Business Lending
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.
Should Alternative Lenders Be Regulated? (Video)
November 4, 2015Funding Circle’s Sam Hodges went back on Bloomberg TV to answer questions about the rise of marketplace lending. On the subject of regulation, Hodges explains that their business model is already pretty heavily regulated.
Meanwhile, David Stockman, a former US Congressman and former director of the Office of Management and Budget, said the regulators should stay away from alternative lenders. Video below:
Treasury Official Discusses Responses to RFI, Offers Mixed Review of Alternative Small Business Lending
November 3, 2015
Antonio Weiss, Counselor to the Secretary of the US Treasury, recently spoke at the Information Management Network Conference on Marketplace Lenders. In his prepared remarks, Mr. Weiss discussed the comments Treasury had received in response to its Request for Information about marketplace lenders. Mr. Weiss highlighted a number of themes about alternative small business finance that he believed had emerged from the responses.
First, Mr. Weiss stated that alternative small business lenders have the potential to increase lending to a historically underserved market.
Structural challenges in the small business lending market often make it difficult for business owners to obtain affordable credit. While larger businesses typically rely on banks for 30 percent of their financing, small businesses receive fully 90 percent of financing from banks. However, small business lending has high fixed costs for banks– it costs about the same to underwrite a $5 million dollar loan as a $200,000 loan. And we know that many small business owners are unable to access the credit they need to grow their businesses. Marketplace lending has the potential to unlock access to the capital markets for these borrowers.
Second, he stated that many responses to the RFI had cautioned that the new underwriting models used by market entrants were still untested. Mr. Weiss stated that many commenters had “noted that new underwriting models have yet to be tested through a full credit cycle” and therefore it was too soon to tell if these alternatives were better than traditional models at predicting future performance.
Third, Mr. Weiss noted that many commenters had argued that protections provided to consumers should be extended to small business borrowers. “[M]any commenters highlighted the need to establish a level playing field. All borrowers—businesses as well as consumers—should have the same protections. Small businesses are run by people. Those people receive protection as individual consumers, but when they are called ‘small businesses’ they get no protection,” he stated.
Mr. Weiss also highlighted calls for increased disclosure requirements. “…[C]ommenters almost universally agreed on the need for, and benefits of, greater transparency. To my mind, this means clear, simple terms that borrowers and investors can understand. For small businesses, transparency requires standardized all-in pricing metrics, so that a business understands a loan’s true cost and can make like-to-like comparisons across different loan products,” he stated.
In closing, Mr. Weiss noted that while Treasury will continue to monitor developments in the marketplace it is not a regulator in the space. Instead, Mr. Weiss stated that Treasury would work to inform those state and federal agencies that do have regulatory authority about developments in the market so that they could take any necessary actions.
Jimmy Kimmel on Shark Tank (Video)
November 3, 2015Jimmy Kimmel and his sidekick Guillermo decided to walk a mile in the shoes of a small business and raise capital from the experts. As you can imagine, it was beautifully done.
Can’t see the video? Click here
OnDeck Q3 Earnings Report Shows Positive Signs (ONDK)
November 2, 2015
Back when OnDeck was telling analysts that they were focusing on growth, critics said they should be focusing on profitability. Now that they’ve had their second straight profitable quarter, critics are pointing out that loan origination growth has slowed. OnDeck can’t win with them, but this quarter’s results were the closest they’ve come to proving themselves.
They originated a little over $482 million worth of loans and reported a profit of $3.7 million. Selling loans through their marketplace to institutional investors is generating immediate income and creating the profits they lacked before.
The reliance on funding advisors (ISOs/brokers) shrank from 20.6% in Q2 to 18.6% in Q3. During the Q&A session, OnDeck CEO Noah Breslow hinted that they may have reached a floor in that ratio. That channel could stabilize and even grow a little bit, he said.
When one analyst asked whether or not loan aggregation platforms were counted under funding advisors or strategic partners, Breslow said they are counted as strategic partners. Only 4% of OnDeck’s loans come from these loan aggregation platforms, the company’s execs admitted, putting to bed any notion that loan aggregators had leverage over OnDeck’s business.
In Q2, analysts became alarmed over the competitiveness of the direct mail channel. This time around, Breslow said the environment hasn’t gotten more or less competitive, that it was about the same. Competition is stabilizing and the advantage goes to the scaled players, he argued after describing their ability to target, analyze, underwrite and fund faster than others. Breslow added that they are not banking on relief from the competition to carry out their long term objectives.
A sentiment discussed on the call but not exactly argued by anyone is that it’s become pretty late in the game for new lenders to start entering the field, the implication being that the long-term competition is already in business, instead of it being some new companies that have yet to form.
The regulatory environment was described by OnDeck as “stable.”
All in all, the results of Q3 were optimistic.
Listen to OnDeck’s Q3 Earnings Call
November 1, 2015
Anyone can listen in to OnDeck’s Q3 Earnings call on Monday, November 2nd by dialing into (877) 201-0168 and using conference ID 55963420.
OnDeck closed sunday at $9.52 and has been relatively stable since August 6th, but has not been able to gain any ground back toward its IPO price of $20.
In their Q2 earnings call, the company admitted that they were up against competition in the direct mail channel. CEO Noah Breslow argued their strategy was to “break through the clutter” and “better communicate our value proposition.” He later added that “competition for customer response remains elevated.”
Back in August, Compass Point analyst Isaac Boltansky wrote to subscribers that the Madden v Midland ruling would hang over the heads of OnDeck and other marketplace lenders.
In an article by Deborah Festa, Robert C. Hora, Douglas Landy and Albert A. Pisa of Milbank, Tweed, Hadley & McCloy LLP, they wrote that one thing that could be done is to simply avoid Second Circuit jurisdiction. “Madden is directly binding if a defendant to a usury claim is sued in and subject to personal jurisdiction in the Second Circuit,” they wrote. “Excluding loans to borrowers located in the Second Circuit may reduce the risk of a usury lawsuit being filed in that circuit,” but added that it wasn’t a foolproof fix.
Meanwhile, Manatt, Phelps & Phillips, LLP attorney Brian Korn said at an invite-only event hosted by Herio Capital on October 8th, that the Madden v. Midland ruling was a non-event for business lenders.
And in Lending Club’s Q3 earnings report, they said, “In regards to our loan issuance framework, we continue to see no measurable impact from the Madden decision that was rendered in May this year by the second circuit Court of Appeals.”
OnDeck is therefore likely to be evaluated on their ability to scale originations as well as keep marketing costs and bad debt down. Analysts may also consider whether or not the lender can defend its relatively high costs and collection practices in an age where the mainstream media is scrutinizing alternative lenders with a closer eye.
The company responded to a front-page NY Times article that put them in an unflattering light earlier this month.
