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The Sky Is Falling: Securitization, Chicken Little Edition

posted by Adam Levitin

It's been quite a week for "valid-when-made (up)".  Not only did FDIC and OCC race to court to defend the doctrine in the context of a 120.86% small business loan, but there's a Bloomberg story out about a set of class action usury law suits (here and here) against the credit card securitization trusts used by Capital One and Chase. The story suggests that these suits threaten the $563 billion asset-securitization market and also the $11 trillion mortgage securitization market. That claim is so readily disprovable, it's laughable. 

Here's the background. New York has a 16% usury cap under Gen. Oblig. Law 5-501. The National Bank Act § 85 provides that that cap does not apply to national banks that are based in other states (such as Delaware), but the National Bank Act only covers banks. The securitization trusts are not banks, but are common law or Delaware statutory trusts. The class action suits argue that under the 2d Circuit's Madden v. Midland Funding, LLC precedent, it is clear that New York usury law applies to the trusts; they cannot shelter in National Bank Act preemption because they are not national banks. 

Obviously, the banks see it the other way, and have invoked valid-when-made as part of their defense. They're wrong, but what irks me is that financial services industry lawyers and trade associations are claiming that if these class action suits succeed the sky will fall for securitization and that the Bloomberg article didn't really question this claim: Bloomberg's headline is that the entire $563 billion ABS securitization market is at risk, and bank attorneys suggest in the article that the $11 trillion mortgage securitization market is at risk too. 

Let's be clear. This is utter nonsense on a Chicken Little scale. These class action law suits affect only part of the $123 billion credit card securitization and the very small $30 billion unsecured consumer loan securitization markets. Even then they do not threaten to kill off these markets, but merely limit what loans can be securitized to those that comply with the applicable state's usury laws. They do not affect mortgage securitization at all and are unlikely to have much, if any impact on auto loan securitization or student loan securitization. To suggest, as the Bloomberg article does, that these class action suits affect the securitization markets for cellphone receivables or time shares (where is there a usury claim even possible in those markets?) is embarrassingly ridiculous. The sky isn't falling, Turkey Lurkey. Full stop. 

The class action law suits do not affect mortgage securitization because there is separate federal statutes (here and here) that preempt all state usury laws for first lien mortgages no matter what entity holds the loan. Additionally, first lien mortgages are never at rates high enough to trigger state usury laws. As for second lien mortgages, the combination of HOEPA disclosure/counseling and substantive term requirements and the Dodd-Frank Ability-to-Repay rule makes it unlikely that many are at rates high enough to trigger state usury laws, and many of those loans are made by non-bank lenders who aren't shielded from usury laws in the first place.

With auto loans, new car financing will never be above state usury caps (there are often different caps for retail installment sale contracts). Moreover, it is unclear if the National Bank Act preemption even applies to a loan acquired rather than originated by a national bank, and most lending isn't done by banks, but by captives and credit unions that are subject to various usury caps. As for used cars, the priciest loans are made by buy-here-pay-here dealers who by definition don't securitize their loans. 

For student loans, the largest private student lender, SoFi, isn't even a bank. Sallie Mae and some other lenders are, but again, interest rates on private student loans are unlikely to exceed state usury caps.  

What this all means is that the impact of upholding Madden in the context of credit card securitization will be to prevent the securitization of that subset of credit card debt that exceeds state usury laws and also to prevent the securitization of some marketplace lending (but that is a very small market). This isn't the sky falling. It isn't preventing credit card loans from being made. It just requires that the higher interest rate loans that violate state usury laws be funded through banks' balance sheets. For states without a usury cap, like Delaware, this means that following Madden would have no impact. For states with higher caps, say 36%, again no impact. Instead, the ruling really affects a subset of loans in states with lower usury caps. The total $563 billion credit card securitization market isn't at risk.

In any event, securitization really isn't so important to credit card lending any more. Banks have become MUCH less reliant on securitization to finance credit card lending as the chart below shows. Only about 12% of credit card receivables are financed through securitization today, down from 40% in 2002.  The loss of off-balance sheet accounting treatment in 2010 is probably a substantial factor in the decline, but the rate of securitization has been decreasing for nearly the past twenty years. 

Credit Card Securitization Rates

(For more than you ever wanted to learn about credit card securitization, which works differently from mortgage or auto loan securitization, for example, see here.) For more information on the suits, see here.  


One other thing: Every one of these securitization REITs I have seen expressly has in its PSA that it is to be governed by the laws of New York.

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