American Predatory Lending and the North Carolina model

posted by Melissa Jacoby

My coauthor Ed Balleisen has co-founded a program on consumer lending of interest to Credit Slips readers. Its initial data collection is particularly useful in documenting the North Carolina experience and its implications for other states. The quote below is from Balleisen's post on Consumer Law and Policy:  

Data visualizations of statistics about the North Carolina mortgage market and consumer protection enforcement complement the oral histories, as do a set of policy timelines and memos about state- and national-level regulation of mortgage lending. Our key findings suggest that more stringent oversight of aggressive mortgage practices moderated the housing boom in North Carolina, and so partially insulated the state from the broad collapse in housing values across the country.

The Brown M&M Theory of Telltale Minor Regulatory Violations or What's Wrong with "Earn a savings rate 5X the national average"?

posted by Adam Levitin

A CapitalOne savings account ad has got me thinking about whether Van Halen has anything to teach regulators. Van Halen is famous for its use of a contract that requires provision of M&Ms for the band, but expressly prohibits provision of any brown M&Ms. It's not that they taste different, of course, but that if a concert promoter fails to adhere to the brown M&M term in the contract, it's a red flag that there might be other more serious problems, so the band will undertake a safety check of the stage and equipment. 

IMG_5469So what does this have to do with CapOne?  I'm one of the few folks in the world who bothers to teach the Truth in Savings Act, so I'm probably more inclined to pay attention to deposit account advertising than most folks. I was about to throw out an early May issue of The Economist (yes, my tastes run distinctly to middle brow), when a CapitalOne ad caught my eye.

The ad, which I've posted to the right says, "Why settle for average?  Earn a savings rate 5X the national average."  In smaller, less bold font it then says "Open a new savings account in about 5 minutes and earn 5X the national average." Under that, in smaller, but bold, "This is Banking Reimagined®." Faint, fine print on the bottom says "ONLY NEW ACCOUNTS FOR CONSUMERS. RATE COMPARISON BASED ON FDIC NATIONAL RATE FOR SAVINGS BALANCE < $100,000. OFFERED BY CAPITAL ONE, N.A. MEMBER FDIC © 2019 CAPITAL ONE" Above this is a photo featuring some random dude (or celebrity I don't recognize) with a croissant and coffee and faux casual outfit (jeans and a t-shirt, but a jacket with a pocket square) inviting the reader to join him. Breakfast and banking perhaps? But in the background, over his shoulder is a sign that says "Savings Rate 5X National Average" (its hard to read in the original, and doesn't come across in my photo, unfortunately).

So what's the problem here?

Continue reading "The Brown M&M Theory of Telltale Minor Regulatory Violations or What's Wrong with "Earn a savings rate 5X the national average"?" »

Total Bankruptcy Filings Remain Low, Chapter 11s Not So Much

posted by Bob Lawless

(Updated and corrected, 5/22). An earlier post noted that bankruptcy filings were down substantially over 50% the first two weeks of April. As the American Bankruptcy Institute reported, bankruptcy filings declined by 46% over the entire month and on a year-over-year basis. I wondered whether the expected increase in bankruptcy filings had begun, and the answer appears to be "not yet."

Using PACER docket searches, I get the following filing numbers for the past six weeks. The decline in filings for the first two weeks of May was roughly the same as the last two weeks of April. There were the same number of business days in all these time periods so the numbers should be comparable:

Total Bankruptcy Filings
  2019 2020 change
April 1 - April 15 33,017 16,097 -51.2%
April 16 - April 30 38,289 22,347 -41.6%
May 1 - May 15 31,958 18,578 -41.8%

Continue reading "Total Bankruptcy Filings Remain Low, Chapter 11s Not So Much" »

The Drama Over the Windstream Case: Boiled Down

posted by Mitu Gulati

One the most discussed and debated corporate finance/contracts cases of 2019 was Windsteam LLC v. Aurelius (SDNY 2019) (Stephen L posted on this here).  A couple of days ago, Elisabeth de Fontenay put up her article "Windstream and Contract Opportunism" on ssrn (here) that is one of first deep dives into the implications of what happened in the case.

I find this case especially interesting because it is about contract arbitrage. Cribbing from Elisabeth's superb narrative, the saga starts when the company in question, Windstream, does a sale-leaseback transaction in violation of its bond covenants (it claims it is not actually violating the covenant because it did the transaction through a subsidiary blah blah -- but as the judge points out, its attempt to elevate form over substance falls flat). As it turns out though, none of the bondholders seem to have either noticed or cared about the violation at the time it happened. The violation only bubbles to the surface when Aurelius, a notorious hedge fund, shows up two years later and demands that the trustee declare a default. At this point, I'd have expected that Windstream would have paid Aurelius greenmail to get them to disappear and everyone would have lived happily after.  But that doesn't happen.  Instead, Windstream officials and Aurelius fund managers get into a nasty battle of words in the press and (I'm guessing) both sides decide that they will fight this to the death.

At this point, Windstream tries to retroactively cure its covenant violation by getting the non-Aurelius creditors to say that they were okay with the transaction and do not want to call the company to the carpet. In theory this should have been doable via exit consents and other familiar corporate moves.  But, in a comedy of errors, Windstream manages to screw up the retroactive cure (and the judge wasn't willing to elevate substance over form on this side of the equation).  End result: Windstream loses and goes into bankruptcy.  That is, everyone loses, including the bondholders, because the value of their bonds goes into the toilet.

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How Are So Many EM Sovereigns Issuing New Debt?

posted by Mark Weidemaier

Mitu Gulati and Mark Weidemaier

We have been working on building a dataset of sovereign bonds and their contract terms. Given the economic fallout of the Covid-19 pandemic--close to 100 countries have approached the IMF for assistance--we would not have been surprised if few low- to mid-income countries had issued sovereign bonds in recent months. Instead, there have been large issuances by Guatemala, Paraguay, Peru, Chile, Philippines, Hungary, Mexico and others. 

Take Mexico, one of the biggest players in the sovereign debt market. The country has been badly hit not only by Covid-19 but by brutal drops in oil prices, tourism, and remittances. These developments surely increased the need to borrow in dollar/euro bond markets, but we would have expected investors to balk, or at least to demand punitive coupons. But that doesn’t seem to have happened.

What explains investors’ continued willingness to lend? Might they have drunk the bleach-flavored Kool-Aid and decided that there will be no deep and sustained economic downturn? Possible, we suppose, but unlikely. More plausible explanations include (i) that financial markets are so awash with QE money that investors have few places to go for yield and (ii) that investors may be betting that countries will be bailed out by an official sector desperate to prevent widespread defaults on sovereign debt.

But, because we are interested in the terms of sovereign bonds, we also wondered if investors were demanding extra contractual protections against the risk of non-payment. That would be a sensible precaution given the likelihood that many countries will be unable to make payments. Indeed, colleagues working on M&A contracts have documented a trend towards including risk-shifting clauses that explicitly address pandemic-related events (for a recent paper by Jennejohn, Talley & Nyarko, see here). With superb research assistance from Amanda Dixon, Hadar Tanne, and Madison Whalen, we wondered whether we would find a similar trend in the sovereign bond markets.

Continue reading "How Are So Many EM Sovereigns Issuing New Debt?" »

Letter from 163 Bankruptcy Judges Backs Venue Reform

posted by Bob Lawless

Support seems to keep building even more for changes to where large corporate debtors can file chapter 11. The latest is a letter from "163 sitting, recalled, or retired United States Bankruptcy Judges." From the letter:

The venue selection options for bankruptcy cases under current law have led to forum shopping abuses that have disenfranchised local employees, creditors, and parties in interest from participation in bankruptcy cases, undermined public confidence in the integrity of the United States Courts and the bankruptcy process, inhibited the development of uniform, national bankruptcy jurisprudence, and led to inefficient allocation of judicial resources. 

The judges join forty-two state attorneys general who signed a February letter supporting similar changes. The House bill (H.R. 4421) now has fifteen co-sponsors, which I believe is more than any venue reform bill has had. With all of that support, my views don't matter much, but I agree too

Like I wrote before, there have been lots of efforts at venue reform, but this time feels different.

Immunity, Necessity and the Enforcement of Italian Debt in the Era of Covid-19

posted by Mark Weidemaier

Mark Weidemaier & Mitu Gulati

The sovereign debt world has been debating how to design an emergency debt standstill for the poorest nations, so that they can devote scarce resources to public health rather than debt service. As we’ve discussed on this blog, the question has come up as to whether countries might be able to use the customary international law doctrine of necessity to defend against creditor lawsuits.

Our discussion hasn’t focused on any particular jurisdiction, although we have implicitly assumed that much of the litigation would take place in New York. Now, let us switch gears to assume (plausibly, we think) that Italy is one of the countries that might need a debt standstill. It has been among the worst hit by COVID-19 and will likely soon have a debt/GDP ratio upwards of 150%. To quote a scary new report out from Schroders (here): “Italy is the prime candidate for being the first [Eurozone] casualty [from the Covid-19 crisis]. Its high indebtedness and lack of economic growth require policies that are either illegal in the eurozone, or politically unpalatable domestically.” 

Our work on the mechanics of an Italian debt restructuring—see here (Mark) and here (Theresa Arnold, Ugo Panizza, and Mitu)—has not discussed necessity or other defenses to enforcement. That’s because most of Italy’s debt is subject to Italian law, and our focus was on how Italy might change this law to enable a restructuring. But let us say that Italy does not take this approach. Perhaps it continues to pretend that a debt restructuring is simply inconceivable. It does not lay any legal groundwork for a restructuring. Instead, Italian politicians simply pray for some magical combination of high growth (unprecedented) and a no-strings-attached bailout package from European authorities. In that event, it is conceivable that a sudden spike in interest rates might prevent Italy from making payments. Assuming no immediate European bailout (Italy’s politicians have demonstrated a distaste for any of the conditionality that would come with ESM funding), that means some risk of having to defend the non-payment against creditor lawsuits.

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The Resurgence of Calls For Financial Literacy

posted by Pamela Foohey

Today is the last day of National Financial Literacy Month. At a time when the economy has come to a grinding halt, it seems pertinent to talk about financial literacy, or, more accurately, the fallacy of financial education. Agata Soroko recently published a short essay in Public Seminar -- The Financial Literacy Delusion. In it, she details how calls for financial education already are ramping up in light of the coronavirus's highlighting how little savings most Americans have. I suspected that the refrain that it's people's fault that they didn't have sufficient savings to cover a few months, and thus that they exacerbated the economic downturn with their inability to control themselves enough to save, would emerge with a vengeance in the coming months.

Combating that narrative will become more important than ever, as a matter of economic policy, but also of kindness and understanding to each other. Indeed, it's important right now as Congress considers how to help American families during the crisis. As Slipster Dalie Jimenez, Chris Odinet, and I wrote in our just-uploaded-to-SSRN essay, The Folly of Credit As Pandemic Relief, forthcoming in UCLA Law Review Discourse, in the CARES Act, Congress predominately provided relief to Americans in the form of credit products, not actual cash. This very likely will prove to be problematic because people will be unable to repay in the coming months, just as they are unable to pay for their necessities now. They simply do not have the money, and will not in the future because people still won't have sufficient income to accumulate meaningful savings. As Soroko writes, financial education cannot solve widening income disparities, rising costs, and wealth inequality--the roots of why many Americans have so little savings.

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PPP Loan Fees for Banks

posted by Alan White

$10 billion of CARES Act funds are going to the banks, especially megabanks, in fees for making “small” business PPP loans. The fees established by Congress, to be paid by the Small Business Administration, i.e. Treasury, range from 1% for loans above $2 million to 5% for loans below $350,000.

The maximum loan amount is $10 million, so those loans generate a nifty $100,000 fee each. At least 40 large public companies received loans from $1 to $10 million.

Given the highly streamlined application process, these fees likely far exceed the costs of originating these loans. The 1% interest rate, while low, still exceeds bank cost of funds. Do the banks need a bailout? First quarter earnings reports for the largest banks show steep drops in earnings, but earnings are still positive. The earnings drop is entirely due to provisioning for expected loan losses; obviously predicting loan performance over the next year is a very tricky business. Nevertheless, the PPP fee structure is designed to subsidize financial institutions not especially in need of a bailout, especially compared to restaurants, main street stores, and other small businesses. In fact, given that SBA is waiving the guarantee fee, why don’t the banks just waive the fees and interest on these loans? And given the robust public subsidies to megabanks, why should SBA pay these fees in the first place? If banks have inadequate capital to weather the coming storm, surely there is a better way to support them than having SBA pay these arbitrary PPP loan fees.

The Role of Chapter 11 Bankruptcy in Addressing the Consequences of COVID19.

posted by Jay Lawrence Westbrook

Many businesses may require bankruptcy proceedings to assist in recovery from the CV Recession. In my view, the best legal approach to any Chapter 11 reforms necessitated by the emerging CV-induced economic crisis lies in building up from the Small Business Reorganization Act (SBRA) to cover more Small and Medium Enterprises (SME), rather than trying to adjust the general provisions of Chapter 11, the home of bankruptcies like General Motors and American Airlines. Our database at the Business Bankruptcy Project shows that in 2018 more than half of the businesses that filed in Chapter 11 in the Southern District of New York would fall under the temporary SBRA cap, $7.5 million.

Most immediately, the recently voted funds for small business must be available in bankruptcy reorganization cases. We must remove any barrier to using them in that way. I start the study of Chapter 11 by reminding students that the clerk at the bankruptcy court does not hand out money. Bankruptcy does not produce funding, although it can help facilitate it in important ways. Thus there is no legal reform that will avoid the need for very substantial financing with implications far beyond reorganization procedures. Bankruptcy cannot help unless it can be used in connection with rescue funding.

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Further Thoughts on Necessity as a Reason to Defer Sovereign Debt Obligations

posted by Mark Weidemaier

Mitu and I posted some preliminary thoughts about the defense of necessity, which might be raised as a basis for allowing sovereign borrowers to defer debt service during the crisis. I wanted to follow up on some of the open issues. A few are technical, addressing some potential objections to the defense. I’ll deal with these first and close with a more fundamental question: What good does this potential defense really do for a sovereign? In thinking through that question, my premise is that many sovereigns will need a temporary standstill on debt service during the crisis. For proposals to this effect, see here, here, and here. (Others will eventually need a debt restructuring, but that’s a topic for another day.) But of course private creditors must agree to a standstill on payments. Those who don’t might sue or file arbitration claims, which will potentially put the sovereign's assets at risk and will certainly consume time and resources to defend. [Last sentence edited for clarity.]

Some background

Necessity is a rule of customary international law. As expressed in Article 25 of the International Law Commission’s draft Articles on Responsibility of States for Internationally Wrongful Acts, a state can invoke necessity to excuse its non-performance of an “international obligation” if non-performance is the only way to address “a grave and imminent peril,” as long as non-performance does not seriously impair an essential interest of the “State or States towards which the obligation exists.” Even if these conditions are satisfied, the state cannot invoke necessity to excuse the violation of an international obligation that “excludes the possibility of invoking necessity.” (Put differently, the doctrine purports to treat necessity as a default rule.) Nor can a state invoke the defense if it has contributed to the state of necessity. Finally, even if the defense is available, non-performance is excused only while the threat persists. The state must resume performance when the crisis ends, and it may have to pay compensation for any loss caused by its non-compliance.

It may not be obvious, but this is a remarkably crabbed conception of “necessity.”

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State Bankruptcy

posted by Stephen Lubben

So Senate Majority Leader Mitch McConnell says States should be able to file for bankruptcy, to get out of their pension obligations. He'd rather that than give them a federal bailout, given current conditions.

I have long argued that States don't need bankruptcy, because they have stronger sovereign immunity (under the Eleventh Amendment) than most actual sovereigns. But put that to one side.

Why does McConnell think that such a bankruptcy will be limited to single class of creditors? Indeed, I doubt such a bankruptcy system would be consistent with the Bankruptcy Clause.

And quite frankly, I suspect bondholders understand this (even if anti-union activists don't). That is why you never see the municipal bond managers advocating for "State bankruptcy." The bankruptcy of any of the 50 states would look more like Puerto Rico's, where haircuts to bondholders are most definitely on the table. The only question is "how much?"

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