Wall Street banks limit their support for online lenders

New York

WALL Street banks are scaling back their role in supporting debt sales that have helped online lending companies double their originations every year since 2010.

Investment banks earn fat fees by helping lenders pool and store their loans until enough are aggregated for sale to investors. But Goldman Sachs Group Inc, Credit Suisse Group AG and JPMorgan Chase & Co are among the Wall Street firms considering limits to their financing for companies that lend to certain higher-risk borrowers, people with knowledge of the policies said. The caution comes in response to a May ruling by the US Appeals Court in Manhattan, which threatens to remove a protection that non-bank lenders have relied on to make high-interest loans. The issue boils down to whether these lenders can pay a bank in an unregulated state to make loans to borrowers in other jurisdictions, where the interest rates could be considered usurious.

The ruling, which is binding in New York, Vermont and Connecticut, presents an "acute risk" to the fast-growing crop of Internet companies led by LendingClub Corp and Prosper Marketplace Inc, according to an Aug 21 report from Compass Point Research & Trading LLC analysts Isaac Boltansky and Michael Tarkan.

Sales of whole loans and bonds tied to these firms' high-yield lending have facilitated the borrowing growth, according to Morgan Stanley researchers led by Smittipon Srethapramote. The so-called marketplace lenders, many of which are startups, are muscling away business from traditional banks and finance companies and are on track to comprise nearly 9 per cent, or an estimated US$900 billion, of the unsecured US consumer loan business by 2020, the analysts said in a May report.

"The concern is focused on enforceability of the notes, which affects their ability to be sold," said New Oak Capital LLC's Richard Kelly, a managing director at the asset-management firm.

The industry works in a roundabout way, which is why the case - originally fought between a borrower and a debt collection unit of Encore Capital Group Inc - is translating into caution on Wall Street. These lenders do not make their own loans. Instead they use a bank in a jurisdiction with little or no usury restrictions to do the originations on their behalf, buy the loans back after they are made, then sell the debt to investors.

Federal law allows the banks to originate loans throughout the country at interest rates that might not comply with laws in all states. The ruling, however, is putting pressure on lenders to alter the way that they originate the debt. It may force them to lower the interest that they charge, Moody's Investors Service said in July. Reducing rates could make their debt less attractive to investors willing to finance risky loans. Investments tied to such lending returned more than 8.5 per cent on average last year, according to data compiled by Orchard Platform.

"Big banks may be concerned that they're essentially lending money on collateral that isn't enforceable or salable," Mr Kelly said.

LendingClub has arranged about US$11.2 billion in loans since inception, the company said in an August presentation. The current legal uncertainty is not impacting its ability to finance its business, according to chief executive officer Renaud Laplanche. BLOOMBERG