US marketplace lending firms should be freed from restraints around “true lender” status that have arisen due to regulatory developments, such as the Madden vs Midland case. This is according to a recent US Treasury report, which also suggests improvements to servicing standards and borrower communication in the federal student loan sector.

The US Treasury highlights the growing role of fintech and nonbank firms in lending in the US, with 3,300 new fintech firms founded between 2010 and 2017. 40% of these are focused on banking and capital markets and lending from these firms now makes up more than 36% of all US personal loans.

The report highlights the importance of marketplace lending in expanding access to credit for consumers and businesses in the US and, in line with this, recommends eliminating constraints resulting from various court cases, such as Madden vs Midland.

It adds that Congress should codify the “valid when made” doctrine to preserve the longstanding ability of banks and other financial institutions, including marketplace lenders, to buy and sell validly made loans without coming into conflict with state interest-rate limits.

Vincent Basulto, partner at Richards Kibbe and Orbe, comments: “It’s helpful to have the support of the government behind the sector and it provides further momentum behind a resolution for the Madden vs Midland issue. It was hoped originally that it would resolve itself naturally over time, but it has since become ingrained in law.

“People are now coming to the conclusion”, he continues, “that there needs to be a cohesive push, including from Congress, to get the issue resolved in a collaborative fashion, on a national level. It still remains the major regulatory issue in the sector and the status quo doesn’t benefit lenders or consumers. There is generally a feeling in the report that there needs to be some degree of harmonisation and a streamlined approach to regulating the sector.”

In the realm of mortgage lending, the report notes that traditional lenders have - since the financial crisis – ceded market share to non-bank lenders, which now account for 50% of new mortgage originations. Both depository and nondepository lenders are now moving toward a digital front-end, either through a proprietary platform or commercially available products.

Additionally, the use of online platforms to submit mortgage applications has increased from 28% in 2016, to 43% in 2017. Few lenders, however, currently have the capability to complete the digital front-end, but instead use a digital application to trigger referral to a loan officer to continue the process in a paper-based way.

Capabilities to support a digital back-end are even less developed in the sector, but it remains integral in offering an end-to-end digital mortgage product, although this is hampered by disparate rules and non-uniform recognition of electronic and remote online notarisations.

The development of digital mortgages could be supported by wider use of electronic promissory notes (eNotes) due to the advantages for the mortgage industry and borrowers in providing convenience, quality control efficiencies and faster origination timelines. eNotes are also, the report states, more readily transferred between holders as they are bought and sold in the secondary market, cost less to store and transmit than paper and offer greater protection against unauthorised tampering, alteration or loss.

The report recommends that Ginnie Mae accepts eNotes and supports the measures outlined in Ginnie Mae’s 2020 road map to develop digital abilities. Additionally, the report suggests that states yet to authorise electronic and remote online notarisation, pursue legislation to explicitly permit the application of this technology and the interstate recognition of remotely notarised documents.

In the area of student lending and servicing in the US, the report highlights that the federal student loan programme represents more than 90% of outstanding student loan volume and is managed by an extensive network of nonbanks for servicing and debt collections. The programme is very complex due to a variety of loan types, repayment plans and product features that are difficult to navigate and increases the difficulty and cost of servicing.

As a result, the report recommends that the US Department of Education establishes and publishes minimum effective servicing standards, to provide clear guidelines for servicing and help set expectations about how the servicing of federal loans is regulated. It also backs greater use of technology in communications with borrowers, enhanced portfolio performance monitoring and management and greater institutional accountability for schools participating in the federal financial aid programmes.

In the area of communication and servicing Basulto also sees room for improvement and that the federal programmes can learn from online lenders. “Federal student lenders”, he says, “could certainly heed the example of the private loan online firms particularly in terms of harnessing digital communication. Their servicing capabilities also are generally pretty solid.”

Basulto adds that concern around servicing is being seen across the board: “What I would say however is that as the credit cycle is expected to turn, scrutiny of the quality and capabilities of servicers is increasing from investors.

“They want reassurances”, he continues, “that servicers will be able to handle a potential uptick in delinquencies, should the economic situation turn. This is being seen across asset classes and there are particularly concerns in subprime auto loans and unsecured consumer lending, including marketplace lending.”

In general, when it comes to the ability of marketplace loans to survive and perform through a downturn, Basulto is quietly confident about marketplace loan securitisations. He says: “In terms of MPL ABS I think that the deals are generally well supported in terms of credit enhancement to maintain cashflows for the foreseeable future. Equally, rating agencies have certainly been pretty conservative in their ratings.”

The report also highlights the growing demand in the US for short-term, small-dollar loans, but says that lenders have been constrained by unnecessary regulatory guidance at a federal level. As such, the US Treasury recommends that the CFPB rescind its Payday Rule, which applies to nonbank short-term, small-dollar lenders, as states already maintain the necessary regulatory authorities and the rule would further restrict consumer access to credit.

Alongside the Treasury report, The Office of the Comptroller of the Currency (OCC) announced that it will begin accepting applications for national bank charters from non-depository fintech companies engaged in banking. The OCC states that fintech firms that receive special purpose national bank charters will be supervised like similarly situated national banks, to include capital, liquidity, and financial inclusion commitments as appropriate.

Basulto has mixed views on the OCC announcement, although he is clear about the general reception of the decision. He comments: “This was viewed as a really positive sign for the sector and received enthusiastically from almost all corners. However, it could be seen as something of a symbolic gesture because it is unlikely that more than a handful of firms will even be willing at this point to apply and I wouldn’t be surprised if not even one new firm has applied and secured a charter by a year from now.”

He adds: “At best it is only going to be the largest, most established platforms in the country that will consider applying. Less established lenders just won’t be able to meet the criteria and it therefore has somewhat limited applicability.”

Additionally, Basulto suggests that firms may not be successful or may not even bother to apply for a bank charter because the OCC’s requirements - including management expertise, liquidity, capital and financial inclusion – are things many fintech firms will not have and it raises the question about whether the OCC is considering what fintech firms are really capable of. He adds that the announcement does still indicate, to an extent, that the OCC is supporting the development of new types of financial firms.

A bigger concern may be the level of opposition at a state level that fintech firms may face. According to Basulto, the last time the OCC charter issue was raised it was met with “fierce criticism and was challenged from a number of states”, which fear losing control over the companies they regulate.

He concludes: “As such it is highly likely that there will be further legal challenges although the OCC has tried to set out a fairly solid statutory basis for the charter - they recognise the challenge to the states and it seems very likely that there will be litigation to help settle this.”

RB