The Senate voted 52 to 47 to repeal the so-called "true lender rule" that consumer advocates and plaintiff lawyers threatened consumers. It was a last-minute banking rule under the Trump administration that covers up who's really behind triple-digit interest rate loans.
If the House follows suit, which it's expected to do, many consumers will get a break they badly need.
The controversy is about non-banks using complex arrangements with banks to offer loans at stratospheric interest rates, and whether consumers were losing legal protections.
By partnering with what are called rent-a-banks in the industry, non-bank lenders can enable triple-digit interest rates on loans.
Non-bank lenders, like those in fintech (tech companies working in the financial services space), face limits by states on how much interest they can charge.
For banks, it's different. "Every state but New Jersey repealed their interest rate limits on banks," says Lauren Saunders, associate director of the National Consumer Law Center (NCLC). Any officially chartered bank can charge whatever it wants.
By partnering with what are called rent-a-banks in the industry, the non-bank lenders can enable triple-digit interest rates on loans. The actual lenders funnel the money, and the profits, through a rent-a-bank, which puts its name on the document. But critics note that it's still the non-bank company that is really making the loan, which a court might find illegal if challenged by the borrower.
'Rogue Banks'
Most banks have a degree of self-control because it's bad for their image. "You don't see 200% APR [annual percentage rate] bank credit cards out there," Saunders says. But there are a "few rogue banks," she says.
"In recent years, new fintechs have emerged that partner with banks to offer responsible small-dollar loans at affordable rates," said Sen. Sherrod Brown (D-Ohio) in an April 28 Senate hearing on the subject. But, as he noted, partnerships with rent-a-banks are at unaffordable rates.
In an NCLC-hosted webinar, Shane Heskin, a partner in the law firm of White and Williams, discussed a client: a desperate restaurant that supposedly had taken a $67,000 loan at an annual rate of 268% from non-bank World Business Lenders. Heskin said that WBL gets 95% of the payments although rent-a-bank Axos Bank is listed on the paperwork. WBL did not respond to requests for comments. Axos said that it no longer had has a relationship with WBL, that the claim of keeping only 5% of profits "is not accurate," and that "[to] the degree Axos Bank has or had third-party relationships that follow this model, and in order to ensure full compliance with applicable law, we have exercised continuous oversight over third-party service providers pursuant to a rigorous compliance program specifically designed to meet the standards" developed by the OCC.
300% Rates
NCLC says there are non-bank lenders getting upwards of 300% rates.
Some people challenge the arrangements, saying that the non-banks are the real lenders and, so, should be far more limited in rates. That's where the rule passed in late 2020 by the Office of the Comptroller of the Currency (OCC), a federal agency that regulates banks, comes into play.
The "true lender" rule—which opponents deridingly call the "fake lender" rule—says that the bank listed on the loan agreement is always the true lender.
"The predatory lender creates the program, finds the customers, processes the applications, decides who they want to approve, the bank rubber stamps the approval, and then the bank sells the loan or almost all the rights to the non-bank lender," Saunders says. "The non-bank lender is doing almost all the work and making almost all the profits." But because the bank is listed on the original loan agreement, under the recent rule, it would be the lender to a court.
In Heskin's restaurant case, the defendants are already trying to use the OCC rule to argue that claims of a rent-a-bank arrangement are "completely misguided," according to a court filing. If Heskin was able to show that WBL was the actual lender, he could argue that state limits on interest rates would apply.
"This rule eliminated confusion, uncertainty and legal risk for banks and their counterparties to enter into the small-dollar lending space, and increased financial inclusion as well as expanded nationwide availability of credit on reasonable terms," read a statement from non-bank lender Opportunity Financial, commonly called OppFi. "This is crucial for the 150 million everyday consumers who need access to credit but are unable to get it through traditional lenders. Third-party partnerships between banking institutions and fintech providers are critical to expanding access to credit and provide best-in-class marketing acquisition, customer service and technology to assess risk beyond mere credit scores to facilitate broader small-dollar lending access."
But, as the statement also says, "it's important to note that we built a strong and thriving business over the course of many years prior to the rule being finalized just a few months ago, and we will continue to do so now." Perhaps rejection of the rule won't hurt OppFi, or other non-bank lenders, that much.
Those in the industry point to the cost of low-dollar loans, and losses from loans that are never repaid, as the reason for very high rates.
"Their default rates are high and that's the problem," Saunders says. "That's not an excuse for predatory lending. That's the reason it should be illegal. If people can't handle their current debts, high-cost debt is not the answer."
As for losses, the lenders "figured someone needed to pay 13 months on a 42-month period to break even, then it was profit," says Saunders. "Their goal was to find people to make enough payments to make a profit."
The Federal Reserve in a 2015 study noted that the break-even annual percentage rate, including writing off defaulted loans, for a $594 amount was, indeed, 103.54%. But when the borrowed amount rose to $2,000, the break-even was about 40%. At $13,057, the break-even APR was 16.25%.
In its financial report on 2020 operations, OppFi annual revenue of $291 million and net income of $77.5 million. That's an extremely healthy before-tax profit rate of 26.6%. Profits between 2019 and 2020 were up more than a third.
If for larger amounts a lender charges 50%, 70%, 100%, 200%, or more, on the whole, they're making good money. If a lender ensures a minimum amount of loan, the losses may not be as overbearing as they are often portrayed.
