A proposed class action against LendingClub Corporation is credit negative for asset-backed securities (ABS) backed by consumer loans originated through online platforms using a partner bank origination model, Moody’s Investors Service says in a new report. The lawsuit confirms that the owners of such loans face legal challenges over whether the loans are exempt from state usury limits.

Bethune vs LendingClub Corporation et al. was filed in the US District Court for the Southern District of New York on 6 April. Lending Club loans have not backed any Moody’s-rated ABS.

“Bethune is the first case we are aware of in which a plaintiff has filed against a consumer marketplace lender over the question of whether its loans are exempt from state usury limits,” says Vice President – Senior Analyst, Alan Birnbaum. “If the plaintiffs in such lawsuits prevail, borrowers could see the interest rates on their loans lowered or their loans deemed void or unenforceable, which would reduce cash flows to ABS backed by the loans.”

If it leads to rulings that create legal precedents or prompts other, similar lawsuits, the Bethune case could affect Moody’s-rated ABS transactions, Birnbaum says in the report, “Proposed Class Action Lawsuit Against Lending Club Is Credit Negative for Sector.” And regardless of the outcome of the litigation, such lawsuits could distract platform operators in the nascent marketplace lending industry from their day-to-day operations, adds Jody Shenn, a Moody’s Assistant Vice President – Analyst.

But if an adverse legal outcome jeopardizes the viability of an online lending platform, the platform may not be able to service loans or repurchase those that breach its representations and warranties. Effective back-up servicing arrangements would limit servicing disruptions in such a scenario, Moody’s says, and the consumer marketplace loan ABS it has rated to date include back-up arrangements with experienced servicers.

The potential for legal challenges over the use of originating partner banks has been front and center of the marketplace lending space since the Madden v Midland Funding LLC decision, in which the Second Circuit Court of Appeals found that a nonbank entity that bought charged-off debt from a bank was not entitled to protection from state-law usury claims. Among other important differences between the cases, the Madden ruling applies only in New York, Connecticut and Vermont, but one of the proposed Bethune classes includes borrowers who reside throughout the US, and so points to legal risks for loans that exceed usury limits elsewhere.

The full reports is available at the source link (paywall) below.