Wednesday, July 29, 2015

Treasury Speaks to Puerto Rico's Debt Problem But Doesn't Say Much

Treasury Secretary Jack Lew sent a letter yesterday responding to questions posed by Sen. Orrin Hatch (R. Utah) about Puerto Rico.   Lew notes that the Obama administration is not considering a federal bailout for Puerto Rico. He said that returning Puerto Rico to a sustainable economic path requires "development of a long-term comprehensive fiscal plan" that addresses Puerto Rico's financial challenges (high unemployment, "labor market challenges" and high energy and transportation costs, "exacerbated by a history of less than adequate fiscal policy choices").  The plan must include input from stakeholders, be based on credible projections for revenue, expenses and growth, and include a "realistic and robust economic growth strategy that encourages new private investment, increases Puerto Rico's competitiveness, and strengthens its economic structure."  Lew said that Puerto Rico's situation requires "a collective action" and "the immediate attention of Congress."  Puerto Rico has about 18 different debt issuing entities that together owe about $72 billion.  Each entity's liability is unique based on the terms of individually negotiated and issued debt.

Puerto Rico's representative (non voting) in Congress has proposed legislation that would permit Puerto Rico's public bond-issuing entities to file for protection under Chapter 9 (H.R. 870). Chapter 9 of the Bankruptcy Code is titled "Adjustment of Debts of a Municipality."  Chapter 9 does not provide a way for a state government to adjust its debts.  Instead, only "a political subdivision or public agency or instrumentality of a State" (a "municipality") may be a debtor under Chapter 9, and only if the municipality is "specifically authorized... to be a debtor under such chapter by State law" or by a State officer empowered by State law to authorize it.  11 U.S.C. sec. 108(c) (requiring also that the debtor be insolvent, wants a plan to adjust its debts in Chapter 9, and has made an effort to work out the debt problem outside of bankruptcy).  The term "State" includes both D.C. and Puerto Rico "except for the purpose of defining who may be a debtor under chapter 9..."  11 U.S.C. sec. 101(52).  So, the proposed legislation amends current law to make Puerto Rico a State for purposes of access to Chapter 9 by Puerto Rican "municipalities". 

Even if Congress acts to amend 11 U.S.C. sec. 101(52) to open chapter 9 to Puerto Rico's municipalities, it's hard to imagine a bankruptcy court-supervised process that might yield economically and politically feasible plans of reorganization for Puerto Rico's municipalities.   Secretary Lew noted in his letter to Senator Hatch the mainland political issue ticking like a bomb within the Puerto Rican debt crisis.  Lew stressed that special bankruptcy legislation is not a "federal bailout."  And, he noted that a court supervised restructuring in a "tested legal bankruptcy regime" could mitigate "further harm [to] retiree investment portfolios across the country" that hold Puerto Rican debt.   More than 20% of mutual bond funds own Puerto Rican bonds according to Morningstar (377 funds out of 1, 884),  In 2012, Puerto Rican government agencies were the second busiest borrowers in the municipal bond market.  Only municipal bond issuers in California were busier.  (California's population is 10 times bigger than Puerto Rico's). Puerto Rican public agency bonds have long been popular because of high yields and triple tax exempt status (federal, state and local).  

How would municipal bond funds fare as creditors in chapter 9 relative to their chances outside of Chapter 9?  In Detroit's bankruptcy, bondholders were happy that the bankruptcy court ruled that union pension claims were not entitled to priority in payment, notwithstanding Michigan law which protected them.  (Contrast the preferred treatment United Auto Workers got in the GM restructuring in its June 2009 bankruptcy, which was achieved with significant Obama Administration intervention outside of bankruptcy.)   On the other hand, bondholders under Detroit's bankruptcy plan did take less than the full amount of their claims  and ultimately settled their objections to the confirmation of the plan on grounds it favored city pensioners over bondholders.  Even in a "tested legal bankruptcy regime" like Chapter 9, politically powerful groups can press their advantage and unlovable "Wall Street" creditors will absorb disproportionate pain.  

Several groups have considered Puerto Rico's financial situation and proposed in very general terms,  pathways out of the current financial disaster:  The New York Federal Reserve, Update on the Competitiveness of Puerto Rico's Economy (2014, updating 2012 report); Anne Kreuger, Rajut Teja, and Andrew Wolfe, Puerto Rico- A Way Forward (June 29, 2015); Centennial Group International, For Puerto Rico, There is A Better Way (July 2015).  The Centennial Group prepared its report for a group of hedge funds that hold Puerto Rican bonds.  Not surprisingly, the report recommended fiscal austerity and structural reform rather than write down of bond debt.

Tuesday, July 28, 2015

Thursday, July 23, 2015

Student Loan "Abuses?"

The CFPB got Discover Financial Services to enter into a $18.5 million settlement to resolve CFPB's claims that its subsidiaries engaged in illegal student loan servicing practices.  Discover did not admit or deny the conduct alleged.  It just agreed to pay $16 million in compensation and $2.5 million in penalties to end the CFPB action against it.

News reports yesterday described Discover's conduct as  "harassment" and "lying" to student loan borrowers.  I thought it would be interesting to see exactly what CFPB alleged that Discover's subsidiaries did.  So I dug up the Consent Order.

In late 2010, Discover's subsidiaries acquired substantially all of Citibank's private student-loan portfolio (about 800,000 loan accounts) and took over as servicer on those loans.  Here is the misconduct CFPB alleged:

  • With respect to the Citibank loans, Discover failed to notify borrowers properly of the amount of interest they paid on their loans for purposes of claiming a federal tax deduction.  CFPB conceded that Discover notified borrowers on their loan statements that they would not get a form 1098-E (reporting interest paid) unless those borrowers first submitted a form W-9S (certifying that the loan proceeds were used solely to pay for qualified higher ed expenses).  That wasn't enough, according to the CFPB, and was "likely to mislead borrowers into believing that they had not paid interest qualifying for the tax deduction...." 
  • For some of the Citibank loans, Discover misstated the minimum amount due by improperly including in the minimum payment calculation interest accrued on loans still in deferment.  Apparently Discover credited all payments properly.  (The agreed redress for borrowers is an account credit equal to $100 or 10% of the overpayment up to $500 per borrower.)
  • Between late 2010 and February 2013, Discover made about 150,000 collection calls at improper times (too early or too late) because, it appears, Discover timed its calls using only the time zone associated with the borrower's cell phone number area code rather than both the area code and the borrower's mailing address.  CFPB alleged "[o]ver 1000 consumers received dozens of calls at inconvenient hours."
  • Discover engaged in collection activity with respect to 252 of the Citibank loans that were in default, and failed to comply with the consumer information requirements imposed on "debt collectors" under the Fair Debt Collection Practices Act.
Discover may have made some mistakes probably because it plunged into a politically sensitive and highly regulated line of business before it had acquired the back office capability to handle it.  Harrassment and lying?   "Abuse" of student loan borrowers?  I don't think so. 

Discover Financial Service stock held steady yesterday and it reported second quarter net income of  $599 million or $1.33 per share

Wednesday, July 22, 2015

California Supreme Court Decides "Separate and Apart" Requires Separate Residences

In Davis v. Davis, decided Monday, the California Supreme Court held that spouses must live separately in different residences to claim that property they accumulate is not community property.  California Family Code section 760 makes all property acquired by spouses during a marriage community property "[e]xcept as otherwise provided by statute," including section 771(a): "earnings and accumulations of a spouse...while living separate and apart from the other spouse, are the separate property of the spouse."  The court held that spouses are not "living separate and apart" when they live together.

Mr. and Mrs. Davis married in 1993 and had two children. Mrs. Davis testified that by 2004, they were "living entirely separate lives" but in the same house.  When Mrs. Davis petitioned for divorce in December 2008, she listed their date of separation as June 1. 2006.  Mr. Davis listed the date of separation as July 1, 2011.

The California Supreme Court considered the history of the 1870 Act in which section 771(a) originated entitled "An Act to protect the rights of married women in certain cases."  The first section of the 1870 Act provided that "[t]he earnings and accumulations of the wife...., while the wife is living separate and apart from her husband, shall be the separate property of the wife."  And, it provided that a wife who was living "separate and apart from her husband" had "sole and exclusive control [over] her separate property," and could sue and be sued without joinder of the husband. Section 4 of the Act provided a means for a wife "living separate and apart" to convey her separate real property without her husband's consent by recording a declaration containing a description of her real estate, the name of her husband, and stating "her own place of residence" and that she is "living separate and apart from her husband." 1870 Act sec. 4.

Before the 1870 Act was adopted, married women had no control over separate or marital property. The husband had absolute right of "management and control" of community property, including the power to sell assets.  Under the predecessor 1850 statute, "rents and profits of separate property" were deemed community property subject to the husband's sole control, and the husband had the exclusive right to manage the wife's separate property "during the continuance of the marriage" subject only to the requirement that to sell or encumber the wife's separate property, the transaction must be documented in an instrument signed by both spouses.  The court concluded that the 1870 Act provided married women some protection from the oppressive effect of the prior law.  As a result of the 1870 Act, a married women who was not physically living with her husband could control her own earnings and control and dispose of her separate property.  Early cases interpreting the scope of the exception in section 771(a) considered not whether separate residences were required, but whether the wife had to show something more, e.g., whether one spouse had "abandoned" the other as part of a "separation which [they] intended to be final."  Tobin v. Galvin, 49 Cal. 34, 36-37.  A married couple was not "living separate and apart" if they were residing in separate places for economic or social reasons, but only when they were living in separate locations and have "no present intention of resuming marital relations and taking up life together under the same roof."  Makeig v. United Security Bank &Trust Co., 112 Cal. App. 138 (1931).

Mrs. Davis cited the dissent  in In re Marriage of Norviel, 102 Cal. App. 4th 1152 (2002) as support for her contention that spouses can be "living separate and apart" while living together.  In that case, the majority recognized that under California law, spouses may live apart (in separate residences) and not be separated.  But, the Norviel majority held, the reverse is not true.   However, the dissent in Norviel found that the evidence introduced at trial supported the trial court's finding that the date of separation predated the husband's physical departure from the marital home, because the husband had communicated his intent to end the marriage before he moved out, and the parties' conduct thereafter was consistent with that expressed intent.  The dissent thought that the majority rule requiring that the couple live in separate residences would not permit the couple "a transition period to take the necessary steps to untangle the financial, legal and social ties incident  to their decision."  Id. at 1166.

The California Supreme Court considered the policy implications of a bright line rule requiring physical separation to establish "living separate and apart."  Mrs. Davis argued as a matter of public policy that spouses may need to reside together in the same residence as "roommates" after they mutually intend an end to their marriage for pressing financial reasons, and one spouse who wants to separate and stay in the marital home may find it difficult to compel the other spouse to move out. The court held that although the rule may impose hardships, it does what a bright line rule does-- it provides predictability of outcome and clear guidance to judges. And, it reduces strategic behavior invited by a more flexible standard.  The bright line rule requiring physical separation "retains the presumption of community property for earnings and accumulations acquired during marriage during a period of time likely to be prior to the institution of court proceedings and any court order of support, thereby protecting the lower earning spouse."

The bright line may not be all that bright.  In a concurring opinion, Justice Liu agreed that "living separate and apart" refers to separate residences, but noted that the majority did not foreclose the possibility of circumstances where a couple could live "separate and apart" with the requisite separate residences "even though they continued to literally share one roof."  Justice Liu added to the history of California's community property laws amendments in the 1970's through which the Legislature afforded both spouses equal control rights in community property, and adopted no-fault divorce, with the effect that by the end of the 1970's the "living separate and apart" exception was not necessary to protect married women.  Rather, the exception now serves to recognize that separation before divorce ends the community "in situations where the spouses have effectively though not formally ended their marriage."  Justice Liu noted that "countervailing considerations of family economics and parenting suggest that the physical separation need not assume the precise form that the Legislature in 1870 envisioned, namely, separate addresses."  Citing the dissent in In re Marriage of Norviel, Justice Liu wrote that the test for whether the parties are "living separate and apart" is whether they can demonstrate not only intention to separate, but also unambiguous, objectively ascertainable conduct amounting to physical separation under the same roof."

New Rule Expands Military Lending Act

Today, the Department of Defense issued a final rule expanding the scope of the Military Lending Act (MLA).  The MLA was enacted in 2006 and was implemented by DOD rules in 2007.  It prohibited contracting with service members for three types of consumer credit products:  1) closed end payday loans for $2000 or less with a term of 91 or fewer days; 2) closed end auto title loans for a term of 181 days or less; and 3) closed-end tax refund anticipation loans.

The new rule, which will become effective in October 2015, expands the scope of the MLA:

  • Imposes a 36% interest rate cap (calculated as the Military Annual Percentage Rate or MAPR) including all interest and fees associated with a loan;
  • Prohibits creditors from imposing mandatory arbitration terms on service member borrowers, and prohibits terms that require service members to waive certain other rights;
  • Prohibits loans to service members that provide a payroll allotment as a condition for obtaining credit, permit rollover of a payday loan, or use of a security in the form of a post-dated check  or a car title (with some exceptions);
  • Expands the definition of "credit" covered by the MLA to include any closed or open-end loan, including car loans but excluding loans secured by real estate;
  • Modifies the provisions relating to the optional mechanism a creditor can use to assess whether a consumer is a "covered borrower" under the MLA;
  • Modifies disclosures a creditor must provide to a covered borrower;
  • Implements the MLA's enforcement provisions.

The DOD consulted (as the MLA required) with a host of federal agencies including the CFPB.  CFPB Director Richard Cordray said "The CFPB strongly supports the Department's efforts to strengthen consumer protections for our nation's military families."  In December 2014, the CFPB issued a report asserting that lenders were exploiting "loopholes" in the MLA.  The CFPB report took aim at "deposit advance products" (see April 2013 CFPB whitepaper OCC's supervisory guidance and Federal Reserve Board on these products).  A "deposit advance product" is a loan that a lender makes to a borrower whose deposit account reflects recurring direct deposits.  The borrower promises to repay the principal plus a fee from the next direct deposit. The underwriting basis for the loan is cash flow (the recurring direct deposit) and not an "affordability" analysis of the borrower's ability to repay the loan and also meet other recurring financial obligations.  

In November 2013, the OCC and FDIC issued guidance governing deposit advance products that applied to banks subject to their regulation.  By early 2014,  banks abandoned the business citing the regulations.  The guidance warned banks that they must to take into account the borrower's ability to pay, and that bank examiners would ensure that bank's deposit advance programs comply.

As part of the comment process on the  DOD's rule, the American Banker's Association (ABA)  urged the DOD not to rely on the CFPB's December 2014 study (the Study) and accompanying comment letter.   1) the CFPB did not apply to the Study the "evidence-based" standards it must apply to its own rule making process under the Dodd-Frank Act; and 2) the Study did not support the conclusion that service members are more vulnerable to deposit advance products than the general public.  (Footnote 11 of the Study makes clear that the differential impact identified in the Study was not evaluated against other explanatory variables that might eliminate statistical significance, and that the differential "does not mean that being a servicemember makes a person more likely to use deposit advance products.").  The ABA further noted that the CFPB has not yet issued its own final rules on deposit advance products. (In March 2015, the CFPB released an outline for potential regulation of the payday lending industry).  

It is clear that Americans have a love/hate relationship with payday loans.  According to a study by Pew, 12 million American's spend about $17 billion on payday loans each year.  The DOD rule is a victory for consumer groups who consider deposit advance products to be "predatory" and oppressive.  It's not clear whether the rule is a victory for service members, who will be excluded from credit products that are available to all other Americans.


Tuesday, July 21, 2015

Treasury Requests Information About Online Marketplace Lending

American Banker called 2014 a "Gold Rush" year for online marketplace lending, and named it the innovation of the year.  Online lenders provide a host of different credit products from merchant cash advance services, cash flow-based loans, and term loans.  Other online companies provide loan matching services for potential borrowers, e.g., Biz2Credit, and Fundera.

Yesterday the Treasury Department published a request for information about online marketplace lending.  Fed. Reg. Vol. 80, No. 138, July 20, 2015, 42866.  Treasury describes "online marketplace lending" as "the segment of the financial services industry that uses investment capital and data-driven online platforms to lend directly or indirectly to small businesses and consumers." Treasury wants information about the business models and products offered by online marketplace lenders, the potential for this type of lending to "expand access to credit to historically underserved market segments," and "how the financial regulatory framework should evolve to support the safe growth of this industry." It recognizes three categories of lenders within this industry segment:  1) balance sheet lenders that hold credit risk and are funded by hedge fund or family office investments; 2) online platforms (peer to peer) that sell securities to raise capital to enable third parties to fund borrowers, but do not retain credit risk; and 3) bank affiliated online lenders funded by a commercial bank, and that directly originate loans and assume credit risk.

How this market will be regulated remains up in the air.  Treasury noted that the CFPB has "broad authority governing standards that may apply to a variety of consumer loans issued through this segment."  In March 2015, the CFPB announced it was considering proposing rules governing payday, vehicle title, deposit advance and certain other high cost installment and open-end loans (specifically loans with a term of 45 days or less and an APR greater than 36%, or lower than 36% if the loan provides for repayment from the borrower's deposit account or paycheck or creates a PMSI in a vehicle).  Treasury noted that potential CFPB rules are "outside the scope" of its request for information and that Treasury is interested in information on online marketplace lenders not covered in the CFPB's proposed rules.  Treasury's RFI notes that the "framework" by which CFPB will regulate consumer loans issued through an online marketplace lender "is currently under discussion" and "the CFPB may ultimately change the scope of any proposed or final CFPB regulation."

Friday, July 10, 2015

Puerto Rico's Problem: How the Politics Breaks

The Wall Street Journal reported yesterday that the "Puerto Rico problem" has U.S. politicians, particularly GOP presidential hopefuls, stumped.  Hillary Clinton, Bernie Sanders and Martin O'Malley have all issued statements backing the pending federal legislation that would open chapter 9 bankruptcy to Puerto Rico's utilities and other public debt issuers.  The legislation is stuck in the House.  Democrats Charles Schumer of New York and Richard Blumenthal of Connecticut may introduce similar legislation in the Senate.

For Republicans, the next step is tricky.  Mutual and hedge fund creditors hold Puerto Rican debt and they want to avoid any write down of their debt-- a likely outcome if Puerto Rican debt issuers can use chapter 9.  On the other hand, about 1 million Puerto Ricans who reside in Florida and many want some federal action.  29 electoral votes are on the table.  Republicans running for president need to be seen as pro Puerto Rico, with compassion for Puerto Rican people and their economic future.  But that is hard to do without appearing to support a "bailout" for Puerto Rico.

Republican Congressman Tom Marino (R. PA) is head of the judiciary panel considering the chapter 9 relief bill in the House.  WSJ reports that he said the fate of the bill depends on whether Puerto Rico first puts together an "austerity plan" for the future.

Reading on Screen vs. Book

According to a report published in December 2009 by the Global Information Industry Center, Americans consumed information outside of work for about 1.3 trillion person/hours in 2008, for an average of almost 12 hours, 100,500 words and 34 gigabytes for an average person on an average day.  The report analyzed consumption of more than 20 sources of information from old fashioned (paper newspapers and books) to new (computer games, satellite radio, and internet video).

The study defined "information" as flows of data delivered to people.  So "information" includes video, with 1.3 zettabytes (a million million gigabytes) from television and about 2 zettabytes from computer games.   Radio and TV dominate  as sources of information, for about 60 percent of the hours expended in consuming information.  But computers have had a huge effect on information consumption.   Before widespread use of computers, information was usually consumed passively (with the exception of telephone).  Reading as a means of consuming information was hit hard by TV.  But reading as a source of information tripled from 1980 to 2008 because reading is how we consume information on the internet.

A 2005 study about reading behavior in the digital environment by Ziming Liu (available online in the Journal of Documentation) concludes that screen-based reading is different than reading text on paper.  People reading on screen tend to spend more time browsing and scanning, and reading more selectively.  They spend less time on in-depth, concentrated reading.

I've noticed a difference for myself between reading the screen and reading text on paper.  The screen is the best for fast access to a wide range of related information.  But, when I need to break down complicated information and really learn it for long term use, the screen is no match for paper.  I had thought my longing for paper and a squeaky yellow highlighter to go with it was nothing more than habit-- an old-fashioned vestige of the way I learned to consume information.  But scientists who research how we consume information by reading are beginning to learn about intrinsic differences in the two modes.  The trick seems to be matching the mode to the text.  The screen is great for Facebook, but not so much for Ulysses.

Wednesday, July 1, 2015

Puerto Rico's Debt - Update

WSJ today reported that Puerto Rico Electric Power Authority (PREPA) and its bondholders are close to a deal that would cover the $400 million plus due to bondholders and avoid default.

Yesterday, Dealbook ran "The Bonds that Broke Puerto Rico" offering an explanation of how Puerto Rico could issue "enough debt to crush it."  The answer:  "a confluence of factors, including American investors' desire to avoid taxes; the mutual fund industry's practice of competing on the basis of yield; complacency about the practice of long-term borrowing to plug holes in budgets; and laws [Puerto Rican] that supposedly give bond buyers ironclad guarantees."  

MoneyBeat ran  Puerto Rico's Crisis Deals a Blow to Municipal-Bond Funds providing more detail on the impact of Puerto Rico's debt problems on the municipal bond market.   Puerto Rico's $3.5 billion in general-obligation bonds issued in 2014 had a yield of 8.7%, compared to the yield on 10-year U.S. treasury notes which was around 2-3% over the same period.   Interest on Puerto Rican bonds is federal and state tax free for investors in every state.  Interest on other municipal bonds is exempt from federal tax, but exempt from state tax only if the investor lives in the state that issued the bonds.  Single-state municipal bond funds have used Puerto Rican bonds to diversify and boost yield.