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
The APR Enigma Confuses Everyone – Even Lenders
April 3, 2016
A study published by Lendio last week confirmed the results found in recent government studies, that small businesses are confused by Annual Percentage Rates. But they’re not alone…
It might be time to reconsider the calls for APR standards in small business lending. In a recent survey of 1,000 small business owners, only 17.4% of respondents chose APR as the easiest method to understand the cost. The vast majority selected the total net dollar cost of the loan as being the easiest.
The data matches the results found in a study conducted by the Federal Reserve Bank of Cleveland last year, in which small business owners generally responded that there was nothing confusing about a loan when cost was presented as a total dollar value. It was interest rates that tripped them up, the Fed determined.
When attempting to answer questions about the total amount owed and interest rates, participants became notably less confident in their ability to make an informed borrowing decision, with many qualifying their answers or indicating they were “not sure.”
– Federal Reserve Conclusion from Alternative Lending through the Eyes of “Mom-and-Pop” Small-Business Owners 8/25/15
Additionally in the Fed study, small business owners guessed the interest rate of a presented hypothetical loan to be anywhere from 5% to 50%, with some saying they just didn’t know. All of them were wrong. An analyst for the Federal Reserve Bank later acknowledged that it was a trick question. “The correct answer is that ‘it depends on how long it takes to pay back,'” said Ellyn Terry, an economic policy analysis specialist. The Fed report itself had to be amended more than a month later because this question and the answers produced in the study were confusing to even the sophisticated parties trying to make sense of it. That amendment reads as follows:
*Note: In practice, for a credit product structured like Product A, the effective interest rate varies depending on how long it takes a borrower to repay which, in turn, depends on the volume and timing of credit card sales receipts. Simply put, the interest owed on Product A is 30% of the principal value, but assuming consistent monthly sales and daily payments, the effective interest rate is on the order of 60%, and higher if funds are repaid sooner than one year. (Added 9.29.2015)
Does that clear it up for you??? Even the added note intended to make the interest rate question more clear is confusing. Small business owners never stood a chance…
But it seems those on the lending side of things are confused too.
Lendio CEO Brock Blake followed up his study with a blog post on LendAcademy to try and articulate the implications of the findings. Titled, Communicating the Cost of Capital in Alternative Lending, Blake was roasted in the comments for comparing a 6-month loan to a 5-year loan by those presumably involved in lending themselves.
Apparently, math is very subjective
In an example Blake used to illustrate a point, he gave a 6-month loan an Effective APR of 83% and a 5-year loan an Effective APR of 19%. Critics eager to point out holes in his argument challenged the fundamental numbers used to construct it.
“By the way, I tried to verify the APR of that #1 loan, and I get 137.03%, not 83%. Has anyone else tried to verify this calculation?”
“I ran the numbers on #1 but came up with a different number altogether. I think the error is in total cost of capital, which should be $4,500 vs. $4,016. With 22% simple interest, interest paid would be $3,960 plus the $540 origination fee.”
One set of facts, 4 different opinions on APR. How can this be?
In sparking this debate, Blake may not have fully convinced readers that a 6-month high-APR loan can be better than a 5-year low-APR loan, but he did unintentionally demonstrate support for his study’s findings, that APR as a universal measurement is flawed since even those that believe they understand it came up with different percentages than their peers.
Consider that the Federal Reserve study referenced above implied to business owners that APR is simply an abbreviation for interest rate, which isn’t true. “When it comes to borrowing for the short term, are you more comfortable knowing the interest rate (APR) or total cost of repayment?” it asked those polled.
Bad form
The Truth in Lending Act (TILA) makes a clear distinction between an APR and an interest rate. “Since an APR measures the total cost of credit, including costs such as transaction charges or premiums for credit guarantee insurance, it is not an ‘interest’ rate, as that term is generally used.” Well then why are they presented as the same thing in a Fed study measuring comprehension of loan costs?
Note also that only one of the Fed study’s mock products mentioned an APR and only in the context of an Effective APR, something that the Fed has long known to be confusing. In April 2006, Macro International (now ICF International) was hired by the Fed to examine the comprehensibility of these very formulas.
One of the most consistent findings was that very few participants understood the meaning of an Effective APR (At that time known as the Fee-Inclusive APR). “Participants had a wide variety of incorrect interpretation of these percentages, including that they were the interest rates that would be paid on fees, penalty rates that would be charged if late payments were made, or the percentages of total transactions that were made of each type.”
It got worse though, because “in addition to a general lack of understanding of the [Effective APR], qualitative testing also found several instances when participants confused this term with their nominal APR for a given transaction.”
But it’s gotten better right?
For all of the studies conducted and regulations implemented, one might expect that banks, which bear the brunt of disclosure requirements in the financial world, would receive the highest marks on transparency. But that’s not the case. Another study, one jointly published by seven Federal Reserve banks, found that dissatisfied business borrowers were slightly more likely to encounter transparency issues with large banks than they were with online lenders.
Bankers probably aren’t surprised by that
Last Fall, B. Doyle Mitchell Jr, who spoke on behalf of the Independent Community Bankers of America during a House subcommittee hearing, said that new loan disclosures [required by Dodd-Frank] was not making it easier for borrowers to understand, to the point that they don’t even know what they are signing anymore. “In fact it is even more cumbersome for them now,” he said.
Non-bank lending critic Ami Kassar has publicly claimed that lenders are simply afraid of disclosing APRs because they don’t want their borrowers to know the real cost.
The data indicates however that borrowers don’t know what to make of APRs. Worse, the issue seems to be a universal one, one that confounds consumers, business owners, government surveyors and those within the lending industry itself.
APRs also struggle to remain relevant as a measure for short term loans. For example, OnDeck CEO Noah Breslow has said that a six month loan with a 60% APR may actually only cost 15 cents on the dollar. “The APR overstates the actual cost of the loan to the borrower,” he previously told Forbes.
“Asked which method was easiest to understand, two-thirds of respondents chose total payback amount,” Lendio’s survey concluded.
That seems to be the trend indeed.
Marketplace Lenders Played Everyone for April Fools
April 2, 2016Friday, April 1st, transported the marketplace lending industry into another dimension, one that made us all April Fools. Here’s some of the believable and not so believable jokes that you might have missed:
A federal judge granted a temporary injunction to halt the entire marketplace lending industry
A late-night meeting on Capitol Hill between representatives of three big banks and several members of Congress quickly spiraled out of control, resulting in an emergency hearing that temporarily shuttered the marketplace lending industry.
Donald Trump funded his presidential campaign with a loan from Prosper
Trump didn’t need the money but he borrowed $35,000 anyway because the deal was too good to pass up.
Donald Trump addressed the Money20/20 Conference community
Make payments great again, said Trump.
Survey revealed that kids aged 1 to 4 are concerned about pre-school debt
Without formal credit history, CommonBond is underwriting pre-schoolers for loans based on their favorite character on Sesame Street. “My CommonBond consultant prepared me to make the transition to pre-school,” says Sawyer Thurston Howell III, a 2-year-old and CommonBond member since March 2016.
Loans now funded via drone delivery
As an alternative to ACH, Dealstruck has begun to transfer piles of money to approved borrowers via drones. “After my deal was funded, I logged on, popped in my address and a bag of cash arrived at my business in half an hour! I didn’t even have to go to the bank,” said one customer.
A free puppy with every loan
Borrowell is proud to announce that our loans will now come with a little something extra!https://t.co/CwEczxsxVo pic.twitter.com/nHArqBP1xr
— Borrowell (@Borrowell) April 1, 2016
Much to the disappointment of applicants, this was indeed an April Fools’ joke.
Of course with all the jokes being made out there on Friday, some people thought that OnDeck’s announcement that President Obama had joined their board of directors was also an April Fools’ joke. OnDeck actually made that announcement two days prior, but unfortunately for OnDeck, it didn’t pick up steam in the press until Friday, which by that point gave it the appearance of a prank.
Due to a federal law that prohibits certain presidential conflicts of interest, Obama’s board seat will not have voting power until after his term ends in January 2017. In an interview with the Wall Street Journal on Thursday, OnDeck CEO Noah Breslow denied rumors that Obama was actually being vetted to replace him as CEO. “We will absolutely value his expertise and experience, but it’s unrealistic to think that a former president will have the time to run a publicly traded company.”
Just kidding. April Fools!
Breaking News: Judge Grants Temporary Injunction to Halt Entire Marketplace Lending Industry
April 1, 2016April Fools 2016
A late night session on Capitol Hill has led to a catastrophic outcome for the marketplace lending industry.
At approximately 11:30 PM Thursday night, lobbyists working on behalf of Bank of America, Wells Fargo and TD Bank scheduled an emergency meeting with six members of Congress to discuss, among other issues, the impact of marketplace lending on their bottom lines. “Q1 earnings won’t officially be released for a while,” said Oregon Congressman Edward Duchovny, who was present, “but loan volumes were down across all three banks by a substantial percentage.”
The drops were so alarming, that each bank had initially concluded that their financial reports had been hacked. “They thought there was a security breach,” said a congressional staff member with knowledge of the meeting who was not authorized to speak on the record. “One bank’s consumer lending unit experienced a drop in originations by 50% year over year.”
Shortly after midnight, a team of bleary-eyed auditors and staff members from the Treasury Department concluded that the numbers were correct and that something nefarious was to blame. “We knew that something like this might happen,” said US Treasury forecast analyst Andrea Mitchells. “When we conducted the RFI last year, we met with some of the banks and flat out told them that marketplace lending was irreversibly changing how people borrow money.”
The revenue loss to banks from marketplace lenders in just the first quarter of this year may total as high as $947 Billion, Mitchells said, which warranted the attention of Federal Reserve Chairman Janet Yellen. Though it was the dead of night, Yellen arrived within the hour, along with a team of economists and attorneys.
“The atmosphere changed really quick,” said the anonymous congressional staff member. “One minute we were eating pizza and Chinese food while parsing these boring financial reports and the next minute Chairman Yellen is warning us all about the systemic threat this poses to the very notion of bank lending altogether.”
Yellen, two attorneys, and three of the six Congressmen present, including Edward Duchovny, arranged for an emergency hearing with a federal judge on the grounds that banks stood to suffer irreparable harm unless drastic temporary action was undertaken.
Within minutes, an attorney argued with a straight face that Bank of America might not even survive to see the market’s close on Friday, in part because almost all of its business had been “hijacked” by marketplace lenders. Judge Thomas McAdams III was clearly rattled by what he heard. “I have no idea what the hell marketplace lending even is,” McAdams pontificated from the bench. “It sounds like you’re just describing every single type of lending that exists and then just adding the word marketplace to it,” he shouted, while waving his gavel around.
Ads run by SoFi, a marketplace lender known mainly for student loans, had apparently inflicted devastating damage with their “Don’t Bank” campaign.
“People saw those advertisements and then actually decided not to bank,” said Jane Martin, SVP of TD Bank. “We thought we had a great case for a temporary restraining order.”
McAdams, who held everyone present in contempt of court, nonetheless granted a temporary injunction on all of marketplace lending.
“I think the judge did the right thing,” said Mitchells of the US Treasury.
Duchovny’s feelings however, were mixed. “I thought we were trying to stop people from lending money at supermarkets,” he said. “I asked Yellen if this would affect my loan with Lending Club and she just gave me the dirtiest look.”
Investors across the world from the US to China are bracing themselves for what is expected to be a tumultuous Friday for stocks.
APRIL FOOLS 🙂
SEC Chair to Marketplace Lenders, Disclose Material Information to Investors
April 1, 2016
Stanford UniversityFor marketplace lenders, less is not more when it comes to disclosure.
At an event held at Stanford University yesterday titled, The Silicon Valley Initiative: Protecting Investments in Pre-IPO Issuers, SEC Chairman Mary Jo White gave a keynote speech that mentioned marketplace lending. “As investors are attracted by potentially higher yielding but riskier marketplace loans as an investment strategy, information about the borrower’s ability to repay the loan underlying the investment is critical,” she said.
The message? The SEC is indeed watching.
“We are also concerned about the adequacy of the information received by investors in registered offerings,” she added. “We expect that investors will receive disclosures about the loans underlying their investments, including information about the borrowers as well as the platform’s proprietary risk and lending models, that will enable them to make informed investment decisions – both at the time of investment and on an ongoing basis.”
Her warning comes at a time when the industry has considered reducing disclosures instead of increasing them. Last year, Lending Club announced that investors on their platform would only have access to 56 data points, down from 100, a decrease of almost half. At that time, investors and industry advocates balked at the news.
Lend Academy’s Peter Renton shared what he thought on 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.”
Some speculated that Lending Club was being forced to do this as a way to prevent investors from trying to reverse engineer their models and beat their grading system for above average yields. For reasons unknown, but potentially due to negative feedback from investors over disclosure, Lending Club changed course and instead added 15 new fields.
To be fair, many marketplaces find that investors simply don’t make use of certain data points and thus they are deemed immaterial. Marketplace lenders also have to balance the privacy of their borrowers with transparency to their investors.
The SEC Chair also spoke about crowdfunding, robo-advisors, the blockchain, and the illusions that subjective private market valuations can create.
Small Businesses Say ‘Yes’ to Online Lending Through NFIB Partnership With Kabbage
March 31, 2016
The largest association of small and independent business owners in the country is embracing online lending.
The National Federation of Independent Business (NFIB) announced a strategic partnership with Kabbage yesterday. The NFIB has more than 325,000 members.
Speaking about Kabbage, NFIB SVP Mark Garzone said, “Access to working capital for an expansion, repairs or short-term cash flow needs is essential for small businesses to thrive. We know that our members will benefit from this valuable resource.”
While the partnership is clearly a sign of Kabbage’s prowess, it also serves to reinforce the value that online lenders can provide to small businesses in general. “Many of our members – like a number of small businesses – struggle with the standard loan process when they need access to working capital,” said Garzone.
Not all online lenders are created equal, but a few have stood out from the crowd, in this case, Kabbage.
Earlier this month in The Atlanta Journal-Constitution, NFIB representative Holly Wade said, “Our fear is that they will over-regulate [online lending] out of existence or to the point that it’s no longer a benefit.”
Marketplace Lenders Will Return to Their Peer Roots, Insiders Say
March 30, 2016
Will marketplace lending revert back to peer-to-peer lending? Insiders said “yes,” during a panel hosted at CommonBond’s NYC office yesterday. Moderated by WSJ reporter Telis Demos, The State of Fintech Lending included two panelists that had something to say about the greatly exaggerated death of “peers” in peer-to-peer lending.
Marketplace lenders will look to tap back into individual investors, said CommonBond CEO David Klein, specifying that accredited investors were an obvious choice but that true retail investors would also play a role.
Fundera CEO Jared Hecht said marketplace lenders can achieve a “network effect” with retail investors, something not likely to occur with institutional sources. The network effect is a phenomenon whereby a good or service becomes more valuable when more people use it. “Retail investors are more loyal to a specific platform,” Hecht said.
Klein explained that the retreat from peers over time stemmed from Lending Club and Prosper’s historical issues with the Securities and Exchange Commission. Both companies faced an existential threat in 2008 over the alleged sale of unregistered securities to unsophisticated investors. They were able to overcome this by agreeing to register every single loan offered on their platforms as a security with the SEC. Today, that has led to both companies becoming part of the top five filers of securities in the US, Klein said. While this registration process is mostly automated, the road to get there was complicated and thus there was a shift towards institutional sources for most new entrants.
But there are signs it’s coming back. Two weeks ago, small business lender StreetShares announced that retail investors would soon be able to invest on their platform. But even then, StreetShares has accomplished this through a less complicated process than the ones Lending Club and Prosper adhere to. Under the JOBS Act’s Regulation A+, startups can raise up to $50 million over a 12-month period from retail investors.
The return path may be slow, however. Prosper for example, still sells 92% of its loans to institutional sources and only 45% of Lending Club loans are sold to retail investors. Even they are not entirely peer-to-peer.
The marketplace lending industry will inevitably come to respect the “peer” again, panelists concluded. “2016 will be the year that marketplace lenders will go from the mainstream to maturity,” Klein said.
Not All Marketplace Lenders Are Created Equal – The State of Fintech Lending
March 30, 2016
It’s kind of a problematic term, said CommonBond CEO David Klein about “marketplace lending.” Klein was one of four industry experts on the State of Fintech Lending panel hosted at their office on Tuesday morning. “Not all marketplace lenders are created equal,” he said. There are different asset classes, different credit spectrums and even different investor responses, he explained.
CommonBond for example, focuses on student lending and more specifically, the very upper end of the credit spectrum. As proof, Klein said the company has not even experienced a 30-day delinquency or default. Compare that asset with some of the products offered by Fundera, which range from merchant cash advances to SBA loans and it’s easy to see why marketplace lending as a category can be overly broad. Fundera CEO Jared Hecht was another panelist alongside PeerIQ CEO Ram Ahluwalia and Macquarie Group Managing Director Brian Foley. WSJ reporter Telis Demos served as the moderator.
Klein’s company deals with institutional investors, which loosely qualifies it as a marketplace in the sense that there are buyers for their loans. Hecht’s company is a marketplace too but for small business owners seeking loans. Fundera is not a lender. “We don’t have to run around and deal with the capital markets,” Hecht said.
Despite the incredible diversity of asset and credit classes, PeerIQ’s Ahluwalia described the quality of the securitizations taking place throughout the industry as very good. “This is going to be a very different movie than The Big Short,” he said. As of the end of 2015, PeerIQ ranked total cumulative securitizations at $8.4 Billion, with 41 deals issued to date (25 Consumer, 9 Student, and 7 Small Business).
Pension funds and insurance funds who are attracted to this space are focused on AAA rated bonds, said Macquarie’s Foley. “They want scale, performance and track record,” he said, adding that they’re happy to trade away return for a reduction of risk so that they can sleep at night.
There’s over 200 marketplace lenders in the US, Klein stated. Only 12 or 13 have reached a certain level of scale though, he added. “2016 will be the year that marketplace lenders go from the mainstream to maturity,” he said.
Perhaps as part of that, however, the marketplace lending term will have to mature with it. “Each category is very different,” said Klein.
The Coalition for Responsible Business Finance Adds Yet Another Perspective on Small Business Lending Advocacy
March 29, 2016Is three a crowd? The Coalition for Responsible Business Finance (CRBF) seeks to improve small business finance.
As a new advocacy organization, the CRBF is dedicated to bolstering the credibility, reliability and security of the growing non-traditional small-business lending industry, they say. Spearheaded by Tom Sullivan, former Chief Counsel for Advocacy in the Small Business Administration, CRBF Advisory Board executives include representatives from the National Federation of Independent Business (NFIB), the National Small Business Association (NSBA), and the Small Business & Entrepreneurship Council (SBE Council).
“CRBF was created to educate state and federal policymakers, media, and communities on how technology and innovation are providing small businesses access to capital that is necessary for growth,” Sullivan said in an organization announcement this morning.
The organization has been developing for some time, but its official pronouncement nearly coincides with that of the Commercial Finance Coalition, another group with a similar goal.
And it’s shaping up to be quite the Spring here in 2016 because the Small Business Finance Association, yet another organization, is preparing to unveil a white paper of guiding industry principles.
And so that makes three, yet each appear to be bringing their own unique perspectives to the table. That is perhaps better than hundreds of unorganized perspectives under no collaborative banners, some industry vets are saying.
“Small business owners expect and deserve choices for credit,” Sullivan said. “And we at the [CRBF] believe that a better understanding of non-traditional small business lending will lead to greater acceptance by customers, regulators, and local, state, and federal elected officials.”
Touché.
