Sean Murray is the President and Chief Editor of deBanked and the founder of the Broker Fair Conference. Connect with me on LinkedIn or follow me on twitter. You can view all future deBanked events here.
Articles by Sean Murray
Lending Club Narrowly Avoids Major Transparency Flop
November 18, 2015After many months of Lending Club warning that they would be REMOVING borrower credit data from note listings, they have completely reversed course and ADDED fifteen new credit attributes. On Peter Renton’s LendAcademy forum, one member speculated that this move was made to compete with Prosper for the attention of institutional investors. If true, that would be entirely misguided.
Almost exactly one year ago, Lending Club announced that they were cutting the amount of data points available to investors from 100 to 56. Renton, a marketplace lending evangelist and founder of the LendIt conference, gave it a negative spin in his blog:
It is pretty obvious by now that I don’t like these changes. For quite some time now Lending Club has been reducing the amount of transparency for investors. Now, some changes I completely understood such as removing the Q&A with borrowers and even the removal of loan descriptions. But removing data that investors have been using to make investment decisions is a step too far in my opinion.
I think Lending Club need to ask themselves if they are a true marketplace connecting borrowers and investors in a transparent fashion or whether they are more of a loan origination platform that makes products available to investors. They are certainly moving more towards the latter, I think, and that is a shame for everyone.
The move was seen by many as a way to stop investors from trying to reverse engineer their models and beat their grading system for above average yields. While understanding that perspective, it is mind boggling that they had planned to remove more data points and make the loans on the platform even less transparent. And here’s why…
Lending Club is a key signatory to the Small Business Borrower’s Bill of Rights, a group of political activists that claim innovative small business lending can only achieve its potential “if it is built on transparency, fairness, and putting the rights of borrowers at the center of the lending process.” With transparency being a focal point of their agenda there, one might find their attempts to reduce disclosure and eradicate transparency a bit hypocritical.
Investors on Renton’s forum who had for months anticipated Lending Club to remove more data points, also viewed it negatively. “I’d have to think hard on whether to continue investing in LC notes without those credit fields — it would be very much like gambling rather than investing,” wrote Fred back on July 8th.
A similarly named user, Fred93, communicated that these data points were all investors had to go off. “We can’t shake a borrower’s hand, feel the firmness of his grip, the sweatiness of his palm. We can’t look a borrower in the eye. We live or die by a handful of numbers, which we hope mean something, on the average,” he wrote.
Clearly some investors weren’t thrilled with the proposed changes. All the while, Lending Club’s co-signatories had been promoting the transparency pledge through speeches, TV appearances, public relation events, and press releases. To be fair, The Small Business Borrowers Bill of Rights is aimed at transparency between business borrowers and sources offering business financing. Lending Club’s planned removal of data was targeted at investors in their consumer notes. It sounds different enough until you consider that 72% of Lending Club’s loans originated in 2014 were funded by investors vastly less sophisticated than the commercial businesses they have pledged to protect. That’s because that money came from consumers, many of whom are unaccredited and went through no screening process. Instead, these investors are presented with a prospectus as if they were buying a stock or bond and stuck with the risk whether they understand it all or not.
These consumers who are legally presumed to be unsophisticated are the very same people that Lending Club planned to reduce disclosures to, all the while heavily promoting to them that they roll over their retirement savings onto their platform. That logic is the very definition of insanity. Obfuscating the reasoning behind certain scoring grades to these investing consumers would be nothing short of unconscionable and would reasonably invalidate any pledge they’ve made towards transparency in other areas.
Lending Club has for now avoided a major flop by reversing course after having added 15 new pieces of data for investors.
While some investors speculated the move had to do with pressure from Lending Club’s institutional investor base. The more likely reason is increasing scrutiny from federal regulators. Less than two weeks ago for example, the FDIC warned banks about marketplace lending and advised them to perform their own underwriting on the loans they buy and not to rely on originator scoring models. A summary of their letter specifically said:
Some institutions are relying on lead or originating institutions and nonbank third parties to perform risk management functions when purchasing: loans and loan participations, including out-of territory loans; loans to industries or loan types unfamiliar to the bank; leveraged loans; unsecured loans; or loans underwritten using proprietary models.
Institutions should underwrite and administer loan and loan participation purchases as if the loans were originated by the purchasing institution. This includes understanding the loan type, the obligor’s market and industry, and the credit models relied on to make credit decisions.
Before purchasing a loan or participation or entering into a third-party arrangement to purchase or participate in loans, financial institutions should:
– ensure that loan policies address such purchases,
– understand the terms and limitations of agreements,
– perform appropriate due diligence, and
– obtain necessary board or committee approvals.
These guidelines conflict with Lending Club’s long sought after goal of getting investors to trust their A-G scoring grades. The banking regulator is advising banks to basically disregard them. “The institution should perform a sufficient level of analysis to determine whether the loans or participations purchased are consistent with the board’s risk appetite and comply with loan policy guidelines prior to committing funds, and on an ongoing basis,” the more complete memo reads. “This assessment and determination should not be contracted out to a third party.”
A law firm with specialized knowledge of the industry, criticized the FDIC’s move when they wrote on their website, “Ironically, given the Treasury Department’s recent request for information, which supported marketplace lending and focused in part on how the federal government could be supportive of the innovations in marketplace lending, we now have a federal banking agency that is creating roadblocks to having banks participate in this dynamic and rapidly growing space.”
Asking banks not to rely on marketplace scoring models alone hardly seems like a roadblock, especially when the models are tucked away in algorithmic obscurity, have hardly been around for very long, and would decide the fate of depositor money. And if this directive indeed contributed to Lending Club’s transparency reversal, then it couldn’t have been any more well-timed.
Whether or not the added data points will make any difference to the performance of investment portfolios is irrelevant. If unaccredited investors and/or depositor money are the source of marketplace loan funding, then Lending Club has a responsibility to disclose as much as possible, no matter how little value they believe certain pieces of information are worth. The 15 additional points are a welcome announcement. The question going forward should be, what else can they disclose?
As a company that pledged so strongly to protect corporations from transparency issues in the developing commercial finance market, they should be trying twice as hard to protect the unsophisticated consumers that invest in the loans they approve and make available for investing. Some of these consumers are prodded into putting their retirement funds on the platform and we all know some people will irresponsibly place their entire retirement portfolio in it. The “Number of credit union trades” a borrower has might not unlock the secret to better investing performance but if it’s something Lending Club knows, the investing public deserves to know it too, if only in the name of transparency which they have so committed themselves to uphold…
The Clock is Ticking: CFPB Blankets Small Business Banking Conference
November 17, 2015At the Small Business Banking conference in Nashville, the CFPB is making its presence known by peppering attendees with this handout:
While not surprising considering they have been advertising this position on LinkedIn, it shows a concerted effort to not only recruit, but also to subtly inform everyone that their involvement is just around the corner.
What is alarming is that the assistant director for small business lending is said to play a role in rulemaking. As you may not be aware, the CFPB has legislative power that can bypass Congress even though it’s part of the executive branch.
Would you like to play a proactive role to protect the industry, improve its reputation, and educate government policy makers? Now is the time to consider joining the Coalition for Responsible Business Finance.
Contact:
CRBF Executive Director Tom Sullivan
c/o Nelson Mullins Riley & Scarborough
101 Constitution Avenue, NW
Washington, DC 20001
(202) 905-2571
Learn more at: http://www.responsiblefinance.com/
Madden v. Midland Appealed to the US Supreme Court
November 15, 2015The Madden v. Midland decision has been appealed to the US Supreme Court and the future of non-bank lending potentially hangs in the balance. The introductory statement reads as follows:
This case presents a question which is critical to the operation of the national banking system and on which the courts of appeals are in conflict. The National Bank Act authorizes national banks to charge interest at particular rates on loans that they originate, and the Act has long been held to preempt conflicting state usury laws. The question presented here is whether, after a national bank sells or otherwise assigns a loan with a permissible interest rate to another entity, the Act continues to preempt the application of state usury laws to that loan. Put differently, the question presented concerns the extent to which a State may effectively regulate a national bank’s ability to set interest rates by imposing limitations that are triggered as soon as a loan is sold or otherwise assigned.
Several attorneys have said off the record that the likelihood the US Supreme Court would actually hear the case is about 100 to 1, because the issue lacks sex appeal. Gay Marriage, Obamacare, these are the type of things that make their way through the system.
Nevertheless, the petition argues the matter at hand:
The Second Circuit vacated the judgment, holding that the National Bank Act ceased to have preemptive effect once the national bank had assigned the loan to another entity. App., infra, 1a-18a. In so holding, the Second Circuit created a square conflict with the Eighth Circuit, and its reasoning is irreconcilable with that of the Fifth Circuit. The Second Circuit also rode roughshod over decisions of this Court that provide broad protection both for a national bank’s power to set interest rates and for its freedom from indirect regulation. And it cast aside the cardinal rule of usury, dating back centuries, that a loan which is valid when made cannot become usurious by virtue of a subsequent transaction.
The Second Circuit, of course, is home to much of the American financial-services industry. And if the Second Circuit’s decision is allowed to stand, it threatens to inflict catastrophic consequences on secondary markets that are essential to the operation of the national banking system and the availability of consumer credit. The markets have long functioned on the understanding that buyers may freely purchase loans from originators without fear that the loans will become invalid, an understanding uprooted by the Second Circuit’s decision in this case. It is no exaggeration to say that, in light of these practical consequences, this case presents one of the most significant legal issues currently facing the financial-services industry. Because the Second Circuit’s decision creates a conflict on such a vitally important question of federal law, and because there is an urgent need to resolve that conflict, the petition for a writ of certiorari should be granted.
Brian Korn, a partner at Manatt, Phelps and Phillips, told the LendAcademy blog in an interview that the Court could rule on the motion at any time and that it takes 4 out of 9 justices to agree to accept the case.
The plaintiff, Madden, has until December 10, 2015 to file a response to the petition.
Industry Message Boards Crack Down on Anonymous Deal Grabbers
November 11, 2015
Industry message boards, including deBanked’s, have begun taking a stronger stance against anonymity to facilitate transparency and protect users. While anyone can still register with their personal addresses, a corporate email address must be provided in the course of soliciting business. Industry participants have reached a general consensus that soliciting deals while hiding behind a free email address raises a red flag.
With hundreds of legitimate vendors to choose from, there should be little need to transact with users that lack basic things such as a company name, office address and phone number.
“I’m bombarded with probably 10 emails every day of the week from a supposedly new lender that wants my business, and they’re really just a broker shop like we are,” said Cheryl Tibbs, in the September/October issue of deBanked Magazine. She warned that fake funders can steal deals and pocket the entire commission. They solicit deals in online forums, by email message or over the phone, and then they offer the deals to companies that really do function as direct funders, she said.
While no online forum was specified in the story, at least two forums have responded by cracking down on anonymity by suspending or banning violators.
The age of the gmail funder is coming to a close. Don’t buy leads from HotLeads4u69@hotmail.com and definitely don’t syndicate with a company that has no known address.
Income Inequality Perpetuated by Low Interest Savings Accounts (GOP Debate)
November 11, 2015The losers of Tuesday night’s GOP debate were Dodd-Frank, the CFPB and the big banks. Hours after I linked to a CFPB job listing for a small business lending fairness assistant director, former Hewlett-Packard CEO Carly Fiorina told America that the CFPB is the beginning of socialism. Government creates the problem and then proposes a solution to the problem it creates, she argued.
Senator Ted Cruz added that the government is in bed with the big banks and it’s leading to the elimination of community banks. As a consequence, he said, small businesses can’t get loans. Two months ago, B. Doyle Mitchell Jr, the CEO of Industrial Bank, who spoke on behalf of the Independent Community Bankers of America made a similar argument during a House Small Business Committee hearing. He said, “I really feel like we’re getting away from helping people and making sure that we make the loans that Washington agrees with and I think that needs to change.”
In the debate, Senator Rand Paul offered his own twist on what’s wrong with the banking system and that’s the inability for poor people to get the same rate of return as rich people. Too little interest is earned by holding money in savings accounts, he argued, and “now we’re even talking about negative interest.”
Three weeks ago, CNBC reported that Narayana Kocherlakota, president of the Minneapolis Fed was in favor of the Fed pushing rates below zero. Really low interest rates can encourage people not to save or just to spend the money, Senator Paul warned, with the result being that the poor are stuck in the cycle of being poor.
According to Jana Randow on Bloomberg, who wrote about the subject of negative interest rates, “if banks make more customers pay to hold their money, retail clients may put their cash under the mattress instead.”
Not mentioned during the debate was marketplace lending where retail investors have the opportunity to earn Wall Street yields. CNBC recently reported that Lending Club and Prosper investors are earning between 5%-9% a year. While it’s true that Wall Street firms now dominate investor demand, there is still enough availability for individuals to literally share the wealth.
The story of marketplace lending might have its roots in the sharing economy, technological disruption, or making markets more efficient, but to Senator Paul’s point, it also presents America’s lower income individuals to build wealth like the rich. Putting your money in an account earning less than 1% interest will keep you poor. Putting it under the mattress will also keep you poor. And spending your money might make you look rich but that will indeed keep you poor. The big banks in effect keep the poor poor by presenting their customers with those three options.
The solution to income inequality (other than by moving to cities and states run by republicans as Paul suggested) is to offer the same opportunities to the poor as the rich have access to. Marketplace lending allows the average American worker to earn the same yield that Goldman Sachs would find attractive. Maybe one of the republican candidates will bring that up in the next debate.
Jeb Bush (if he can hang in the race) has invested on the Lending Club platform, which we learned when he disclosed his historical tax returns and could possibly speak from his own experience.
CFPB Signals Alarming Interest in Small Business Lending
November 10, 2015
The Consumer Financial Protection Bureau posted an alarming job opportunity on LinkedIn last month for the position of Assistant Director for Small Business Lending Markets. Ominously self-labeled as an “Expression of Interest” rather than a job opening since the job is not currently open to applications yet, the CFPB has inadvertently revealed its own expression of interest in small business lending.
If there was any doubt that data collection required under Section 1071 of Dodd Frank was never going to happen, the CFPB also revealed that there will not only be a person responsible for small business lending, but in fact an entire team. And they won’t just be collecting data, but they’ll be monitoring it, analyzing it, interpreting it, and advising on rulemaking, according to the listing.
Candidates are being offered a once-in-a-career opportunity to make the market for small business finance fairer and more transparent.
So much for just collecting data, the CFPB apparently plans to directly insert itself into the fairness of transactions conducted between commercial entities.
Perhaps, we are not too far off from a world like this:
Check out my thoughts about the troubling narrative developing around small businesses in the Sept/Oct magazine issue of deBanked.
Mike Cagney vs. Todd Baker: The Debate at the Marketplace Lending and Investing Conference
November 6, 2015
“You’re big buyers of some of this paper until you’re not,” said Todd Baker, the managing principal of Broadmoor Consulting, LLC, to a crowd of institutional investors and bankers at the Marketplace Lending and Investing Conference in New York. Seated to his right was his debate adversary, SoFi CEO Mike Cagney, who offered many opposing viewpoints. You can’t choose to not run a business because you fear it could some day shut down, Cagney argued.
The two opponents had battled before though Op-eds published in American Banker. “The hard truth is this: while MPLs [Marketplace Lenders] have introduced valuable innovation into financial services, they carry a fundamental flaw that threatens to undermine their business, destabilize financial markets and cause real economic hardship,” wrote Baker back on August 17th. The flaw he addressed is access to funding. Baker argued that if investors don’t want to buy loans, then the marketplace lender is dead because their existence relies on the transaction fees from loan originations.
Cagney responded directly two days later. “The scenario [Baker] describes can’t happen. It is true that an MPL needs a buyer to originate loans — without one, the marketplace needs to raise rates until a buyer emerges. If there is no buyer, MPLs simply stop lending — they won’t start originating underwater loans.”
That perhaps played partly to Baker’s argument because if indeed there was an absence of buyers then the marketplace lender stops originating loans… and would at least temporarily be dead or would at least not be generating revenue.
But during the live debate, Cagney cast the suggestion of there being no buyers aside. Companies like his are targeting large market segments, where there will theoretically always be demand at some price, not niche market segments that could dry up in a crisis. “The beauty of marketplace lending is we’re balance sheet light,” Cagney told the crowd while pointing out that banks get into trouble with lending because of how leveraged they are.
That viewpoint contrasted that of two Goldman Sachs VPs that told the same crowd earlier that marketplace lenders would eventually move towards keeping loans on their balance sheets.
SoFi is of course an exception to the mold of the average marketplace lender, which Baker made sure to point out. Most people in the room were aware of SoFi’s $4 billion private market valuation. It’s clear that Cagney knows what he’s doing, Baker said out of respect several times on stage. His comments were directed less at SoFi and more on marketplace lenders in general.
Baker worried that these loans were being classified as fixed income investments too soon. These loans are not backed by large corporations, he warned, but by consumers. They won’t act like fixed income investments forever, he said.
Cagney took the criticism in stride and basically chided Baker and those that share his concerns as being unwilling to pursue opportunities because they are simply afraid of change.
Someone knows where I am at all times, he jokingly warned the audience of bankers, in case any of them had planned to kidnap him and put an end to his disruptive endeavors.
SoFi’s brand is of being an anti-bank or a fixer of the broken banking system so Cagney no doubt expected doubters at a conference produced by American Banker’s parent company.
Baker told Cagney that he had a nice libertarian view that didn’t make sense over in the real world. Cagney gleefully accepted the label of libertarian and rejected the notion that the real world and the libertarian world weren’t one and the same.
The two agreed to cordially disagree and notably did not shake hands when the debate ended. Cagney, the anti-banker, appeared to win over a significant portion of the audience. To his credit, the conference was aptly named the Marketplace Lending and Investing conference, not the Traditional Banking Forever conference.
Both sides made valid arguments, but one thing is for certain, banking will never be the same.
Marketplace Lending and Investing Conference (Part 1)
November 5, 2015Source Media’s Marketplace Lending and Investing conference kicked off today with a bang. During the opening keynote, two VPs at Goldman Sachs predicted that the industry would shift to retaining loans on balance sheets instead of continuing with the gain-on-sale model. The irony is that OnDeck appears to be going in the opposite direction since their recent path to profitability is being made possible by their new reliance on gain-on-sales.
The available solutions presented to small business financing problems at the conference covered the entire gamut. Pango Financial president Candice Caruso for example, explained that small businesses can get funding by rolling over money from a qualified retirement plan. Pango’s model capitalizes on The Employee Retirement Income Security Act of 1974 (ERISA), a 40-year old law that can be streamlined with the help of technology. ERISA established the regulation that allows for a private company to use retirement funds as business capital through an Employee Stock Ownership Plan (ESOP).
Companies like Pango have found a clever way to scale the benefits out of old policies and it’s opportunities like these that have everybody excited. QED Partners founder Frank Rotman summed it up best when he recited his own Wall Street Journal quote, “It feels like the Internet in 2000. Everyone is chasing it, but they aren’t sure what ‘it’ is.”
Rotman also cautioned lenders who are trying to throw money at technology as a fix to scale their businesses. You can’t just throw money at technology, he argued. “Technology needs to be in your DNA.”
For marketplace lenders like QuarterSpot, they fit that bill well. Their CEO Adam Cohen was the Chief Software Developer for JetBlue Airways.
And among some of the other names in attendance, many are on the fast track for success. Expansion Capital Group for example just closed a $25 million credit facility with Northlight Financial and Bastion Management. And there’s also Pearl Capital who was recently acquired by Capital Z Partners. And Herio Capital, founded by one of OnDeck’s earliest employees, recently reached a new funding milestone.
At the end of the day, Anjan Mukherjee, the Counselor to the Secretary and Deputy Assistant Secretary for Financial Institutions of the U.S. Treasury Department told attendees not to bank on regulatory interest being forgotten about with a new presidential administration. Certain agendas can be “de-emphasized”, he said, but overall at least as far as the Treasury is concerned, enough important people will not transition away. They won’t forget everything, he explained.
