On September 3, 2020, the California Department of Business Oversight (DBO) announced that it has launched a formal investigation into whether Wheels Financial Group, LLC d/b/a LoanMart, formerly one of California’s largest state-licensed auto title lenders, “is evading California’s newly-enacted interest rate caps through its recent partnership with an out-of-state bank.” Coupled with the California legislature’s passage of AB-1864, which will give the DBO (to be renamed the Department of Financial Protection and Innovation) new supervisory authority over certain previously unregulated providers of consumer financial services, the DBO’s announcement is an unsurprising but nonetheless threatening development for bank/nonbank partnerships in California and throughout the country.
In 2019, California enacted AB-539, the Fair Access to Credit Act (FACA), which, effective January 1, 2020, limits the interest rate that can be charged on loans of $2,500 to $10,000 by lenders licensed under the California Financing Law (CFL) to 36% plus the federal funds rate. According to the DBO’s press release, until the FACA became effective, LoanMart was making state-licensed auto title loans at rates above 100 percent. Thereafter, “using its existing lending operations and personnel, LoanMart commenced ‘marketing’ and ‘servicing’ auto title loans purportedly made by CCBank, a small Utah-chartered bank operating out of Provo, Utah.” The DOB indicated that such loans have interest rates greater than 90 percent.
The DBO’s press release stated that it issued a subpoena to LoanMart requesting financial information, emails, and other documents “relating to the genesis and parameters” of its arrangement with CCBank. The DBO indicated that it “is investigating whether LoanMart’s role in the arrangement is so extensive as to require compliance with California’s lending laws. In particular, the DBO seeks to learn whether LoanMart’s arrangement with CCBank is a direct effort to evade the [FACA], an effort which the DBO contends would violate state law.”
Because CCBank is a state-chartered FDIC-insured bank located in Utah, Section 27(a) of the Federal Deposit Insurance Act authorizes CCBank to charge interest on its loans, including loans to California residents, at a rate allowed by Utah law regardless of any California law imposing a lower interest rate limit. The DBO’s focus in the investigation appears to be whether LoanMart, rather than CCBank, should be considered the “true lender” on the auto title loans marketed and serviced by LoanMart, and as a result, whether CCBank’s federal authority to charge interest as allowed by Utah law should be disregarded and the FACA rate cap should apply to such loans.
It seems likely that LoanMart was targeted by the DBO because it is currently licensed as a lender under the CFL, made auto title loans pursuant to that license before the FACA’s effective date, and entered into the arrangement with CCBank after the FACA’s effective date. However, the DBO’s investigation of LoanMart also raises the specter of “true lender” scrutiny by the DBO of other bank/nonbank partnerships where the nonbank entity is not currently licensed as a lender or broker, especially where the rates charged exceed those permitted under the FACA. Under AB-1864, it appears nonbank entities that market and service loans in partnerships with banks would be considered “covered persons” subject to the renamed DBO’s oversight.
Should the DBO bring a “true lender” challenge against LoanMart’s arrangement with CCBank, it would not be the first state authority to do so. In the past, “true lender” attacks have been launched or threatened by state authorities against high-rate bank/nonbank lending programs in DC, Maryland, New York, North Carolina, Ohio, Pennsylvania and West Virginia. In 2017, the Colorado Attorney General filed lawsuits against fintechs Avant and Marlette Funding and their partner banks WebBank and Cross River Bank that included a “true lender” challenge to the interest rates charged under the defendants’ loan programs, even though the annual percentage rates were limited to 36%. Those lawsuits were recently dismissed under the terms of a settlement that established a “safe harbor” that permits each defendant bank and its partner fintechs to continue their programs offering closed-end consumer loans to Colorado residents.
While several states oppose the preemption of state usury laws in the context of bank/nonbank partnerships, federal banking regulators have taken a different stance. Thus, both the OCC and FDIC have adopted regulations rejecting the Second Circuit’s Madden decision. A number of states have challenged these regulations. Additionally, the OCC recently issued a proposed rule that would establish a bright line test providing that a national bank or federal savings association is properly regarded as the “true lender” when, as of the date of origination, the bank or savings association is named as the lender in a loan agreement or funds the loan. (We have submitted a comment letter to the OCC in support of the proposal.) If adopted, this rule also will almost certainly be challenged. The FDIC has not yet proposed a similar rule. However, since Section 27(a) of the Federal Deposit Insurance Act is based on the federal usury law applicable to national banks, we are hopeful that the FDIC will soon propose a similar rule.
Bank/nonbank partnerships constitute an increasingly important vehicle for making credit available to nonprime and prime borrowers alike. We will continue to follow and report on developments in this area.