Business Lending

FIRE DRILL IN ILLINOIS: BUSINESS FUNDING COMPANIES TARGETED IN REPRESSIVE BILL

* Update 6/30 AM: Sen. Jacqueline Collins, D-Chicago is expected to introduce a revised bill today.
** Update 6/30 PM: Reintroduction of the bill has been delayed while they wait for comments from additional parties

Bankers and non-bank commercial lenders – two groups that often disagree – are united in their opposition to financial regulation proposed in Illinois. Both contend that if the state’s Senate Bill 2865 becomes law it could choke the life out of small-business lending in the Land of Lincoln and might set a precedent for a nightmarish 50-state patchwork of rules and regulations.

Foes say the measure was created to promote disclosure and regulate underwriting. They don’t argue with the need for transparency when it comes to stating loan terms, but they maintain that a provision of the bill that would cap loan payments at 50 percent of net profits would disrupt the market needlessly.

Opponents also regard the bill as an encroachment on free trade. “The government shouldn’t be picking winners or losers – the market should be,” said Steve Denis, executive director of the Small Business Finance Association, a trade group for alternative funders.

The states or the federal government may need to protect merchants from a few predatory lenders, but most lenders operate reputably and have a vested interest in helping clients succeed so they can pay back their obligations and become repeat customers, several members of the industry maintained.

“The ability to pay is really a non-issue,” noted Matt Patterson, CEO of Expansion Capital Group and an organizer of the Commercial Finance Coalition, another industry trade group. “I don’t make any money if a borrower doesn’t pay me back, so I don’t make loans where I think there is an inability to pay.”

Outsiders may find interest rates high for alternative loans, but companies providing the capital face high risk and have a short risk horizon, said Scott Talbott, senior vice president of government affairs for the Electronic Transactions Association, whose members include purveyors and recipients of alternative financing. Several other sources said the risks justify the rates.

Besides, a consensus seems to exist among industry leaders that most merchants – unlike many consumers – have the sophistication to make their own decisions on borrowing. Business owners are accustomed to dealing with large amounts of money, and they understand the need to keep investing in their enterprises, sources agreed.

In fact, no one has complained of any small-business lending problems in Illinois to state regulators, said Bryan Schneider, secretary of the Illinois Department of Financial and Professional Regulation and a member of Gov. Bruce Rauner’s cabinet.

Regulators should not indulge in creating solutions in search of problems, Sec. Schneider cautioned. “When you’re a hammer, the world looks like a nail,” he said, suggesting that regulators sometimes base their actions on anecdotal isolated incidents instead of reserving action to correct widespread problems.

But the proposed legislation could itself cause problems by placing entrepreneurs at risk, according to Rob Karr, president and CEO of the Illinois Retail Merchants Association, which has 400 members operating 20,000 stores. “It would stifle potential access to capital for small businesses,” he warned.

Quantifying the resulting damage would present a monumental task, but a shortage of capital would clearly burden merchants who need to bridge cash-flow problems, Karr said. Shortfalls can result, for example, when clothing stores need to buy apparel for the coming season or hardware stores place orders in the summer for snow blowers they’ll need in six to eight months, he said.

Restaurant owners and other merchants who rely on expensive equipment also need access to capital when there’s a breakdown or a need to expand to meet competition or take advantage of a market opportunity, Karr observed.

Capital for those purposes could dry up because just about anyone providing non-bank loans to small merchants could find themselves subject to the proposed legislation, including factoring companies, merchant cash advance companies, alternative lenders and non-bank commercial lenders, said the CFC’s Patterson.

Banks and credit unions are exempt, the bill says, but a page or two later it includes provisions written so broadly that it actually includes those institutions, said Ben Jackson, vice president of government relations at the Illinois Bankers Association.

Trade groups representing all of those financial institutions – including banks and non-banks – have joined small-business associations in working against passage SB 2865. “The most important thing is to make sure we’re coordinating with the other groups out there,” the SBFA’s Denis contended. “Actually, Illinois was good practice for the industry in how we’re going to go about dealing with attempts at regulation.”

Patterson of the CFC agreed that associations should coordinate their responses to proposed legislation. “We’ve tried to gather all the affected players in the space and have dialogue with them,” he maintained.

Even though that various associations reacting to the bill generally agreed on principles, their competing messages at first created a cacophony of proposals, according to some. “There was a lot of noise, and I think we’ll all learn from that,” Denis said. “The industry has to learn to speak with one voice to legislators.”

Citing the complexity of dealing with 50 states, 435 members of Congress and 100 senators, Denis said everyone with an interest in small-business lending must work together. “If we don’t, we lose,” he warned.

Many of the groups came together for the first time as they converged upon the Illinois capital of Springfield last month when the state’s Senate Committee on Financial Institutions convened a hearing on the bill. The committee allowed testimony at the hearing from three groups representing opponents. The groups huddled and chose Denis, Jackson and Martha Dreiling, OnDeck Capital Inc. vice president and head of operations.

City of Chicago Treasurer Kurt Summers was the only witness who testified in favor of the bill, according to Jackson. The idea of regulating non-bank commercial lenders in much the same way Illinois oversees lending to individuals arose in Summers’ office, said an aide to Illinois Sen. Jacqueline Collins, D-Chicago. Sen. Collins serves as chairperson of the Financial Institutions Committee and introduced to the bill in the senate.

Sen. Collins declined to be interviewed for this article, and Treasurer Summers and other officials in his of office did not respond to interview requests. However, published reports said Drew Beres, general counsel for Summers, has maintained that transparency, not underwriting, is the main goal. Talbott has met with Sen. Collins and said she’s interested primarily in transparency.

Support for the bill isn’t limited to the Chicago treasurer’s office. Some non-profit lending groups and think tanks back the proposed legislation, opponents agreed. The bill appeals to progressives attempting to shield the public from unsavory lending practices, they maintained.

Politicians may view their support of the bill as a way of burnishing their progressive credentials and establishing themselves as consumer advocates, said opponents of the legislation who requested anonymity. “It’s an important constituency,” one noted. “No one is against small business.”

After listening to testimony at the hearing, committee members voted to move the bill out of committee for further progress through the senate, Jackson said. Eight on the committee voted to move the bill forward, while two voted “present” and one was absent. But most of the senators on the committee said the legislation needs revision through amendments before it could become law, according to Jackson.

The legislative session was scheduled to end May 31. If the bill didn’t pass by then it could come up for consideration in a summer session if the General Assembly chooses to have one, Jackson said. If it does not pass during the summer, it could come to a vote during a two-week “veto session” in the fall or in an early January 2017 “lame duck session.” Unpassed legislation dies at that point and would have to be reintroduced in the regular session that begins later in January 2017, he noted.

Although time is becoming short for the proposed legislation, it’s a high-profile measure that could prompt action, particularly if amendments weaken the rule for underwriting, Jackson said. The Illinois General Assembly sometimes passes important legislation during lame duck sessions, he said, noting that a temporary increase in the state sales tax was enacted that way.

Whatever fate awaits SB 2865, some in the alternative funding business have suspected that the bill came about through an effort by banks to push non-banks out of the market. But cooperation among groups opposed to the proposed legislation appears to lay that notion to rest, according to several sources.

“I don’t get that impression,” Denis said of the allegation that bankers are colluding against alternative commercial lenders. “I think this shows banks and our industry can get together and share the same mission.”

Talbott of the ETA also counted himself among the disbelievers when it comes to conspiracy theories against alternative lenders. “I’d say that’s a misreading of the law and not the case,” he said. “Traditional banks oppose this because it would effectively reduce their options in the same space.”

The interests of banks and non-banks are beginning to coincide as the two sectors intertwine by forming coalitions, noted Jackson of the state bankers’ association. A number of sources cited mergers and partnerships that are occurring among the two types of institutions.

In one example, J.P. Morgan Chase & Co. is using OnDeck’s online technology to help make loans to small businesses. Meanwhile, in another example, SunTrust Banks Inc. has established an online lending division called LightStream.

At the same time, alternative funders who got their start with merchant cash advances and later added loans are contemplating what their world would be like if they turned their enterprises into businesses that more closely resembled banks.

And however the industries structure themselves, the need for small-business funding remains acute. Banks, non-banks and merchants agree that the Great Recession that began in 2007 and the regulation it spawned have discouraged banks from lending to small-businesses. The alternative small-business finance industry arose to fill the vacuum, sources said.

That demand draws attention and could lead to bouts of regulation. Although industry leaders say they’re not aware of legislation similar to Illinois SB 2865 pending in other states, they note that New York state legislators discussed small-business lending in April during a subject matter hearing. They also point out that California regulates commercial lending.

Many dread the potential for unintended results as a crazy quilt of regulation spreads across the nation with each state devising its own inconsistent or even conflicting standards. Keeping up with activity in 50 states – not to mention a few territories or protectorates – seems likely to prove daunting.

But mechanisms have been developed to ease the burden of tracking so many legislative and regulatory bodies. The CFC, for instance, employs a government relations team to monitor the states, Patterson said. The ETA combines software and people in the field to deal with the monitoring challenge.

And regulation at the state level can make sense because officials there live “close to the ground,” and thus have a better feel for how rules affect state residents than federal regulators could develop, Sec. Schneider said.

Easier accessibility can also keep make regulators more responsive than federal regulators, according to Sec. Schneider. “It’s easier to get ahold of me than (Director) Richard Cordray at the Consumer Financial Protection Bureau,” he said.

Also, state regulators don’t want to take a provincial view of commerce, Sec. Schneider noted. “As wonderful as Illinois is, we want to do business nationwide,” he joked.

State regulators should do a better job of coordinating among themselves, Sec. Schneider conceded, adding that they are making the attempt. Efforts are underway through the Conference of State Bank Supervisors, a trade association for officials, he said.

At the moment, state legislatures and federal regulators have small-business lending “squarely on their agenda,” the ETA’s Talbott observed. The U.S. Congress isn’t paying close attention to the industry right now because they’re preoccupied with the elections and the presidential nominating conventions, he said.

The goal in Illinois and elsewhere remains to encourage legislators to adopt a “go-slow approach” that affords enough time to understand how the industry operates and what proposed laws or regulations would do to change that, said Talbott.

At any rate, the industry should unite in a proactive effort to explain the business to legislators, according to Denis. “We need to work with them so that they understand how we fund small businesses,” he said. “That’s the way we can all win.”