Financial Services Law

Auto Loans at the Top of OCC's Supervisory Priority List

Why it matters

In two recent speeches, Comptroller of the Currency Thomas J. Curry discussed the supervisory priorities of the Office of the Comptroller of the Currency (OCC), including bank operational risks, increased credit exposures and insufficient loan loss reserves. In one speech, the Comptroller focused on risks associated with non-prime auto loans packaged as asset-backed securities. In another speech, Curry expressed concern that conscious decisions by banks to increase their risk appetites are the result of increased competition and are worrisome. Most particularly, the Comptroller identified concentration risk as a reason for concern. For example, too much concentration on non-prime auto loans—like subprime mortgages just a few years prior—could put lenders and the market at risk. "[W]hat is happening in this space today reminds me of what happened in mortgage-backed securities in the run up to the crisis," the Comptroller said, noting the relaxed underwriting standards and extended maturities currently available for car loans. "Although delinquency and losses are currently low, it doesn't require great foresight to see that this may not last. How these auto loans, and especially the non-prime segment, will perform over their life is a matter of real concern to regulators. It should be a real concern to the industry." The Comptroller noted that commercial real estate loans, especially in the construction and multifamily housing sectors, are also on the OCC's radar. Banks should prepare themselves for increased attention from examiners with regard to these loans.

Detailed discussion

The Comptroller discussed the never-ending importance of operational risk, a lesson learned from the recent financial crisis, when the industry paid "a heavy price for dropping the ball" on both compliance and operational risk. "[W]e all need to do a better job at identifying significant operational risks that otherwise seem mundane," Curry said. "If these activities or processes have the potential to pose significant or serious reputational, legal or financial risks, just like credit risk and cybersecurity, they cannot be neglected no matter how pressing other needs may seem at the time."

Curry said the cycle has reached a point where credit risk is moving to the forefront. As banks reach for loan growth and ease underwriting standards, "it's a time when supervisors and bank risk officers need to be most vigilant," he warned.

The Comptroller noted that auto lending represented more than 10 percent of retail credit in OCC-regulated institutions in the second quarter of 2015, up from 7 percent during the same time period in 2011. Increasingly, banks are packaging these loans into asset-backed securities rather than holding them in a portfolio, Curry said. In turn, the securities are being greeted by strong demand from investors.

"But what is happening in this space today reminds me of what happened in mortgage-backed securities in the run up to the crisis," the Comptroller said. "At that time, lenders fed investor demand for more loans by relaxing underwriting standards and extending maturities." In the current auto loan market, 30 percent of all new vehicle financial loans feature maturities of more than six years, and borrowers can obtain a car loan even with very low credit scores, he noted.

"With these longer terms, borrowers remain in a negative equity position much longer, exposing lenders and investors to higher potential losses," Curry explained. "Although delinquency and losses are currently low, it doesn't require great foresight to see that this may not last. How these auto loans, and especially the non-prime segment, will perform over their life is a matter of real concern to regulators. It should be a real concern to the industry."

The Comptroller was quick to point out that neither home equity loans nor auto loans are inherently unsafe. "However, what is inherently unsafe are excessive concentrations of any one kind of loan," Curry said. "You don't need a very long memory to recall the central role that concentrations—whether in residential real estate, agricultural land, or oil and gas production—have played in individual bank failures and systemic breakdowns. It's an old movie that's been reprised on a regular basis."

For this same reason, the OCC is also closely watching growing exposures in commercial real estate loans, particularly in the construction and multifamily housing sector, Curry told attendees, as well as loans to non-depository financial institutions.

The Comptroller expressed the hope that "banks would take the initiative to address concentration risk on their own, without supervisory action," citing the guidance issued in December 2006. Moreover, the Comptroller suggested that "every bank should be taking a hard look at the loan loss allowance, and asking if it's appropriate for the level of risk their institution is taking on." Moreover, the Comptroller noted that the environment is changing. "We're seeing loan growth in all asset categories, greater risk acceptance, weaker underwriting, and growing asset concentrations."

How is the OCC dealing with these risks? A "conscious strategy of identifying emerging concerns before they become entrenched problems," Curry said, with a focus on transparency and accountability. The agency's Semiannual Risk Perspective and supervision operation plan both offer a spotlight on areas of focus for the OCC (transparency) and a way for the media and the industry to take the regulator to task for its failure to take appropriate action (accountability).

"Looking back, it's clear that all of us made mistakes in the run up to the financial crisis—regulators and financial institutions alike. And I believe all of us recognize we have to do better," Curry concluded. "[T]he best way to avoid major disruptions down the road is to take sensible and tough-minded steps now. And that, I can promise you, we are doing."

To read the Comptroller's prepared remarks, click here.

To read the Comptroller's speech before the RMA Annual Risk Management Conference in Boston, MA, on November 2, 2015, click here.

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CFPB Rushes to Aid of RushCard Customers; Will Industry Face Fallout?

Why it matters

A recent technical glitch for a major prepaid card could result in greater oversight for the industry as a whole. In October, consumers using prepaid RushCards were suddenly unable to access their funds. The company blamed technical problems due to a processor switch. But as the problem continued—and consumers complained of late fees as a result of being unable to pay their bills—the Consumer Financial Protection Bureau (CFPB) stepped in. Expressing concern about "cascading financial effects," director Richard Cordray released a statement that the Bureau is prepared "to use all appropriate tools" to provide relief to affected consumers. "We have stressed that RushCard and its relevant business partner must ensure that no other consumers will be denied access to their funds," Cordray said, adding that he also spoke with fellow regulators "to ensure a comprehensive response." Specifics about potential enforcement actions were not mentioned. The incident has already yielded a putative class action lawsuit as well as calls from consumer groups to heighten supervision of the growing market of prepaid card providers. Also, just about a year ago the CFPB proposed extensive new regulation of prepaid accounts. The proposed rules would not have prevented the problems that arose with the RushCard. Nevertheless, the proposal received much industry comment, and the RushCard situation will strengthen the CFPB's position regarding its proposed rules.

Detailed discussion

A recent incident has drawn attention to the burgeoning prepaid card market, leading consumer protection advocates to call for greater oversight of the industry. Consumers—particularly young and low-income individuals without bank accounts—are increasingly using the cards for services traditionally undertaken by banks. More employers are using the cards to pay workers, who in turn use the account to pay bills and make daily purchases. One of the most popular prepaid products on the market: UniRush's RushCard, backed by hip-hop legend Russell Simmons.

But beginning October 12, RushCard users faced serious problems: some balances had dropped to zero despite having money in the account; in some cases, direct deposits made to their accounts were returned, and other users were locked out of their accounts even though funds were available. Technical problems were to blame, the company said, due to a switch in payment processors. Card issuer MetaBank said it was working with RushCard to help consumers by overnighting money in order to avoid late fees or fines.

RushCard released a statement promising to waive its fees for the next four months, from November 1 to February 29. During the "fee-free holiday," both old and new customers will not incur charges from the company's fee schedule, out-of-network ATM fees, or card-to-card transfer fees.

"Very soon, RushCard will be making a significant announcement on how we plan to make this right with our customers who were severely inconvenienced and in some cases suffered hardships," UniRush CEO Rick Savard said in a statement. "We have worked extremely hard in the past few years to build a product that is safe, secure and cost-effective for our customers. We are going to do everything we can for our customers and for the communities in which they live to restore their trust and faith in us."

But the company's efforts may not be enough.

The next day, Consumer Financial Protection Bureau (CFPB) director Richard Cordray released a statement expressing concern about the "cascading financial effects" of consumers being locked out of their accounts, such as late fees due from unpaid bills. "The CFPB is taking direct action to get to the bottom of this situation that may have harmed thousands of innocent consumers already," Cordray said. "We have stressed that RushCard and its relevant business partners must ensure that no other consumers will be denied access to their funds."

The Bureau also vowed that it "is prepared to use all appropriate tools at our disposal to help ensure that consumers obtain the relief that they deserve," Cordray added, noting that he has discussed the situation with his counterparts at the Office of the Comptroller of the Currency (OCC) as well as the Federal Trade Commission "to ensure a comprehensive response that addresses the situation quickly and holds accountable all of the parties involved to make consumers whole."

Cordray did not get specific about potential enforcement actions or other regulator efforts. If the problem was really the result of a technical glitch—and not a consumer protection misstep—then the Bureau (and other regulators) may have limited options on taking action against UniRush or RushCard.

The Bureau released proposed regulations for the prepaid card market in November 2014, but they have yet to be finalized. And even if the rules were in place, they are geared toward consumer protection issues (broader fee disclosures and easier access to account information, for example), not technical errors. However, the RushCard situation did show the extent of prepaid card use and the problems that may arise for consumers when a popular card experiences disruptions. Accordingly, the RushCard experience has likely strengthened the CFPB's position regarding its proposed rules in the face of strong industry comment.

One consumer took matters into her own hands, filing a putative class action in New York federal court against UniRush. Stephanie Fuentes charged UniRush with negligence and unfair and deceptive practices, among other claims, going on the offensive against a ban on class actions found in the company's terms of service. "The terms of RushCard's arbitration provision, waiver of class action rights and right to trial by jury are unconscionable and Plaintiffs and Class Members would not have agreed to those terms or deposited any money with RushCard had they known about the fraudulent, unlawful and unfair activity and misrepresentations as described in this Complaint," Fuentes alleged.

Consumer groups also took action, sending a letter to the CFPB, OCC, and Board of Governors of the Federal Reserve System suggesting "the occurrence raises important questions about the extent to which prepaid cardholders are adequately protected." The National Consumer Law Center, Americans for Financial Reform, the Center for Responsible Lending, and Consumer Action—joined by seven other organizations—also encouraged the Bureau to move forward on its proposal to limit arbitration agreements in consumer contracts.

"To the extent that any laws were violated in this incident, courts should be able to address any violations and order relief for all impacted consumers," the groups wrote. "If the rights of hundreds of thousands of consumers were violated, they should not have to file hundreds of thousands of individual claims before private arbitrators in a process that is closed to the public."

To read CFPB director Cordray's statement, click here.

To read the complaint in Fuentes v. UniRush, click here.

To read the letter from the consumer groups, click here.

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FDIC Puts Out Welcome Mat for New Bank Applications

Why it matters

Could new bank applications and de novo bank openings be in the future? To encourage new applications, the Federal Deposit Insurance Corporation (FDIC) has met with state regulators to express interest in new applicants and conducted training sessions in preparation for incoming applications. The agency has faced criticism that standards for granting deposit insurance have been too high, resulting in few de novo institutions over the last few years. While 25 charters were approved by regulators in 2009, the number dropped to 13 in 2010 with near nil over the ensuing years—and just one so far in 2015. A spokesperson for the FDIC said new applicants are encouraged and "we welcome proposals for deposit insurance." Many would take the odds against either a significant uptick in applications or many new banks opening anytime soon.

Detailed discussion

Over the last few years, new bank applications have all but dried up. In 2009, 25 charters were approved by federal regulators. But the following year, the number dropped to just 13 with few applications at all in recent years. So far in 2015, just one de novo application has been approved.

But the Federal Deposit Insurance Corporation (FDIC) is looking to change that trend, meeting with state regulators, conducting trainings, and encouraging applications for de novo institutions. The regulator conducted a joint training session with the Conference of State Bank Supervisors earlier this year, for example, and has expressed interest in new charters during meetings with state banking commissioners.

Critics have charged the FDIC with keeping deposit insurance standards too high—with high initial capitalization requirements and, until recently, restrictions on growth for a seven-year de novo period—resulting in fewer applications. Others note the financial climate has not been exactly conducive to bank start-ups over the last few years as the economy struggled to recover; Dodd-Frank added to banks' regulatory compliance burden and the intensity of examinations for anti-money laundering and, more recently, consumer lending compliance increased. The challenge of raising capital in a low-earnings environment and finding qualified directors and the next generation of approvable bank executives further complicated the de novo application and approval process. The changing technology (mobile phone apps) and demographics (millennials) of banking make the viability of the three-year business plan required for FDIC insurance applications almost suspect upon arrival. The evolving competition of nontraditional entities—such as nonbank financial technology companies and peer-to-peer lenders—entering the market may also be impacting the rate of applications for traditional de novo bank charters, which must also be submitted to state regulators for state banks or the Office of the Comptroller of the Currency for national banks in parallel with the FDIC application for insurance. Unique business plans with a higher risk profile or foreign investment and ownership often exacerbate the review and approval process.

Is the time right for new charters? The FDIC meetings and trainings seem to be part of a concentrated effort on the part of the FDIC to encourage new applications. "New bank formation helps foster a vibrant community banking sector," Barbara Hagenbaugh, the deputy to the chairman of communications for the FDIC, told American Banker. "We welcome proposals for deposit insurance and staff are available to discuss the application process and possible business plans with potential applicants." Time will tell.

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California Amends LLC Law, Eases Lender Obligations

Why it matters

Earlier this month, California Governor Jerry Brown signed into law Assembly Bill 506, a measure that amended the state's Revised Uniform Limited Partnership Act, making it easier for lenders to make loans and protect their interests with respect to limited liability companies (LLCs). The new law tweaks some of the requirements for association and disassociation of members of LLCs as well as the consent for merger or modification of an LLC's operating agreement, eliminating the obligation that a lender confirm that each member of the LLC agreed to a merger, for example. Other changes were made to the provisions for judgment creditors, indemnity and payment of LLC obligations, as well as fraud and material misrepresentations of value, with an overall message of greater deference to the LLC's operating agreement. The new law takes effect January 1, 2016.

Detailed discussion

Changes to the California Revised Uniform Limited Partnership Act were signed into law by Governor Jerry Brown last month, set to take effect January 1, 2016. For lenders, the changes will make it easier to make a loan to a limited liability company (LLC) or a member of an LLC secured by liens on the borrower's membership interest.

The amended law tweaked association and disassociation from an LLC. One or more persons may form an LLC by signing and delivering articles of organization to the Secretary of State. As for disassociation, members can disassociate at any time by express will; disassociation can also occur upon specified events, such as an individual's death.

The Act authorizes the legal representative of a member to exercise all of his or her rights. For example, if the member has died or his interest is being administered by a third party under a valid power of attorney, the executor, administrator, guardian, conservator, attorney-in-fact, or other legal representative may step in his shoes with all powers the member had under the articles of organization.

For lenders, this means greater protection of rights as a lien holder on a borrower's LLC membership if the loan documents included a power of attorney.

Previously, the law required that all members of the LLC had to approve a merger, conversion, or amendment of the operating agreement. In turn, lenders were required to confirm with each member of a merged LLC that they agreed to the merger. The Act eliminated this due diligence requirement for lenders, who no longer need to confirm the merger with each member.

A modification to provisions on the indemnity and payment obligations of an LLC could also prove beneficial to lenders. Pursuant to AB 506, the LLC must indemnify any "agent" to the extent that the third party has been successful on the merits in defense or settlement of any claim, issue, or matter if the agent acted in good faith. The bill broadly defined the term "agent" to encompass any officer, employee, or other agent—including a lender, if he or she acted in good faith and in a manner that the agent reasonably believed to be in the best interests of the LLC and its members.

Other changes were made to the requirements for dissolution and the LLC's certificate of cancellation, the conversion of the LLC to another form of entity, and made the LLC law consistent with another recent bill that allows for electronic signatures without compliance with the Electronic Signatures in Global and National Commerce Act.

To read AB 506, click here.

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Treasury Discusses Online Marketplace Lending

Why it matters

Regulatory oversight of online marketplace lending is moving forward, with representatives from the Department of the Treasury sharing six "central themes" drawn from comments on the agency's Request for Information (RFI) about the industry issued earlier this year. Speaking separate conferences in New York, Treasury Counselors Antonio Weiss and Anjan Mukherjee both said the agency gathered several takeaways based on the comments, from the scope of the current market (mostly prime and near-prime borrowers) to fair lending concerns raised by the use of nontraditional data in credit underwriting decisions. The officials also discussed risk retention, the growing number of partnerships between online marketplace lenders and traditional financial institutions, and encouraged industry to look beyond the small number of servicing and collection firms currently being used in order to improve borrower experience. As the Treasury continues to analyze the comments received from the RFI, they said the agency will continue to work with state and federal regulators "to ensure that innovation in lending proceeds within a framework that protects borrowers and preserves safety and soundness."

Detailed discussion

In July, the Department of the Treasury published a Request for Information (RFI) posing 15 distinct questions regarding online marketplace lending, seeking comment on the various business models and products offered by such lenders to both small businesses and consumers. The Treasury also asked about the potential for the market to expand access to credit to historically underserved segments and how the regulatory framework should evolve to support the "safe growth" of the industry.

After a comment period open through the end of September, the Department received 104 responses from individuals, businesses, advocates, and trade associations at the Information Management Network Conference on Marketplace Lenders. Manatt submitted a comment letter which is available by clicking here.

Treasury Counselors Antonio Weiss and Anjan Mukherjee appeared at separate events last week giving a preliminary readout of the RFI submissions and the Department's reactions. Mukherjee was interviewed by Manatt Partner Brian S. Korn at the American Banker's Marketplace Lending conference.

The officials emphasized that the Treasury "will seek to foster, not impede, innovation that increases competition and broadens access to affordable credit for creditworthy borrowers and businesses. But we will also be vigilant in ensuring that innovation does not undermine important privacy and consumer protection priorities. And we plan to continue our work in close dialogue with our regulatory partners."

Six themes emerged from the comments, according to the officials.

Online marketplace lending is currently serving mostly prime and near-prime borrowers consolidating debt from credit cards or student loans, Weiss said. While this allows borrowers to obtain lower-cost loans, it means expanding access to those "further down the credit spectrum remains largely an aspirational goal," he acknowledged, as many lending platforms have minimum credit score requirements, effectively barring participation by low- and medium-income households.

One area that does seem ripe for growth: lending to small businesses, which receive 90 percent of their financing from banks and are often looking for credit to grow their businesses. "Marketplace lending has the potential to unlock access to the capital markets for these borrowers," Weiss said.

The second theme found in the comments: the new underwriting models have yet to be tested through a full credit cycle. "It is too soon to tell … if these alternatives perform better than traditional models at predicting creditworthiness, particularly in a more difficult economic environment," Weiss noted.

The Treasury also received comments on a related point: consumer protection concerns regarding compliance with fair lending obligations given the increasing amount of nontraditional data used in credit underwriting decisions. "Just because a credit decision is made by an algorithm, does not mean it's fair," Weiss said. "Advocates expressed concern that the new credit models are a 'black box' and applicants have no recourse if the information being used is incorrect."

Many commenters emphasized the need to establish a level playing field, Weiss said, and policymakers should be mindful of the regulatory framework already in place so that the same standards of transparency and accountability, for example, apply to both bank and nonbank lenders.

Transparency was another theme highlighted by commenters. "For small businesses, transparency requires standardized all-in pricing metrics, so that a business understands a loan's true cost and can make like-to-like comparisons across different loan products," Weiss said. "For consumers, transparency should encompass clear terms and conditions, on both mobile and desktop devices, and simple payment plan options. And for all borrowers, it should include standardization of disclosure and credit performance. For investors, transparency means, at a minimum, standardized representations and warranties."

The fifth theme: the growing number of partnerships that online marketplace lenders are forging with banks, community development financial institutions (CDFIs), and other businesses. These relationships can allow banks to leverage the new models while giving marketplace lenders access to new customers. "As these partnerships develop, they may bring the benefits of new credit models to borrowers in low-income communities, who could potentially have the most to gain from access to more affordable credit," Weiss said.

Finally, many commenters referenced risk retention, albeit with a wide range of views. Some argued for transparency on loan pricing, product features, and performance in lieu of holding credit risk; others asserted that noneconomic interests, such as reputational risk from making bad loans, already serve as "skin in the game" for lenders; while some comments advocated for the necessity of risk retention.

With the themes laid out, Weiss explained the next steps in the process. Although the Treasury is not a regulator in this area, the agency is analyzing the comments from the RFI, working with regulatory partners "to better inform our collective understanding of the issues," and continuing to monitor developments in the marketplace.

For his part, Mukherjee offered that the Treasury, as Chair of the Financial Stability Oversight Council, a financial regulatory consortium created by Dodd-Frank, might suggest additional regulation to the primary regulators of banks, consumer lenders and securities issuers. The Department might also push for legislative change in order to provide clarity and transparency—including perhaps in response to the recent Second Circuit decision in Madden v. Midland Funding.

"Our guiding principle will remain to seek the broadest possible access to safe, affordable and sustainable credit," Weiss told attendees. "We will be mindful to preserve and promote the American entrepreneurial spirit in the growing financial technology industry. However … we must not allow innovation to undermine consumer protections, privacy concerns, and other important policy priorities. We will need to find a balance."

In the interim, industry should "lead efforts to ensure safety and soundness, transparency, and equal borrower protections," Weiss urged. He cited a lack of innovation in backend operations, with a heavy reliance by marketplace lenders on a small number of servicing and collections firms.

"As we've learned in mortgages and consumer loans, poor servicing can have devastating effects, especially for struggling borrowers," Weiss said. "We encourage entrepreneurs to focus attention on constantly improving the borrower experience, from customer acquisition straight through to collections in the event of delinquency or default."

Mukherjee made the important point that the change in Administration which will occur in January 2017 may not spell the end of the regulatory push in the space. He said each transition team works with the incoming Administration to transition work in progress. "Of course, tone at the top is meaningful, so it may depend on who wins the election."

To read Treasury Counselor Weiss's prepared remarks, click here.

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