Congress close to reversing Trump-era lending loophole that allowed 'rogue banks' to bleed Americans

Finally, there's something 52 senators can agree on: If a legal money lender is charging you Tony Soprano-level interest rates, you're at least entitled to know who they are.


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 "Every state but New Jersey repealed their interest rate limits on banks," says Lauren Saunders, associate director of the National Consumer Law Center (NCLC).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.

How an Obama-era effort to help small businesses backfired

The Jump-Start Our Business Start-Ups (or JOBS) Act of 2012 was supposed to mean great opportunities for small business owners to raise capital and grow family-controlled businesses. At the time President Barack Obama called it "a potential game-changer" that would give them "access to a big, new pool of potential investors—namely, the American people."

The law was intended to allow small operations to raise money through crowdfunding, pretty much the same way people raise money with a GoFundMe type campaign or how companies use Kickstarter for specific projects.

Except, things didn't work out quite that way for either small businesses or small-time investors. New rules, called Reg CF (for crowdfunding), from the Securities and Exchange Commission were supposed to fix problems that had made the concept pretty much unworkable. But nine years after the law was passed, it has ended up favoring larger enterprises while strengthening the hold on business financing of Wall Street banks, Silicon Valley venture capitalists and other large financial players.

The Intent

The law was a response to the Great Recession. Banks, after years of reckless practices, tightened lending standards even as they accepted taxpayer bailouts. The Federal Reserve noted in 2010 that many small businesses said they couldn't get credit even if they seemed credit-worthy.

"This was a bill that originated in a Republican-controlled House and it was designed to be a law that made access to capital easier," said Roger Royse, a corporate and securities lawyer in Palo Alto, Calif.

Then the bill hit the Democratic-controlled Senate."It changed from an ease-of-capital-raising bill to an investor protection bill," Royse added. After all, the government has to make sure that investors don't lose their savings to a risky small business, or at least so said the Senate Democrats who worked the bill over.

The practice is long-established. Going back to the 1934 creation of the SEC under President Franklin D. Roosevelt, a double focus on capital and investor protection has been standard.

Small Business Hurting

Even though the worst of the Great Recession had passed, the needs for business funding are eternal. The Federal Reserve in a 2019 report found while 48% of small businesses either had or obtained sufficient financing, 23% had a financing shortfall, and 29% might have unmet financing needs. Also,80% of small business owners wanted their enterprise to grow.

Regular investors sought good returns. Taking a flyer on small businesses was also more appealing as interest rates fell, making the return on fixed-income investments like safe corporate bonds and Treasury notes hardly enough for a cup of coffee. Meanwhile, big institutions and wealthy people kept gaining major profits from investments in hot companies.

The initial SEC regulations for the JOBS Act fell short. Companies could raise at most a tad more than $1 million. That wasn't enough money "to justify the cost" of complying with the rules, Royse said. Complying with the regulations was expensive.

There was also a $100,000 limit on the amount of capital an individual, no matter how well-heeled or savvy, could invest in a year. The same limit applied to institutions. That greatly reduced the total pool of money that might be available for small businesses.

Business Impact

The new regs increase the amount a business can raise to $5 million. That helps rationalize the company's costs. But it really doesn't fix the problems.

"The regs weren't necessarily designed for your brick-and-mortar mom-and-pop business to go out and raise capital," said Nick Mathews, CEO of Mainvest, one of the platforms that companies crowdfunding under the regulations might use.

No, they don't, but that is what the 2012 law was intended to do.

The regulations require detailed disclosures, not the kind most small businesses can explain in plain English. The accepted and generally tortured legalese the SEC prefers "requires an infrastructure comprised of financial, accounting, and legal professionals," said David Bissinger, a securities litigator and partner with Bissinger, Oshman & Williams in Houston. The lawyers, auditors, and other staff to check everything favors firms raising at least close to the $5 million limit under the JOBS Act.

"I just become skeptical," that companies with a valuation under $100 million can adequately perform the compliance and "whether that securities offering makes sense for anybody," Bissinger told DCReport.

The terms of getting capital are also challenging.

"Reg CF is designed for something like scalable businesses," Royse said, meaning companies that can grow fast and get big, with a large potential payoff for investors.

"They don't have to be Silicon Valley unicorns," he added, referring to hose firms valued at a billion dollars before they even sell stock to the public."But I think they have to be something with opportunities for growth."

Surrendering Control

Under the crowdfunding scenario, the company looking for money has to give something in return. It may be equity—a significant slice of the business. Equity financing often means that big and savvy institutions demand that the people who came up with the idea surrender control of their baby business and a huge share of future riches. That tends to keep wealth concentrated in the hands of the already rich.

That is in part what the JOBS act was intended to address – entrepreneurs not earning big financial rewards because of lack of access to capital to grow their business without giving up confiscatory amounts of ownership to venture capitalists.

Another approach substituted royalty financing or shared earnings arrangements, where investors get a cut of future profits, instead of providing equity ownership. "There are a lot of those out there, now," said Royse. "It's like really expensive debt."

According to Matthews, Small Business Administration-backed bank debt runs in the range of 7% annual interest. The more complicated sharing arrangements effectively translate into a 10% to 20% interest rate on the amount loaned, a steep expense when Treasurys pay a bit more than 1%, home mortgages go for as little as 1.75% and many people with good credit scores can pay under 10% on credit card debt.

In a down year when revenues shrink, the JOBS Act theory was that owners would pay out less in royalties or shared earnings, helping level out the often-volatile finances of small companies so they endure until better times return. In a good year, though, the payout gets much larger.

All this means that the system of raising money for new businesses remains heavily weighted in favor of the venture capitalists, the big Wall Street stock and bond writers and other big boys of finance. The big winners are institutional investors—pension funds, hedge funds, and private equity firms—that can get the investments they want and do their own form of crowdfunding. That is, crowding out the little people so they still keep the best investments for themselves.

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