California has reformed consumer loan interest rates. But will lenders find loopholes?

By Tom Dresslar, Special to CalMatters |   
The people of California, through their legislature and governor, just decided to end a decades-long, unbridled fleecing of millions of the state’s borrowers. 

Some predatory lenders, however, may launch a scheme that could, for their companies, effectively overturn that sovereign decision.

Gov. Gavin Newsom has signed into law Assembly Bill 539 by Assemblywoman Monique Limón, Santa Barbara Democrat. The measure sets an annual interest rate cap of roughly 36% on consumer loans from $2,500 to $10,000 made by non-bank lenders.

For the prior 34 years, under state law, the sky was the limit on rates charged for such loans. Last year, 333,416 non-bank consumer loans in the $2,500 to $10,000 range had annual percentage rates of 100% or higher. That represented 40.7% of such loans. In the $2,500-$4,999 range, the triple-digit APR ratio was 55.5%.

Existing state law has permitted high-cost lenders to prey on hundreds of thousands of financially vulnerable borrowers who have few credit options. Many live in minority communities. All too often, these consumers, trapped in loans they cannot afford, stop making payments and end up even less able to obtain credit in the future.

AB 539 addresses this problem, one of the most significant market hazards California consumers face today. Even before the measure passed the Legislature, however, three lenders told investors they had an escape hatch.

The three firms are Elevate Credit, Inc.Enova International, Inc. and CURO Group Holdings Corp. The lending businesses they operate in California are called, respectively, Rise Credit, CashNet USA, and Speedy Cash.

In 2018, those lenders made a combined 24.7% of the triple-digit APR loans in the dollar range affected by AB 539.   

In late-July earnings calls with investors, the three companies made AB 539 seem like a pesky fly easily flicked away. All they have to do, the firms’ executives said, is form partnerships with out-of-state banks in lender-friendly confines and, presto, AB 539’s rate caps vanish. 

Federal law makes the magic trick possible.

At the risk of getting too technical, Section 1831(d)(a) of the Federal Deposit Insurance Act allows state-chartered banks to “export” to all other states the loan rates allowed in the state where they are located. 

So if their home state’s laws have no rate restrictions, such banks can charge borrowers in other states any amount they want, regardless of limits imposed by the consumer’s state laws.   

Non-bank lenders in California and other states–many of them operating online–have exploited this breach of state sovereignty. The partnerships they enter with state-chartered banks allow them to evade state regulation and interest rate limits because the bank technically originates the loans, bringing the FDIA provision into play.

However, these agreements often have turned out to be little more than legal subterfuge. In a typical case, the bank sells the loans back to its non-bank partner within a few days after originating them. The non-bank, not the bank, retains most or all of the risk from non-payment. The bank frequently is indemnified against other losses arising from the agreement. The non-bank does all the customer acquisition, all the loan servicing, all the interaction with customers. Ask borrowers in these circumstances to identify their lender, and they will name the non-bank.

Such agreements raise serious questions about whether the bank or non-bank is the true lender. And if the non-bank is the true lender, it should not be allowed to use federal law to evade state regulation. 

Courts have ruled on both sides of the true lender question. So, while in Elevate’s July 29 earnings call one executive bragged about how the firm used a bank partnership to evade rate limits in Ohio, the arrangements are not impenetrable legal fortresses.

In New York and Colorado, officials have taken strong pro-consumer stances by proactively attacking fringe lenders’ transparent use of banks to evade their states’ laws.

One way California can fight this threat to AB 539 is to take a tough stand on the true lender issue. State officials could announce plans to adopt regulations setting criteria that determine when the bank is the true lender. They could make it known they will aggressively litigate the true lender issue.

State officials also should work with federal regulators, and regulators in states where banks form these partnerships, to stop the agreements before they happen.   

Bottom line: California’s government leaders must make every effort to stop Elevate, Enova and CURO—and their ilk—from joining with out-of-state banks to thumb their noses at California, its consumers and its democratic process.

Tom Dresslar is a former reporter and served as a Deputy Commissioner at the California Department of Business Oversight, the state’s regulator of financial service industries. He wrote this commentary for CalMatters, a public interest journalism venture committed to explaining how California's Capitol works and why it matters. Please see his past commentaries for CalMatters by clicking herehere, and here.

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