OCC cracks open a debt trapdoor

In the middle of a worldwide pandemic and national crisis, the Office of the Comptroller of the Currency (OCC) has taken steps that could undermine the ability of states to protect their residents from the perils of high-cost loans.

When the OCC issued a final rule on May 29th on permissible interest for loans that are transferred or sold, it chose a side in a long-running legal debate that could strengthen the right of national banks to partner with high-cost consumer finance companies. 

This decision could put more people at risk of falling into debt traps, particularly those individuals who may be struggling to make ends meet. The new rule, which clarifies a power granted to the OCC under the National Bank Act, could allow “rent-a-bank” lending to revitalize partnerships between banks and ultra-high-cost payday lenders. 

The National Bank Act gives national banks the ability, known as “pre-emption,” to operate within the rules of their home state and to apply those terms when making loans in any other state. 

The champions of pre-emption contend that it makes our financial system more efficient, as pre-emption allows a national bank to offer the same product in every state. Without such power, the diversity of regulatory regimes across 50 states would impose significant compliance costs on banks. That perspective says that reduced costs should increase the supply of credit in places where caps would otherwise make riskier loans unprofitable. To some extent, the history of the credit card speaks to that logic, as credit cards were not as prevalent before Smiley v. Citibank (South Dakota) N.A. The ability to charge higher rates coincided with the expansion of credit card debt. 

Here’s the catch: given the chance to choose from laws in 50 states, banks largely decided to move their operations to the places where they could charge the highest rates. If you have a credit card, you may have noticed that your statement is almost always mailed from addresses in one of two states: Delaware or South Dakota, and that is not by accident. Leaders in each state largely eliminated interest rate caps on their loans as a means of attracting bank jobs. The strategy worked. Today, credit card issuers employ thousands of highly-paid professionals in both states. Still, while pre-emption did increase the supply of credit card debt, there’s no evidence to suggest that it led to more low-cost debt, and in fact, the evidence suggests that pre-emption contributed to higher rates in some states.

The key legal principle in Smiley was that if a loan was “valid-when-made,” then it was lawful for a bank to export its home state rules anywhere in the country, and to do so without having to change interest rates to comply with state laws. 

Nonetheless, banks were not the only financial institutions for whom the valid-when-made question held significance. It also mattered when a loan was sold. Debt collection agencies like to buy debts from lenders in other states, as do fixed-income investors in securities markets. Yet the key point for this comment is how it relates to a relatively small market – the set of loans made by banks that are then sold to non-bank consumer finance lenders.   

Even if a layperson misses the legal nuances inside of valid-when-made, they would grasp the significance first hand if payday lenders and high-cost installment loan companies start to open storefronts in places where such products had previously been considered to be usurious. Most likely, many web surfers will have the same surprise, when their browsers are populated with offers for fast cash and easy money. Worse still, some will take up those lenders on their offerings, and if the past is a predictor of the future, some of them will fall into debts they cannot repay. 

Industry professionals developed a new model, known informally as rent-a-bank, that became a common tool for payday lenders to rely on banks to make loans in states that had strict usury caps. 

Typically, the rent-a-bank model worked like this: 

  • A non-bank lender finds a customer, even if the applicant lives in a state where interest rates are capped at levels below the lender’s liking. 
  • The non-bank lender would help the applicant apply for a payday loan, including filling out the paperwork. 
  • However, in the contract, the loan would be originated by the bank. After a short period of time, the bank sells the loan back to the non-bank lender (or a related entity), minus a service fee. 

The bank benefits from a steady stream of fee revenue and in turn, the non-bank payday lender has a path to circumvent laws in certain states.  

Participating in rent-a-bank partnerships became the province of a handful of relatively unknown banks. A report by several consumer advocacy groups cataloged the top players: Eagle National Bank, Goleta National Bank, People’s National Bank (TX), First National Bank of Brookings (SD), BankWest (SD), Brickyard Bank (IL), County Bank (DE) and First Bank (DE). 

Those banks partnered with many of the largest payday lenders to make loans with exorbitant rates, often north of 300%. Some of the better-known storefront payday lenders included Advance America, Check’n Go, Ace Cash Express, Dollar Financial, Express Money and EZPawn. County Bank specialized in working with online payday lenders. Those sites had colorful names: eFastCashLoans.com, 500cash.com, 911emergencycash.com, QuickLoans2Go.com and others. 

Then something happened in 2004 that cast uncertainty over the rent-a-bank model. Georgia’s legislature applied a new standard to partnerships, declaring that an entity that was a “true lender,” as defined by one that has the “predominant economic interest,” could not rely on a national charter to evade state laws. Since most originating banks sold the loans before the first repayment was due, anyone relying on a true lender argument had a strong case. 

Accordingly, the true lender doctrine created a door that plaintiffs and regulators opened to mount challenges. True lender litigation introduced risk factors that led to a pullback in the presence of these rent-a-bank arrangements, as banks now faced compliance risks. If they did craft new contracts where they held more economic risk, they also exposed their balance sheets to the high loss rates associated with high-risk lending. 

That uncertainty expanded in 2015, when the U.S. District Court for the Southern District of New York placed an additional constraint on pre-emption, writing in  Madden vs. Midland Funding, LLC that “although national banks’ agents and subsidiaries exercise national banks’ powers and receive protection under the NBA (the National Bank Act) when doing so, extending those protections to third parties would create an end?run around usury laws for non?national bank entities that are not acting on behalf of a national bank.”

The U.S. Court of Appeals for the Second Circuit drew a line in the sand by asserting that applying New York’s usury laws to purchases of charged-off debts did not “significantly interfere” with a national bank’s privileges under the National Bank Act.  

The OCC felt that the courts had made a mistake. Industry associations echoed the OCC’s opinion. In a amicus brief, the American Bankers Association wrote that “unless corrected by this Court, the decision below will disrupt the secondary market for loans, upon which the primary market for lending depends; as a result it will chill the primary market for making loans and thereby increase the costs borrowers face.”   

At the end of 2019, the OCC and the FDIC initiated a rulemaking to clarify how the valid-when-made rule should be applied. Advocates and some 24 state attorneys general argued strongly in favor of Madden; not surprisingly, lenders commented in favor of valid-when-made.  

The rule sought to clarify the debate, asking if “interest permissible prior to the transfer continues to be permissible following the transfer.” 

On June 2nd, the OCC issued a final rule, stating simply that “when a bank transfers a loan, interest permissible before the transfer continues to be permissible after the transfer.”

On June 4th,  Brooks explained the decision as a question of the integrity of a borrower through the analog of a landlord-tenant relationship: “If I promise to pay you rent, and then you sell that contract to somebody else, then I still have to pay that person the rent. The amount of the rent doesn’t change, it’s whatever the rent was when we made it.” The benefit, according to Brooks, is that the sale of debt gives additional liquidity to banks, which results in the supply of credit. 

Taken in that context, valid-when-made might seem reasonable, but of course, apartment buildings don’t pick themselves up and relocate to a different state. 

The FDIC has not yet published its conclusion.

Even if valid-when-made is affirmed, it is possible that the “true lender” provision will still stand in the way of rent-a-bank partnerships.

While it appears that the valid-when-made doctrine will stand, the issue of how regulators respond to rent-a-bank partnerships is not entirely settled. How they see partnerships, specifically those that seem designed purely as a means of evasion, could still survive as a protection for consumers. 

The FDIC had noted, in its companion proposed rulemaking issued at the end of 2019, that  “the FDIC supports the position that it will view unfavorably entities that partner with a State bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing state(s)”

On June 5, Karl Racine, the Attorney General of the District of Columbia, filed a complaint against Elevate Loans, charging that it used a rent-a-bank partnership to violate the Consumer Protection Procedures Act. Notably, Racine filed after the OCC’s ruling, and while neither of the two named bank partners are regulated by the OCC, the suit relies on the true lender doctrine. 

The complaint alleges that Elevate’s Rise installment loans bore rates of between 99% and 149% and its Elastic lines of credit charged between 129% and 251%, even though the District caps rates on licensed lenders to between 6% and 24%, depending on the type of loan. Elevate’s bank partners are FinWise Bank, a Utah state-chartered bank, for Rise loans, and Republic Bank & Trust (Kentucky), an FDIC-chartered institution, for its Elastic line of credit. 

The DC attorney general believes that Elevate issued at least 871 Rise loans and 1,680 Elastic lines of credit to District residents, resulting in millions of dollars in “unlawful interest.”

Next Steps

The FDIC initiated its own rulemaking on the valid-when-made question, with comments closing two weeks after that of the OCC. While it is not certain that the FDIC will reach the same conclusion as the OCC, it would be a surprise if they did not follow the OCC’s lead.

The possibility exists that other regulators could walk a careful line that supports valid-when-made without acceding to rent-a-bank schemes by crafting a meaningful true lender test. That would be a workable approach, as it would protect the ability of loans to be sold for the purposes of providing liquidity to banks, while also preventing evasionary partnerships between banks and non-banks that exist to subvert state laws. Likewise, it is also possible that state attorneys general, 24 of whom have already expressed their negative feelings about rent-a-bank, could litigate against the partnerships. 

Elevate Credit acknowledged the power of the true lender standard in a 2020 report to investors, noting that if it was characterized as a true lender in courts, its contracts could be unenforceable, and when coupled with possible fines and penalties, they would have to change their business practices. They also noted that in such an event, their bank partners might terminate their relationships.

While it is hard to predict what comes next, as many actors could play meaningful roles in shaping the next chapters of this debate, it does seem likely that the cadence of change has picked up. We can expect to hear from the FDIC on its own final rule in the coming weeks, and it is a possibility that courts or legislators could also exert changes of their own to the question. While it is hard to say where things find their ultimate resolution, we do believe that if states can protect their ability to control lending by applying the true lender standard, then many consumers will be shielded from dangerous products. 

As an organization that defends the rights of consumers to access fair and responsible credit, the National Community Reinvestment Coalition will continue to press regulators and banks to establish a marketplace where everyone can access safe and affordable financial products.

Adam Rust is a senior policy advisor at NCRC.

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