Colorado issues safe harbor for bank / fintech lending programs
The Administrator of the Colorado Uniform Consumer Credit Code (an agent of the Office of the Attorney General of Colorado) (the “Colorado Administrator”) announced a settlement with Avant LLC and Avant of Colorado LLC (together, “Avant”) and Marlette Funding LLC (“Marlette”)1 in his lawsuit challenging the “banking partnership model” for the provision of consumer credit services. The regulation has far-reaching implications for bank / fintech lending programs.
In 2017, the Colorado administrator continued two bank / fintech loan programs that provided loans to Colorado consumers: one operated by Avant for its banking partner, WebBank, a Utah chartered bank; and the other operated by Marlette for its banking partner, Cross River Bank, a New Jersey State chartered bank (CRB). The Colorado administrator alleged that the consumer loans offered to Colorado residents under the two programs violated the Colorado Uniform Consumer Credit Code. Specifically, the Colorado administrator alleged that neither WebBank nor CRB were the “true lenders” in their respective lending programs because the fintech companies operating the lending platforms bore all the risks under the program. If Avant and Marlette were the legal “real lenders” in these programs, then the loans could have been subject to Colorado usury limits, which could have rendered some of these loans inapplicable.
On June 9, the Colorado Administrator’s case against Marlette was upheld when a Colorado State Magistrate’s Court found that “non-bank buyers are prohibited under 5-2-201 of CRS to charge interest rates on designated loans greater than Colorado interest. caps and, moreover, that [CRB] cannot export its interest rate to a non-banking organization such as the defendant Marlette, and finally, that the [Colorado] the law is not preempted.2 Based on this analysis, the Court concluded that the interest rate export duties were limited to banks and could not be enforced by non-bank assignees. This decision is only binding on Marlette and CRB with respect to this particular program.
However, on August 18, Colorado Administrator, Avant, Marlette, CRB, and WebBank collectively agreed to a groundbreaking settlement that establishes a safe harbor framework for consumer loan programs where bank loans are sold to fintech companies (the “Colorado Safe Harbor Framework”), overriding the June 9 decision of the Colorado State Magistrate’s Court against Marlette and CRB. As part of the settlement, Avant, Marlette, CRB and WebBank have also agreed to collectively donate a total of $ 1.05 million to the Colorado Attorney General’s office to cover litigation costs and to donate $ 500,000 to the Colorado MoneyWi program. in support of Kindergarten to Grade 12 Financial Literacy Education.
Colorado Safe Harbor Framework Methods
Under the recently announced Colorado Safe Harbor Framework, a bank / fintech loan program can provide loans to consumers in Colorado if it follows one of three methods:
The first method would restrict the ability of a bank and a fintech to enter into a committed forward flow purchase agreement on loans that have been issued by the bank in excess of the Colorado usury limit; however, there would be no restriction on contracts to purchase uncommitted forward flows. It is important to note that, notwithstanding the above restriction, a bank and a financial technology company may enter into committed forward flow agreements for loans issued by the bank that do not exceed the Colorado usury limit. Uncommitted forward flow purchase agreements would satisfy this part of the safe harbor as long as they did not include: (1) broad indemnification provisions in the event of default by the financial technology company of purchase bank loans or losses resulting from a borrower’s failure to make payments on those loans; and (2) the use of collateral accounts deposited by FinTech companies to be used by the originating bank to directly fund these loans or to secure the financing of these loans originally.
The second method would restrict the original bank’s ability to transfer loans to FinTech companies using one of the following two methods. Either that (1) would restrict a forward flow agreement committed to more than 49% of the economic interest in all loans taken in a calendar year in excess of Colorado’s usury limits by the bank under ‘a specific fintech loan program and there could be no facilitated commitment for the balance of these loans; or (2) restrict a forward flow agreement committed to more than 25% of the economic interest in all loans made in a calendar year in excess of Colorado’s usury limits by the bank under a specific fintech loan program, but there could be an uncommitted term flow arrangement for the balance of these loans as long as the bank and the fintech company have adhered to the limits of Method # 1. Economic interests for these purposes would include (1) the sale of entire loans; (2) the sale of shareholdings or debts; (3) any transfer entailing acceptance by the assignee of the economic risk of loss; (4) any sale of securities backed by entire loans or receivables (excluding the acquisition by the associated fintech of these securities as part of a widely subscribed securitization); and (5) any transfer of any of the above to an affiliate of the applicable fintech. However, in either scenario under this Method # 2, there would be no such restrictions on loans below Colorado usury limits.
The third method would restrict the bank’s ability to transfer loans to a single FinTech company beyond 85% of all loans made by the bank under this program, whether or not the loans violate bank limits. Colorado usury and would require the bank to make no more than 35% of loans under a one-time program with a fintech company with an interest rate above Colorado’s usury limits.
Each of these methods under the Colorado Safe Harbor Framework is limited to an individual relationship between a single bank and a single fintech company. Additionally, regardless of the method over a bank / fintech lending program chosen to operate, the Colorado Safe Harbor Framework requires the bank to maintain rigorous oversight of the bank / fintech lending program and also enforces an annual percentage rate cap (APR) of 36%. on all loans issued by the bank under such a program.
Prior to this settlement, other state and federal “real lender” actions and decisions focused on bank loan retention. Rather, the framework established by the Colorado administrator emphasizes the risk the bank retains with respect to the loans it makes, rather than the loans themselves. By retaining a documented risk in the execution of loans to Colorado consumers, either by not having a committed buyer or by limiting the percentage of loans that can be sold after origin, the bank has both the “skin in the game” and the monitoring of its origins by its regulators.
What the regulation means for future settlements
It is important to note that the Colorado Safe Harbor framework will provide greater protection for Colorado banks and fintech companies with respect to the “real lender” issue than (1) the recently entered final rule. in force from August 3 published by the Office of the Comptroller of the Currency (OCC) affirming the doctrine of “valid once granted” with regard to loans granted by national banks and federal savings banks; and (2) the Federal Deposit Insurance Corporation (FDIC) proposed a corresponding rule regarding state chartered banks and “valid when established” that comes into effect on August 21 (collectively with the OCC Final Rule, the “VWM rules”). As has been reported, the attorneys general of California, Illinois and New York are challenging the OCC’s decision in a recent lawsuit filed on July 29, alleging that the OCC does not have the power to ‘issue such regulations under federal law and such a rule encourages lending predators. Unlike VWM rules, the Colorado Safe Harbor Framework only applies to bank / fintech loan programs and does not cover other consumer loans that may be considered predatory as the interest rates charged on these loans consumption exceeds Colorado’s wear rate. On July 20, the OCC proposed a “real lender” rule for domestic banks that provides that the bank is the “real lender” if, on the inception date, (1) it is named as a lender in the loan agreement ; or (2) it finances the loan. The deadline for comments on this proposal is September 6, 2020.
We expect most bank / fintech lending programs to comply with the Colorado Safe Harbor Framework by choosing Method # 1 or the hybrid approach under Method # 2, both of which will involve a flow agreement to term without commitment with bank ordering parties. With either of these methods, banks will not always have a readily available buyer for the loans they make, as these are uncommitted facilities. In the event that a fintech company refused to buy loans offered to it by its banking partner, the bank would have three options: keep the loans on its balance sheet (thus increasing its capital obligations), sell the loans to another buyer (including a special purpose entity securitization transaction) or sponsor its own securitization of these loans.
The Colorado Safe Harbor Framework offers a model for other state attorneys general to follow and could provide much needed regulatory certainty for the FinTech community, including accessing capital markets through securitization. The Colorado Safe Harbor Framework provides Colorado residents with access to credit from banks that are overseen and reviewed by their prudential regulators while protecting its citizens from other types of loans that may be considered predatory if the rates charged are higher than Colorado wear limits. Because it is more prescriptive than the VWM Rules, it offers better consumer protection while promoting responsible banking partnerships.
Fintech lending programs have been able to develop and prosper over the past decade due to the ability of banks to export interest rates and fees from the state where each of these banks is located or to operate their functions. originate loans to borrowers in other states and then sell those loans on the secondary market. With proper advice and advocacy, the Colorado Safe Harbor Framework is the first of what could be widespread adoption by state regulators of requirements for bank / fintech lending programs that allow responsible lending to their residents.
1 The Colorado Administrator’s affairs also included securitization trusts that purchased the consumer loans at issue as defendants.
2 Order re Plaintiff’s Motion for Determination of Law, Slip Op., Denver District Court, Denver County, Colorado, No. 2017CV30376 (June 9, 2020).