CFPB to Collect Data on Small Business Lending, Implement Section 1071 and Circulate RFI
May 10, 2017
Update: We are streaming the hearing LIVE on our home page.
Update: You can download the CFPB’s Request for Information here. A transcript of Cordray’s prepared remarks are at the bottom of the page.
Update: CFPB White paper estimates that merchant cash advances are less than 1% of the small business finance market on an aggregate dollar volume basis, factoring 7%, and equipment leasing 13%. They estimate that the small business financing market is roughly $1.4 trillion in size. They also estimate that there are less than 1.5 million merchant cash advance “accounts” in the US, more than 6 million term loan accounts, and more than 7 million factoring accounts.
Update: The CFPB is releasing a Request for Information (RFI), asking industry participants to define a small business, explain where small businesses seek financing and the kinds of products that are made available to them, reveal the categories of data that small business lenders are using and maintaining, and to provide input on privacy implications that may arise from disclosing information to the CFPB.
Update: The CFPB is indeed announcing their plans to implement Section 1071 of Dodd-Frank.
Beginning at 1:45PM EST on Wednesday, the CFPB will be holding a hearing in Los Angeles on small business lending. According to the agenda, “the hearing will feature remarks from Director Cordray, as well as testimony from consumer groups, members of the public, and industry representatives.”
Sources contend that the director will use the hearing as an opportunity to announce the agency’s plans for the implementation of Section 1071 of Dodd-Frank which grants the CFPB the authority to collect data from small business finance companies. Some critics have characterized the law as an attempt to push affirmative action into small business lending, while others worry the CFPB will attempt to exceed its statutory authority and exact penalties based on the data it collects.
Unless Trump fires Cordray for cause, the director’s term will continue until July 2018.
industry representatives making remarks at the hearing include:
- Todd Hollander, Managing Director, Union Bank
- Makini Howell, Executive Chef and Owner, Plum Restaurants, and Main Street Alliance Member
- Kate Larson, Director, U.S. Chamber of Commerce
- Elba Schildcrout, Director of Community Wealth, East Los Angeles Community Corporation
- Josh Silver, Senior Advisor, National Community Reinvestment Coalition
- Robert Villarreal, Senior Vice President, CDC Small Business Finance
If possible, we will attempt to embed the live stream on our site.
Full transcript of Cordray’s prepared remarks below
Thank you all for coming. It is good to be here again in Los Angeles. Today, the Consumer Financial Protection Bureau is announcing an inquiry into ways to collect and publish information about the financing and credit needs of small businesses, especially those owned by women and minorities. We are well aware of the key role they play in our lives. Small businesses help drive America’s economic engine by creating jobs and nurturing local communities. It is estimated that they have created two out of every three jobs since 1993 and now provide work for almost half of all employees in the private sector. Yet we perceive large gaps in the public’s understanding of how well the financing and credit needs of these entrepreneurs are being served.
As you probably know, Congress provided the Consumer Bureau with certain responsibilities in the area of small business lending. And there is a strong logic behind this. When I served as the Ohio Attorney General, we recognized the need to protect small businesses and nonprofit organizations by accepting and handling complaints on their behalf, just as we did for individual consumers – an approach that proved to be very productive. In addition, the line between consumer finance and small business finance is quite blurred. More than 22 million Americans are small business owners and have no employees. And, according to data from the Federal Reserve, almost two-thirds of them rely on their business as their primary source of income.
Congress specifically has charged the Consumer Bureau with the responsibility to administer and enforce various laws, including the Equal Credit Opportunity Act. Unlike other consumer financial laws, the ECOA governs not only personal lending, but some commercial lending as well. In fact, we have now conducted a number of ECOA supervisory examinations of small business lending programs. Through that work, we are learning about the challenges financial institutions face in identifying areas where fair lending risk may exist, and we are assisting them in developing the proper tools to manage that risk.
In the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress took a further step to learn more about how to encourage and promote small businesses. To help determine how well the market is functioning and to facilitate enforcement of the fair lending laws, Congress directed the Consumer Bureau to develop regulations for financial institutions that lend to small businesses to collect certain information and report it to the Bureau. The Request for Information we are releasing today asks for public feedback to help us better understand how to carry out this directive in a way that is careful, thoughtful, and cost-effective.
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We have considerable enthusiasm for this project. In my own case, I have seen firsthand how small business financing can have a big economic impact. When I served as the Treasurer of Ohio, we had a reduced-interest loan program to support job creation and retention by small businesses. The way the program worked was that the state could put money on deposit with banks at a below-market rate of interest, and this deposit was then linked to a same-sized loan to a small business at a correspondingly below-market rate. This so-called “Linked Deposit” program had been authorized more than twenty years earlier, but had gradually fallen into disuse.
At its core, however, the program made good sense. Small businesses are often in desperate need of financing to update and expand their operations, and if they can get inexpensive financing, they often can fertilize their ideas for growth and be even more successful. So we diagnosed the program and found that after its initial success, it had become too bureaucratic. We heard from both banks and businesses that the program, which was still paper-based, was so slow and cumbersome that nobody wanted to use it.
So we changed all that. We put the process online, rebranded it as the “Grow Now” program, and made specific commitments to those who wanted to participate in it. We told them they could fill out a typical application in 30-60 minutes, and we promised them they would have a yes-or-no answer on their application within 72 hours. That was not easy, and it required very close coordination with the banks that took part in the program. But we did it, and the “Grow Now” program really took off. Only about $20 million had been allocated when we started, but in less than two years we deployed more than $350 million, helping about 1,500 small businesses create or retain approximately 15,000 jobs across the State.
It was also exciting and interesting to see how the businesses were able to use the loan funds. I can recall a construction business in northeast Ohio that needed a loan to buy a large piece of equipment so the company could compete for new and different jobs. They got the money, they got the equipment, and they thrived. I recall a manufacturer in northern Ohio that needed money to turn their factory sideways on their property so they could utilize more space and employ more people. We funded the build-out, they executed on it, and they met their goals for growth of output, revenue, and jobs. And I recall a company in western Ohio that started out as a caterer, began making their own tents for events, recognized that they might be able to succeed as tentmakers, and needed financing to be able to bid on a major project with the U.S. Department of Defense. We got them the loan, they got the bid, and Inc. magazine named them one of its 500 fastest-growing businesses of that year!
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The moral of this story is that business opportunity – especially opportunities for small businesses – often hinges on the availability of financing. People have immense reserves of energy and imagination. Human ingenuity is the overwhelming power that allows human beings to reinvent the future and make it so. These forces unleash what Joseph Schumpeter called the “gales of creative destruction” that constantly mold and reshape the patterns of our economic life. Innovation has sharpened our nation’s economic edge for generation after generation, but when credit is unavailable, creativity is stifled.
To make the kind of meaningful contributions they are capable of making to the American economy, small businesses – particularly women-owned and minority-owned businesses – need access to credit. Without it, they cannot take advantage of opportunities to grow. And with small businesses so deeply woven into the nation’s economic fabric, it is essential that the public – along with small business owners themselves – can have a more complete picture of the financing available to this key sector.
Some things we do know. We are releasing a white paper today that lays out the limited information we currently have about key dimensions of the small business lending landscape. According to Census data, and depending on the definition used, there are an estimated 27.6 million small businesses in the United States. We estimate that together they access about $1.4 trillion in credit. Businesses owned by women and minorities play an especially important role in this space. Women-owned businesses account for over one-third (36 percent) of all non-farming, private sector firms. The 2012 Survey of Business Owners, the most recent such information available, indicates that women-owned firms employed more than 8.4 million people, and minority-owned firms employed more than 7 million people. Those are huge numbers: by comparison, in 2014 fewer than 8 million people were employed in the entire financial services sector.
When small businesses succeed, they send constant ripples of energy across the economy and throughout our communities. For example, a 2013 study by the Federal Reserve Bank of Atlanta found that counties with higher percentages of their workforce employed by small businesses showed higher local income, higher employment rates, and lower poverty rates. In order to succeed, businesses need access to financing to smooth their cash flows for current operations, meet unexpected contingencies, and invest in their enterprises to take advantage of opportunities as they arise. Another study found that the inability to obtain financing may have prompted one-in-three small businesses to trim their workforces and one-in-five to cut benefits.
Unfortunately, much of the available data on small business lending is too dated or too spotty to paint a full picture of the current state of access to credit for small businesses, especially those owned by women and minorities. For example, we do not know whether certain types of businesses, or those in particular places, may have more or less access to credit. We do not know the extent to which small business lending is shifting from banks to alternative lenders. Nor do we know the extent to which the credit constraints that resulted from the Great Recession persist and to what extent. The Beige Book produced by the Federal Reserve on a regular basis is a survey of economic conditions that contains a huge amount of anecdotal information about business activity around the country. But it has no systematic data on how small businesses are faring and whether or how much they are being held back by financing constraints.
Given the importance of small businesses to our economy and their critical need to access financing if they are to prosper and grow, it is vitally important to fill in the blanks on how small businesses are able to engage with the credit markets. That is why Congress required financial institutions to report information about their applications for credit from small businesses in accordance with regulations to be issued by the Consumer Bureau. And that is why we are here today for this field hearing.
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The inquiry we are launching today is a first step toward crafting this mandated rule to collect and report on small business lending data. To prepare for the project, we have been building an outstanding team of experts in small business lending. We are enhancing our knowledge and understanding based on our Equal Credit Opportunity Act compliance work with small business lenders, which is helping us learn more about the credit application process; existing data collection processes; and the nature, extent, and management of fair lending risk. We also have learned much from our work on the reporting of home loans under the Home Mortgage Disclosure Act, which has evolved and improved considerably over the past forty years.
At the same time, we recognize that the small business lending market is much different from the mortgage market. It is even more diverse in its range of products and providers, which range from large banks and community banks to marketplace lenders and other emerging players in the fintech space. Community banks play an outsized role in making credit available to small businesses in their local communities. And unlike the mortgage market, many small business lenders have no standard underwriting criteria or widely accepted scoring models. For these reasons and more, we will proceed carefully as we work toward meeting our statutory responsibilities. And we will seek to do so in ways that minimize the burdens on industry. Our Request for Information released today focuses on several issues.
First, we want to determine how best to define “small business” for these purposes. Despite the great importance of these firms to our economy, there is surprisingly little consensus on what constitutes a small business. For example, the Small Business Administration, in overseeing federal contracting, sometimes looks at the number of employees, sometimes looks at the annual receipts, and applies different thresholds for different industries. For our part, the Consumer Bureau is thinking about how to develop a definition that is consistent with the Small Business Act, but can be tailored to the purposes of collecting business lending data. So we are looking at how the lending industry defines small businesses and how that affects their credit application processes. Having this information will help us develop a practical definition that advances our goals and aligns with the common practices of those who lend to small businesses.
Second, we want to learn more about where small businesses seek financing and the kinds of loan products that are made available to them. Our initial research tells us that term loans, lines of credit, and credit cards are the all-purpose products used most often by our small businesses. In fact, they make up an estimated three-fourths of the debt in the small business financing market, excluding the financing that merchants or service providers extend to their small business customers to finance purchases of the sellers’ own goods and services. But we want to find out if other important financing sources are also being tapped by small businesses. Currently, we have limited ability to measure accurately the prevalence of lenders and the products they offer. We also want to learn more about the roles that marketplace lenders, brokers, dealers, and other third parties may play in the application process for these loans. At the same time, we are exploring whether specific types of institutions should be exempted from the requirement to collect and submit data on small business lending.
Third, we are seeking comment about the categories of data on small business lending that are currently used, maintained, and reported by financial institutions. In the statute, Congress identified specific pieces of information that should be collected and reported. They include the amount and type of financing applied for; the size and location of the business; the action taken on the application; and the race, ethnicity, and gender of the principal owners. Congress determined that the reporting and disclosure of this information would provide a major boost in understanding small business lending. At the same time, we are sensitive to the fact that various financial institutions may not currently be collecting and reporting all of this information in the context of other regulatory requirements. And we understand that the changes imposed by this rule will create implementation and operational challenges.
So we will look into clarifying the precise meaning of some of these required data elements to make sure they are understood and consistently reported. We will be considering whether to add a small number of additional data points to reduce the possibility of misinterpretations or incorrect conclusions when working with more limited information. To this end, we are seeking input on the kinds of data different types of lenders are currently considering in their application processes, as well as any technical challenges posed by collecting and reporting this data. We will put all of this information to work in thinking carefully about how to fashion the regulation mandated by Congress under Section 1071 of the Dodd-Frank Act.
Finally, the Request for Information seeks input on the privacy implications that may arise from disclosure of the information that is reported on small business lending. The law requires the Consumer Bureau to provide the public with information that will enable communities, government entities, and creditors to identify community development needs and opportunities for small businesses, especially those owned by women and minorities. But we also are authorized to limit the data that is made public to advance privacy interests. So we will be exploring options that protect the privacy of applicants and borrowers, as well as the confidentiality interests of financial institutions that are engaged in the lending process.
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The announcement we are making today, and the work we are doing here, reflect central tenets of the Consumer Financial Protection Bureau. We are committed to evidence-based decision-making. We aim to develop rules that meet our objectives without creating unintended consequences or undue burdens. We want to see a financial marketplace that offers fairness and opportunity not just to some, but to all. A marketplace that does so without regard to race, ethnicity, gender, or any of the other elements of our fabulous American mosaic. We all know that small businesses are powerful economic engines. They supply jobs that lift people out of poverty or dependence, teach essential skills, and serve as backbones of our communities. So we mean to meet our obligation to develop data that will shed light on their ability to access much-needed financing. It is essential to their future growth and prosperity, and therefore to the growth and prosperity of us all. Because what Cicero observed in ancient Rome still holds true today. He said, “Nothing so cements and holds together all the parts of a society as faith or credit.” Our communities depend on both of those precious things just as much today.
As we launch this inquiry, I want to remind all of you that we value the feedback we get. We take it seriously, consider it carefully, and integrate it into our thinking and our approach as we figure out how best to go forward with this work. So we ask you to share your thoughts and experiences to help us get there. And we thank you again for joining us today.
Re-Banked
April 23, 2017
Just a few years ago, the financial services community was fixing for a battle of David and Goliath proportions—with scrappy, upstart online lenders threatening to rise up and vanquish the fearful and mighty brick and mortar banks. Instead, the unexpected happened: a number of well-respected online lenders and banks set aside their battle arms and began looking for ways to collaborate with their rivals—offloading loans, making referral agreements and establishing more formal partnerships, for example.
“In the real world, sometimes David wins. Sometimes Goliath wins. Just as plausibly, sometimes both sides carve up a market and they often have different offerings that target unique customers,” says Brayden McCarthy, vice president of strategy at Fundera, a New York-based marketplace for small business lending that works with a variety of lenders, including traditional banks.
Certainly, the change didn’t happen overnight. But over time, both online lenders and banks have been forced to tailor their expectations more closely to market realities. Despite their fast growth trajectory, several online lenders have come to realize that they lack several things many banks have, namely a strong, time-tested brand, a solid customer base and ample capital. Banks, meanwhile, have realized that their slow start out of the gate with respect to technology is a severe competitive disadvantage, and that they need more nimble, savvy partners to stay in the game.
Given these shifts, more and more online lenders and banks are taking the approach that if you can’t beat ‘em, join ‘em. Although some industry leaders are actively pursuing strategies that put them in direct competition with banks, partnerships of varying degrees between traditional banks and alternative players are increasingly common. As a result, the lines separating the two are getting increasingly blurry.
“Market forces are acting as a shotgun at the wedding. Whether the two sides are entirely comfortable with the marriage is irrelevant, they need one another,” says Patricia Hewitt, chief executive of PG Research & Advisory Services LLC in Savannah, Georgia. “They’re stronger together than they are alone.”
The evolution of Square is a prime example. The San Francisco-based company really packed a punch in the merchant services world with its mobile card reader designed for small businesses. From there, the payments company sought additional ways to diversify, eventually turning to merchant cash advance as a way to help small business customers obtain funds quickly. Then, in March of last year, Square moved into online lending, teaming up with Celtic Bank of Utah to offer small business loans online. The partnership got off to a running start. In its most recent earnings report, Square said it facilitated 40,000 business loans totaling $248 million in the fourth quarter of 2016—up 68 percent year over year—while maintaining loan default rates at roughly 4 percent.
Even SoFi, the San Francisco-based online lender that has been pointedly outspoken in its anti-bank rhetoric, now has bank-like aspirations. In February, the lender acquired mobile banking startup Zenbanx, giving it the ability to offer checking accounts and credit cards in 2017. Also in February, SoFi teamed up with Promontory Interfinancial Network to enable community banks to purchase super-prime student loans originated by the online lender. Large banks have been buying SoFi loans for several years.
COLLABORATION IS THE WAVE OF THE FUTURE
Many see collaboration between banks and online lenders as a logical step in the industry’s evolution. Online disrupters have forever changed the face of lending—in the same way that online brokerage shaped the financial advisor industry, according to Bill Ullman, chief commercial officer of Orchard Platform.
“There’s a tendency to want to view things as either black or white, online lenders vs. banks. The reality is that the entire financial services industry is undergoing a transformation with technology as the core driver,” he says. “I am of the view that both traditional financial services companies and fintech players can survive and thrive,” Ullman says.
For its part, Orchard recently inked a deal with Sandler O’Neill that provides access to the Orchard platform for the investment bank and brokerage firm’s bank and specialty finance clients. The deal is expected to help small banks better evaluate their options with respect to online lending opportunities.
Partnerships between online lenders and banks take many forms. Some of them are behind the scenes, where marketplaces sell loans to banks or banks informally refer customers. Others are more public. For example, in September 2015, Prosper and Radius Bank of Boston teamed up to offer personal loans to certain customers through the bank’s website using the Prosper platform. Customers can borrow from $2,000 to $35,000 in this manner.
Then in December 2015, JPMorgan Chase and OnDeck joined forces in order to dramatically speed up the process of providing loans to some of the banking giant’s small business customers. In April 2016, Regions Bank and Avant announced a partnership to better serve customers who don’t meet Regions’ credit criteria.
Avant’s customers typically have a credit score between 600 and 700, while Regions sets the bar higher. “The benefit for banks is that they do not need to worry about a platform taking away customers that meet their own credit criteria,” according to Carolyn Blackman Gasbarra, head of public relation at Avant.
She notes that Avant expects to replicate this model with more banks in 2017. “Lately many platforms and banks have come to realize their counterparts are more friend than foe,” she says.
Given the changing tides, industry watchers expect to see more relationships develop between online lenders and banks over time. These could include referral agreements, technology licensing arrangements, formalized revenue-sharing partnerships and perhaps even outright acquisitions.
PARTNERSHIP ADVANTAGES
Certainly, working together can be mutually beneficial for both online lenders and banks. For new online lenders and other fintech players, partnering with an established bank allows them to bypass significant regulatory and compliance hurdles because the necessary requirements are already in place.
“Why jump through all the hoops when you can just have a buddy system with an existing lender?” says Kerri Moriarty, head of company development at Cinch Financial, a Boston-based company dedicated to helping people make smarter investment decisions.
Fintechs that license their technology to banks still have to meet the high standards of third-party vendors determined by bank regulators, notes Stan Orszula, co-head of the fintech team at the Chicago law firm Barack Ferrazzano Kirschbaum & Nagelberg LLP.
“But it’s still less onerous than being a direct lender,” says Orszula, who works closely with banks and fintech providers on legal, regulatory and corporate issues. “They are learning that they need banks. They really do.”
Even seasoned online lenders that have a regulatory framework in place can benefit from bank relationships by using banks’ established brands as leverage. “Everyone knows Chase, Bank of America and American Express,” says McCarthy of Fundera. “They have a solid name and a solid in-built customer base to be able to offer product to them,” he says.
Teaming up with a bank gives added credibility to an online lender, at a time when the public’s confidence has faltered due to highly publicized troubles at certain firms. “Partnering has a very important signaling effect that these online players are here to stay,” McCarthy says.
Banks, meanwhile, need the nimbleness and innovation that online lenders provide. “Banks realize they have to catch up with the fintech disrupters,” says Mark E. Curry, president and chief executive of SOL Partners, which provides strategic management and information technology consulting services to financial services companies.
DIFFERENT TYPES OF PARTNERSHIP OPPORTUNITIES ABOUND
When it comes to partnerships between banks and online players, there are numerous options. In the small business lending space, for example, McCarthy of Fundera says he expects banks to continue buying loans from online lenders, as they have been for many years. He also expects more banks will route declined applicants to online lenders or online loan brokers. “This is a partnership that will allow them to make up some incremental revenue by referring business,” he says.
In addition, McCarthy says he expects banks to make products available through online marketplaces and use an online lender’s technology for online loan applications. He also expects banks will use online lenders’ technology for underwriting and servicing loans.
Years ago, before John Donovan joined Bizfi, he recalls talking to a salesman for a large national bank. The bank didn’t offer a lending product that he could give to small businesses and the salesman was losing customers as a result. “That’s where we see a lot of those opportunities,” says Donovan, chief executive of the online marketplace for small business loans.
For instance in March 2016, Bizfi partnered with Western Independent Bankers, a trade association, for over about 600 community and regional banks, to link small business clients to financing options through Bizfi. Many banks don’t offer small business loans below $150,000, whereas the average loan Bizfi does is $40,000, Donovan says, adding that the company would like to develop additional relationships similar to its agreement with Western Independent Bankers.
In the future, he predicts fintechs will continue to be more receptive to the idea of working with banks and vice versa, as the industry digests the impact of deals that are still in their early days.
FINDING STRATEGIC GROWTH OPPORTUNITIES
As banks and online lenders become increasingly accustomed to working together, there may be more opportunities for strategic acquisitions. For instance, Sandeep Kumar, managing director of Synechron, a global consulting and technology firm, expects to see banks—especially mid-tier players that don’t have the resources to innovate like big banks buying lending-related start-ups. He says banks will likely be most interested in companies that can help them with AI and other techniques to pinpoint where they should spend more efforts on cross-selling and customer profiling, for example. “There are many start-ups in this area that have very compelling technology,” he says.
On the other hand, Chris Skinner, an independent commentator at The Finanser Ltd., a research and consulting firm in London, points out that the two cultures don’t always mesh. “Quite a few startups have young, entrepreneurial founders that would loath the idea being acquired by a bank. So it really depends on the circumstances,” he says.
Valuation differences between large banks and leading online lenders may also be a sticking point for some deals, Ullman of Orchard points out. Banks’ concern over their valuation “will place a certain amount of restraint and discipline on the tech M&A activities they pursue,” he says.
ANTICIPATING TROUBLE IN PARADISE
While increased collaboration between online lenders and banks sounds good on the surface, John Zepecki, group head of product management for lending at D+H in San Francisco, urges both sides to proceed with caution. “You have to find an arrangement where you don’t have conflict,” he says. “If your innovation partner also is a competitor, it’s a challenge. If you have an inherent conflict, it doesn’t get better over time.”
That’s one reason why companies like Chicago-based Akouba have come on the scene. In Akouba’s case, its goal is to provide banks with the technology such that they don’t have to partner with an online lender that has the potential to compete for business. “We don’t compete with the bank in any way whatsoever,” says Chris Rentner, the company’s founder and chief executive.
Akouba’s business lending platform—which the American Bankers Association endorsed in February—provides banks with leading edge technology that integrates the bank’s own unique credit policies into a convenient, online process—from application to documentation— all the way to closing and funding. The bank uses its own credit policies, originates its own loans and owns the entire brand and customer relationship.
Rentner says he started the business with the idea in mind that the online lending model wouldn’t be sustainable long-term and that working alongside banks—as opposed to competing head to head— was the direction to go. “The idea that they could somehow get all of the consumers out of the banking world and onto their platforms was never going to happen. That’s why we exist today,” he says.
Can Factors and MCA Companies Get Along?
April 7, 2017
At the factoring conference in Fort Worth, TX on Thursday, the 2 PM panel was officially called The Fintech Disruption. But it could’ve just as easily been named The MCA Disruption considering that the panelists all ran companies engaged in either unsecured business lending or MCA. The tension in the packed room was palpable. For some factors, the competitive pressure they feel with unsecured finance companies cuts deep, down to their soul. So naturally it only made sense, being that it’s Texas and all, that they lassoed a few of those unsecured guys up and put them on stage to explain theirselves.
So what’s the best way for an MCA company to make a peace offering to a room full of factors?
Sol Lax, the CEO of Pearl Capital Business Funding LLC, kicked it off by telling the audience that a small business customer might begin their quest for capital by searching the internet for a small business loan. “There’s no factoring companies that are going to pop up,” he exclaimed, suggesting that they were already losing when it came to the Internet to acquire customers and had little hope of catching up. But if you are a small factor, he conceded, you should continue generating leads through relationship building since the Internet is now so cost-prohibitive.
Dean Landis, the President of Entrepreneur Growth Capital, ran with that and asked attendees to raise their hands if they really pay attention to the cost of lead acquisition. While this was an informal survey, virtually no one raised their hand, seeming to confirm that deal flow for factors is largely acquired through relationships. Landis, who played the role of moderator and devil’s advocate, asked if MCAs and factors were really even targeting the same customers. Would you lend to someone who already has a senior lien? he asked. “These [MCA] guys figured out how to do that.”
Dan Smith, President of Fora Financial and Paul Rosen, Chief Sales Officer of OnDeck, explained that their customers often seek a fast-paced application-to-funding process, which drew a rebuke from an audience member who had a hard time believing that so many merchants truly needed that speed and simplicity. Smith and Rosen countered by saying that customers will choose whatever is best for them and that not every customer fits their boxes.
Lax advised factors to look at the bigger picture, that one big lender on their own might not seem like a threat but that a company like OnDeck could license out their scoring model to banks and banks could adapt that to make loans to companies they have otherwise been ignoring (the same ones that go to factors) and compete against the factors directly.
As the audience chipped away with questions about the soundness of these scoring models and fintech, Smith of Fora reminded everyone that they still have underwriters that are manually overseeing deals, rather than let computers do everything entirely on their own. “You can literally fintech yourself out of the business,” Smith cautioned lenders who might overzealously replace their core competency with algorithms that don’t perform as well.
But even then, do these scoring models work when merchants gets stacked on? This question was asked and it suggests that stacked merchants have a higher risk of default. Rosen of OnDeck confirmed that when he said “customers that stack on us have much higher loss rates.” Meanwhile, Smith said that when customers are doing something that affects their model, they just need to improve their model, just like they would if there was a recession or some other economic event underway. “All of our models are built on lifetime value,” he said. They want to grow and nurture their clients, he explained.
While factors fear that MCA companies could stack on their clients, there are signs that a path forward exists. An informal poll of the room indicated that not only are factors referring prospects to MCA companies but that MCA companies are returning the favor and sending prospects to them. The former was more prevalent.
Lax of Pearl, was more pointed about the future for factors. “You either need to evolve or become a phone booth,” he proclaimed. He prefaced that with a story about a child who was absolutely befuddled by an old Superman movie, as in ‘what were all these ridiculous random booths doing in the city that enabled Clark Kent to go around changing his clothes?’ The concept of a phone booth could hardly even be explained to the next generation. “Your industry is suffering a phone booth moment,” Lax said to the factors.
Is he right?
To the unsecured lenders and MCA companies who attend the factoring conference, they invariably see value in partnerships. And for the factors still hesitant to take that step, is it really the MCA model that’s causing friction? Or is it the evolution of the way that businesses interact with financial technology, i.e. fintech? And might fintech disrupt everyone in the end?
Only time will tell.
Quotes and paraphrases were derived from the panel. The summary is my own analysis of it and much of the 90-minute discussion was omitted here for brevity.
In Advance Capital Secures $50 Million In Additional Financing
March 29, 2017New York, NY — On March 27th, Times Square-based In Advance Capital secured a $50 million credit line to continue the rapid growth of its merchant cash advance business. The eighteen-month-old company, led by founders Shalom Auerbach and Thomas Corliss, attributes its portfolio transparency, discipline, and strong relationships with investors as the key contributing factors in securing the additional capital.
“In an industry that is increasingly difficult to access capital, we are very pleased to have earned the confidence of sophisticated investors who have provided capital that aligns their objectives with ours, which is to provide fast and flexible working capital to small business owners experiencing the challenges and opportunities of high growth,” says Shalom Auerbach, IAC’s CEO. In Advance Capital has focused on creating a more streamlined process to facilitate its own growth, including a quicker underwriting process, while seeing 220% more applications within the last two months.
“In Advance is a testament that you can build and grow a company in a competitive industry if you concentrate on hiring top talent, servicing, and listening to your customers,” Corliss says.
“It’s all hands-on deck at In Advance which also makes our work environment a special place to work.”
In Advance is also please to announce its recent Executive Management addition to staff, Keith Nason as Chief Operating Officer. Keith Nason brings over 10 years of expertise to driving operational leverage, streamlining process and data science analytics.
About In Advance Capital
Founded in 2015, the company provides working capital to small business owners. To learn more, visit http://www.inadvancecap.com or call 646-412-3303.
In This Online Lender’s Earnings Report, Profits, MCAs and Term Loans
March 22, 2017Limited details were offered when Enova, a publicly traded company, acquired The Business Backer (TBB) in June 2015. For one, the Cincinnati Business Courier had the exclusive, which one might not describe as the typical go-to source for online finance news. But TBB was not typical. Based in Blue Ash, Ohio as opposed to New York City or San Francisco, the company had originally focused on offering merchant cash advances before eventually expanding their suite of solutions to include other products.
According to Enova’s earnings report, TBB had been purchased for $26.4 million with an estimated contingent $5.7 million of that being based on future earn-out opportunities. There was a caveat though. If future operating results exceeded expectations, that contingent amount could increase over time, but not beyond where the total consideration paid for the company exceeded $71 million. As of 2016’s year-end, that contingent amount had increased by $3.3 million.
Enova’s report makes several mentions of their merchant cash advance business or as they call them, receivable purchase agreements (RPAs). For the most part, they obscure the financial metrics of this aspect by lumping it in with installment loans. These installment loans are described as “multi-payment unsecured consumer installment loan products in 17 states in the United States and in the United Kingdom and Brazil” with repayment periods of two to sixty months, so yeah, they’re pretty different.
Their RPA customers, however, “average approximately $1.5 million in annual sales and 10 years of operating history while those who obtain an open line of credit account average approximately $450 thousand in annual sales and 7 years of operating history,” the report says. These lines of credit are primarily offered through a business lending subsidiary called Headway Capital.
While companies like Lending Club and OnDeck grab all the headlines, Enova describes itself as a “leading technology and analytics company focused on providing online financial services.” And in 2016, they extended nearly $2.1 billion in credit to borrowers and had a net income of $34.6 million.
On the company’s Q4 earnings call in February, Company CEO David Fisher said, “There currently seems to be a bit of a shakeout occurring in the non-bank small business lending and financing industry. A number of our competitors have either ceased funding or completely shut down over the past several months. From the intelligence we were able to gather, this is largely due to credit issues and their portfolios. As we mentioned last quarter, we have taken a more methodical approach than some to growth for our small business products. And we’re now seeing the benefits of that approach. Recent advantages of our small business book are performing well and the unit economics continue to improve especially as acquisition costs have dropped following the shakeout I just mentioned.”
Enova’s small business financing portfolio only constituted 12% of their loan portfolio at the end of last year. And at $13.70 a share, the company’s current market cap is larger than OnDeck’s.
Confidence Stable For Small Business Lenders and MCA Companies
February 26, 2017Recent events may be putting a slight damper on the confidence of industry CEOs in being able to access capital needed to grow their businesses, but continued success of the industry in general is ticking back up. This data is according to the latest survey conducted by Bryant Park Capital and AltFinanceDaily of small business lending and merchant cash advance company CEOs.
Confidence in the industry’s continued success bumped back up to 81.9% in Q4, while confidence in being able to access capital reached its lowest level since the survey’s inception. Still, at 82.7%, it’s high.
In late November of 2016, CAN Capital, one of the industry’s largest companies, encountered problems that caused the company to suspend funding. Several of their competitors since then have reported a boost in submission volume, which they partially attributed to that event.
Pressure on companies to merge or exit the market may also be kindling optimism for larger players who stand to gain market share.
What Shakeout? Breakout Capital Secures $25 Million Credit Facility
February 8, 2017
Put a tally up on the board for small business lenders in 2017. McClean, VA-based Breakout Capital, which just announced a move into a larger office last week, has also secured a $25 million credit facility with Drift Capital Partners. Drift is an alternative asset management company.
Breakout is young by today’s industry standards, founded only two years ago by former investment banker Carl Fairbank, who is the company’s CEO. And don’t count them out just because they’re not in New York or San Francisco. Washington DC’s Virginia suburbs have become somewhat of a hotspot for fintech lenders. OnDeck, Fundation, StreetShares and QuarterSpot all have offices there, Fairbank points out. “And Capital One is right up the street,” he adds while explaining that the community has a strong talent pool that is familiar with creative lending. Breakout has already grown to about 20 employees and they’re still growing, he says.
Fairbank considers Breakout to be a more upmarket lender, whose repertoire includes serving the near-prime, mid-prime customer. CAN Capital and Dealstruck had focused on this area and both companies stopped funding new business in 2016. As I point this out, I ask if that suggests that segment is perhaps too difficult to make work.
“Candidly, that’s the part of the market that I feel the best about,” he says matter of factly. The company tries to product-fit deals based on the borrower, and will even make monthly-payment based loans. “I think the subprime side with the stacking and the debt settlement companies is a very very difficult place to play right now,” he says, adding that they have worked with subprime borrowers using their original bridge program but that they’ve kind of pulled back from doing those. As with all programs regardless, their goal is to graduate merchants into better or less costly products later on. We have helped merchants move on to get SBA loans, he maintains.
That all sounds very hands on, and part of it is, Fairbank confirms while asserting that technology does indeed do a lot of the legwork. “There’s absolutely a human element to underwriting these deals,” he says. He also agrees with much of what RapidAdvance chairman Jeremy Brown wrote in a AltFinanceDaily op-ed titled, The New Normal. Both Breakout and RapidAdvance refer to themselves as technology-enabled lenders, an acknowledgement that tech is a component of the company, not the entire company itself.
“I think we will see the beginning of the demise of fully automated, no manual touch funding,” Brown wrote in his article.
Brown also predicted that the legal system will ultimately impose order on some industry practices like stacking or that a state like New York could take a public policy interest in products he believes have legal flaws. As he was writing that, Governor Cuomo’s office published a budget proposal that redefined what it means to make a loan in the state. And it leaves much to be desired, some sources contend. Two attorneys at Hudson Cook, LLP, for example, published an analysis that demonstrates how its wording is ambiguous and far-reaching.
“What they really need to do is take the time to think through the implications and basically do a full study of the market to ensure that what they’re pushing forward is going to have the desired consequences,” Breakout’s Fairbank offers on the matter.
This doesn’t mean he’s anti-regulation. The company already holds itself to high standards and customer suitability and is a founding member of the Coalition for Responsible Business Finance.
“I personally do believe that there’s bad forms of lending or cash advances in the market and I’m sure that’s what Cuomo thinks as well but at the same time, it’s getting pushed very quickly and they really really ought to step back and do the research to understand the broader implications and to understand what exactly they’re trying to accomplish,” he maintains.
His pragmatism extends to the OCC’s proposed limited fintech charter, which he finds intriguing, assuming it gets buttoned up. “I believe it’s a concept worth pursuing,” he says, explaining that regulators will need to get comfortable with unsecured lending.
In the meantime, he’s optimistic about Breakout’s prospects. “In a time when institutional appetite for alternative finance companies has dried up, we believe our ability to raise a credit facility in this market speaks volumes about what we have already accomplished, our position as a leading player in the space, and our prospects for strong, but measured, growth,” Fairbank is quoted as saying in a company announcement. The company was also invited and joined the Task Force for the PLUM Initiative, a collaboration between the U.S. Small Business Administration (SBA) and the Milken Institute to more effectively provide capital to minority-owned businesses throughout the United States. The Task Force consists of a very select group of industry leaders, who are in positions to improve access to capital in underserved markets, according to the announcement.
While other companies are making adjustments or in his opinion, continuing to make questionable underwriting decisions, Fairbank thinks his formula for success works. “I think that we do look at deals differently than most folks because I intentionally built the core of my underwriting team with folks who are not from this space so they take a more traditional approach and mix it with some of the greatest aspects of alternative finance.”
CAN Capital is Changing the World’s Most Expensive Tire
January 16, 2017
Acting CEO Parris Sanz told the WSJ that what’s happening at CAN Capital right now is akin to changing a flat tire. “We hit a bump in the road and blew out a tire,” Sanz said. “We just need to change out the tire, and we’ll be back on the road.”
But sources say that the company is in the midst of trying to sell off assets including its loan portfolios to raise cash in a hurry. In the span of a few weeks the company has let go of more than half of its employees, has suspended funding new deals, put its top executives on leave, been sued by a shareholder, and suffered a rapid amortization event with its $200 million bond deal. That’s on top of a breach that the WSJ reported with CAN’s $650 million credit facility led by Wells Fargo. A spokesperson for Wells told me they could not provide any comment or information on the matter.
And CAN’s issues aren’t the result of a changing economy, but rather internal systems that couldn’t keep up with their innovations. They’ve even hired a restructuring company to assist them through this crisis. It now being more than a month and a half since the story first broke, the WSJ puts the amount CAN is trying to raise “to strengthen its financial position” at $100 million.
If this is how they go about changing a tire, it may be time they sign up for AAA Roadside Assistance. For the merchant cash advance industry, their predicament is one of the biggest events of the decade by virtue of their history, size and renown. The company has funded more than $6 billion to small businesses since they launched in 1998.
Consider that just a few months ago, CAN was seemingly riding high as it promoted its new lending transparency initiative as part of the Innovative Lending Platform Association. And in July, Sanz represented the MCA & small business lending industry in a congressional hearing dedicated to financial institutions and consumer credit.
CAN’s top competitor is OnDeck whose stock has only inched up 8% since November 29th.
A spokesperson for CAN reiterated that this was an issue that they self-discovered and self-reported. “In the absence of information, people are making incorrect assumptions,” she said. “It affected about 3% of total assets in the portfolio under our senior line. It’s a manageable situation and one we are working through as we position ourselves for success in 2017.”
