State compliance for lending, servicing, and collections (even with bank sponsorship)

All lending companies including the ones using sponsor banks have to register with states. Depending on the structure of the partnership and coverage, your responsibilities may vary. Read the post.

There are only 2 ways to legally originate loans. One is using state lending licenses and the other is using partner banks. Both of these options have their respective advantages but in either case, you still need to register with different states. In some cases, also acquire licenses. The extent of registration and licensing depends on how the responsibilities are divided between the bank sponsor and the platform.

Most people don’t realize that state level compliance is necessary for any type of lending, servicing, or collections activity.

Depending on the type of activity you want to perform, you’ll need to register with each state separately.

State registrations for lending companies are required for 2 main reasons:

• to originate loans

• to service/collect on loans

Generally, companies that are licensed to originate loans can also service their own loans without an additional servicing license.

But if you have partnered with a bank sponsor and want to service those loans, you will need a servicing license.

All states will require you to do 3 things:

• Register: and get a license that allows the type of activity you want to perform (lending, servicing, collections)

• File reports: monthly, quarterly, semi-annually, or annually depending on the requirements of licenses

• Complete audits: annually or per the audit frequency of different states

Each of these activities requires internal and external legal/compliance resources.

Most founders are not aware of these requirements. We didn’t know them either.

Over 6 years of running Stilt, we had to learn everything from scratch.

At Stilt, we were registered in about 25 states and went through at least 10 comprehensive audits across different states.

Here is more color on the various elements:

State Registration:

The first step to start your activity is to register with the state.

To register, you’d need to figure out the right type of license needed.

Determining the license needed is not that simple. It requires exploration based on the product you want to offer. Generally, you’ll hire a law firm to analyze the potential licenses you’d need. This can cost up to tens of thousands of dollars.

Here’s a template you can use to define your credit product.

Once you figure out the right type of license, then you’ll need to determine the requirements for filing the license.

The requirements also also a moving target and sometimes need obscure things like a “surety bond.”

To get a surety bond, you’d need to find an insurance broker that helps you get this bond.

You may also need to prove additional requirements like maintaining a minimum balance (or tangible net worth).

You’ll need to submit all personal and company financials for every director, officer, or greater than 10% owner of the company (in some cases, it’s even 5%).

I won’t bore you with the details of the requirements here. Just know that it’s a lot of paperwork.

The good news is that states are moving to the NMLS system. So, for some states and types of licenses, you can use the same paperwork to apply for a license in multiple states. It’s still not streamlined but getting better.

License maintenance:

Acquiring a license is a one-time task, but maintaining it requires regular reporting. The type and extent of reporting depend on the license.

Expect to report at least annually and at most monthly.

You’ll need to determine the reporting frequency with the state.

The bad news here is that each state requires you to submit these reports in different formats and different ways. For most states, you’ll need to update it on their portal. You’ll probably need to create accounts on each state’s website. In some cases, you’ll need to email and request confirmation.

These reports can get complicated. You may be asked to report on the activity of just that state and your overall business. States may also require metrics to be calculated in a specific way.

You will also need to attest to the accuracy of the reporting.

This is a time consuming task for internal teams. Make sure you allocate enough resources for this.

Just to give you an idea, states may require you to submit audited financials, all customer complaints, resolution timelines, loans originated in that state, loans originated overall, interest earned from borrowers in that state (and overall), applications submitted, loans declined, principal paid down, delinquent loans, fees charged, etc.

As you can see, depending on the numbers, different teams need to get involved. No one team knows how the numbers should be calculated for regulatory purposes. And compliance teams generally rely on different teams to get it right.

Again, states will require you to attest to the accuracy of numbers.

Audits:

Some states (like Illinois) generally conduct audits every year.

Depending on the type of license, they will ask you for detailed data on all loans.

State auditors will go through all the materials and check for compliance against the stated regulations.

This can get tricky quickly. Here’s how:

When you acquire a license, you will need to understand the regulations of each state and code them in the system. Some simple examples include usury limitations, interest accrual methods, late fee requirements, etc.

But the regulations change all the time. Each regulation impacts multiple teams (product, engineering, marketing, etc.) and those changes need to be implemented within the state time.

All marketing materials across all channels need to be stored for review and submission.

If you are using a bank sponsor, you can use tools like Themis** to keep track of everything.

During audits, states evaluate if you complied with the regulations since you acquired the license or since the most recent audit. And if shortcomings were found, did you implement changes to fix those shortcomings?

In some cases, states also ask for detailed financials and reconcile loan payments against bank accounts and the loan ledger.

Audits also include communication with the borrowers.

It means that all teams need to be involved during an audit.

Generally, the compliance team collects information from the different functions and submits it to auditors.

A lot of back office and compliance support is needed across the whole organization to register, report, and defend audits for state licenses.

Conclusion:

If you are entering the lending business, you’ll need to peform all of the above tasks. Bank sponsors abstract a lot of work but you still need to interact with different states.

Bank sponsors would require you to comply with the state regulations.

That’s why it’s important to build compliance muscle within the org and work with external parties that have experience with this.

I barely scratched the surface in this post.

My goal is to get you thinking about the support you’ll need to manage state compliance for your fintech company.

**I’m a teeny tiny investor in Themis.