California Dept. of Business Oversight Launches ‘Real Lender’ Investigation into Auto Title Lender and Bank of Utah Partnership | Ballard Spahr LLP
On September 3, 2020, the California Department of Business Oversight (DBO) announced that it had opened a formal investigation to find out whether Wheels Financial Group, LLC d / b / a LoanMart, formerly one of the largest licensed auto securities lenders to the State of California, “is evading the newly adopted interest rate caps in California with its recent partnership with a foreign bank. ” Associated to the passage of AB-1864 by the California legislature, which will give the DBO (which will be renamed the Department of Financial Protection and Innovation) a new supervisory authority over certain previously unregulated consumer financial service providers, the DBO announcement is an unsurprising but nonetheless threatening development for partnerships banking / non-banking in California and 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 from $ 2,500 to $ 10,000 by California Financing Law (CFL) approved lenders at 36% plus the federal funds rate. According to the DBO press release, until the FACA took effect, LoanMart provided state-licensed auto title loans at rates above 100%. Subsequently, “using its existing lending operations and staff, LoanMart began to ‘market’ and ‘manage’ auto title loans purportedly made by CCBank, a small Utah chartered bank operating in Provo , in Utah. ” The DOB reported that these loans have interest rates above 90 percent.
The DBO press release said it had issued a subpoena to LoanMart requesting financial information, emails and other documents “relating to the genesis and parameters” of its deal with CCBank. The DBO said it “is investigating whether LoanMart’s role in the arrangement is broad enough to require compliance with California loan laws.” In particular, the DBO is investigating whether LoanMart’s arrangement with CCBank is a direct effort to escape the [FACA], an effort that the DBO said would violate state law. “
Because CCBank is a state chartered and FDIC insured bank located in Utah, Section 27 (a) of the Federal Deposit Insurance Act allows CCBank to charge interest on its loans, including loans to residents of California, at a rate permitted by Utah law independent of any California law imposing a lower interest rate limit. The objective of the DBO in the investigation appears to be whether LoanMart, rather than CCBank, should be considered the “true lender” of the auto securities loans marketed and managed by LoanMart and, therefore, whether the federal regulatory authority. CCBank to charge interest, as permitted Utah law should not be followed and the FACA rate cap should apply to these loans.
It seems likely that LoanMart was targeted by DBO because it is currently licensed as a lender under the CFL, granted auto title loans in accordance with this license prior to the effective date of the FACA and entered into the agreement with CCBank after the effective date of the FACA. However, the DBO’s investigation of LoanMart also raises the specter of the DBO examining the ‘true lender’ of other bank / non-bank partnerships where the non-bank entity is not currently licensed as a lender. or broker, especially when the rates charged exceed those permitted under the FACA. Under AB-1864, it appears that non-bank entities that market and service loans in partnerships with banks would be considered “covered persons” under the oversight of the renamed DBO.
If DBO challenges the “real lender” of LoanMart’s arrangement with CCBank, it would not be the first state authority to do so. In the past, “real lender” attacks have been launched or threatened by state authorities against high rate bank / nonbank lending programs in Washington, Maryland, New York, North Carolina, in 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, which included a challenge to the interest rates charged under the defendants’ loan programs, even if the annual percentage rates were limited to 36%. These lawsuits were recently dismissed under the terms of a settlement which established a “safe harbor” that allows each defendant bank and its fintech partners to continue their programs offering gated consumer loans to residents of Colorado.
While several states oppose the pre-emption of state usury laws in the context of banking / nonbank partnerships, federal banking regulators have taken a different position. Thus, both the OCC and FDIC passed bylaws rejecting the Madden Second Circuit ruling. A number of states challenged these regulations. In addition, the OCC recently published a proposed rule which would establish a clear criterion provided that a national bank or a federal savings association is rightly regarded as the “true lender” when, at the date of creation, the bank or the savings association is designated as lender in a loan agreement or funds a loan. (We have submitted a letter of comment to the OCC to support the proposal.) If passed, this rule will also almost certainly be challenged. The FDIC has yet to propose a similar rule. However, since Section 27 (a) of the Federal Deposit Insurance Act is based on the Federal Usury Act applicable to domestic banks, we hope the FDIC will soon come up with a similar rule.
Bank / non-bank partnerships are an increasingly important means of making credit available to credit borrowers as well as to major borrowers. We will continue to monitor and report on developments in this area.