sidestepping state laws by forming partnerships with banks in states where no such rules exist.
This ruling will stop the practice lenders can make a loan to a borrower for as as example in New York where for most loans interest rates cap out at 16 per cent - by originating it in a state like Utah, where no usury limits exist.
Companies such as Prosper Marketplace Inc , and Lending Club which are referred to as peer-to-peer lenders because they began by directly linking funders and borrowers over the Internet, matchup loan seekers with investors like hedge funds.
Without a successful appeal ruling by the U.S. Supreme Court, the lower court’s ruling means some of these peer-to-peer lender's current loans may be deemed contradicting state interest-rate caps. That presents a risk to loans already sold into securities that are assisting to finance the industry’s growth, and lays out an obstacle to future originations of high-yielding credits, which attract the most investor demand.
Richard Eckman, a partner at Pepper Hamilton LLP said the decision “may create a catastrophe” for investors and companies trying to trade in the debt.
The largest marketplace lender LendingClub in August calculated that 12.5 percent of its consumer-loan portfolio could be affected by the court's decision. Since 2011, it has originated $11.2 billion in loans and may now have to lower interest rates it charges on those loans to comply with state laws, or face the prospect of the loans being classified as null and void.
LendingClub declined to comment on the latest court ruling which was also unpopular news for debt investors such as RiverNorth Capital Management LLC, and others that look for high returns for investors. Last month Moody’s warned that such a ruling posed a credit risk to current securities tied to the debt, as investment companies such as BlackRock Inc. bundled loans to be sold as bonds.
RiverNorth declined to comment.
Alan Birnbaum and Matias Langer, both Moody's analysts, wrote in a report “If interpreted broadly, interest rates on some loans backing marketplace lending asset-backed securities transactions could be reduced, or the loans themselves be void."
Chief executive officer of Cross River Bank, Gilles Gade, said investors have warned they would simply turn down loans to borrowers in certain states, because they didn't yield as much or they may be affected by the court decision. The New Jersey-based bank is an origination partner for more than twelve lending platforms.
Isaac Boltansky, Compass Point Research & Trading LLC analyst said the case at present is applicable only in Vermont, Connecticut and New York but may have wider implications as the market “begin to question” marketplace lenders’ origination structures.