Alternative Lenders Are Waiting for a Shakeout
October 28, 2015
Back in April at the LendIt conference in New York, the big consensus was that not all underwriting was created equal and therefore several players wouldn’t survive long enough to make it back to LendIt in 2016. Six months later at Money2020 and so far everyone is still standing.
Loan terms are getting longer, rates cheaper and the cost to acquire borrowers higher. Somebody has to be feeling the pressure but in a rather benign economic and regulatory environment, it’s clear skies.
Valuations are soaring. SoFi is valued at more than $4 billion and Kabbage at more than $1 billion.
But Robert Greifeld, the CEO of Nasdaq warned attendees about the validity of private market valuations. “A unicorn valuation in private markets could be from just two people,” he said. “whereas public markets could be 200,000 people.” At best he described a private market valuation as being just a rough indicator.
And some wonder if these valuations are based on just scale, rather than the ability to underwrite more intelligently and efficiently than a bank. OnDeck for example, had a Compound Annual Growth Rate (CAGR) in originations of 159% from 2012-2014 when the average originations CAGR for their peers is currently 56%. But OnDeck has the advantage of time. With nearly a decade of data under their belt, they’ve been able to see what works and what doesn’t.
“You have to have enough bad loans to build a good credit model,” said OnDeck CEO Noah Breslow during a Money2020 panel discussion.
For Aaron Vermut, CEO of Prosper, getting their company to the next level was about having access to institutional capital. As a marketplace, and as a company that almost died several years ago, he pointed out, institutional money was the inflection point for them to grow. The peer-to-peer model that actually depended purely on “peers” is what held their company back.
One thing several lenders seemed to agree on was the limited applicability of FICO. FICO is not the thing to use for a small business loan, said Sam Hodges, Managing Director and Co-founder of Funding Circle. His words didn’t come as a surprise since credit scores are generally the domain of consumer lending.
But doubts about FICO’s ability to predict performance didn’t just come from the commercial finance side. Prosper’s Vermut explained that consumers still think their FICO score is the most important factor in the rate they get. So even though they’ve got a system to predict repayment outside of FICO, they’re kind of forced to incorporate it because consumers are being educated to believe that’s what matters most.
The irony was not lost that as Vermut said that on a panel, he was seated next to Kenneth Lin, the CEO and founder of Credit Karma, a company that educates consumers about credit. “A credit score is one of the most important components of a consumer’s financial profile,” says Credit Karma’s website. Such language puts a tech-based lender with their own scoring model perhaps at odds with what their own prospects believe.
For instance if a potential borrower with a 750 FICO score is offered a high interest rate because the lender’s advanced and more in-depth underwriting determined them to be high risk, they’re going to walk away confused.
That of course begs the question, who needs to change? Those educating consumers about credit scores or the lenders who are moving away from them?
Before educational services shift though, it would probably make sense if the lenders can prove that their non-FICO dependent systems will work in the long run. And the sentiment among many lenders is that there are plenty of flawed models out there that will inevitably fail. That makes a shakeout not just a matter of if, but when.
Six months after LendIt, everybody is still standing. Whispers from in and around Money2020’s halls and exhibit floor revealed that the confident lenders wish the correction would happen sooner rather than later but that they are prepared to wait however long it takes.
Right now, confidence about the future on the commercial finance side came in at an 83.7 out of 100, according to the Small Business Financing Report. While there are no other points of reference to compare that to, industry captains are generally very bullish.
That could mean that for those secretly under tremendous pressure already, you could be left waiting for a shakeout for a very long time.
Did Your Deal Slip Out The Back Door?
October 22, 2015Gil Zapata found himself in the right place at the right time to catch someone red-handed at backdooring, the practice of stealing an alternative-funding deal and cheating the original ISO or broker out of the commission.
It seems that Zapata, who’s president and CEO of Miami-based Lendinero, was sitting in a client’s office about three years ago when the phone rang. The call came from an employee of a direct funder that had turned down Zapata’s deal to fund the merchant. Now, the employee was offering funding from another source without notifying Zapata. Fortunately, the merchant didn’t accept the surreptitious funding, Zapata said. “There’s a huge loyalty factor with maybe 50 percent of the clients an ISO has under their belt,” he noted.
But many merchants sign up for backdoor deals out of ignorance, callousness or desperation, and the problem seemed to gather momentum in the first quarter of this year, according to Cheryl Tibbs, owner of Douglasville, Ga.-based One Stop Funding LLC.
When Tibbs found herself the victim of backdooring a few months ago, the merchant’s loyalty to the ISO prevailed once again. “Because of the relationship we had with the merchant, he let us know and didn’t go along with it,” she said.
Both cases fall into one of the categories of backdooring. This type usually occurs when an ISO or broker submits a deal and the funder declines it, said John Tucker, managing member of 1st Capital Loans LLC in Troy, Mich. An employee of the funder then takes the file and offers it to other funders, often those that accept higher-risk deals. The funder’s employee conveniently forgets to include the originator in the commission, Tucker said. Meanwhile, the employee’s boss might know nothing of the post-denial goings-on.
In another variety of backdooring, ISOs or brokers deceptively claim that they’re direct funders. They solicit deals in online forums, by email message or over the phone, and then they offer the deals to companies that really do function as direct funders. In many cases, the fake funders pocket the entire commission, Tibbs said.
“I’m bombarded with probably 10 emails every day of the week from a supposedly new lender that wants my business, and they’re really just a broker shop like we are,” she maintained.
To guard against both kinds of backdooring, ISOs and brokers should know their funding sources, everyone interviewed for this article suggested. “What we’ve done is tighten up on how we do submissions,” Tibbs said. “We’re very particular about which lending platforms we use.” Although her company has contracts with 60 to 70 funders, it uses only three or four regularly, she noted. “Shotgunning” deals to lots of potential funders invites backdooring, Tibbs said.
Tibbs also scrutinizes deals to determine which funder would provide the best fit. That way, fewer deals are declined and thus fewer became candidates for backdooring by unscrupulous funder employees. “We have a system. We scrub it. We do the numbers,” she said of her company’s close attention to underwriting, which helps determine what funders would accept the deal.
Her company also keeps a watchful eye on every deal’s progress. “We know exactly where the deal is, and who’s looked at it,” she said. It also helps to insist upon having a dedicated account rep, Tibbs emphasized. That way she can form a relationship that discourages backdooring.
Perhaps the most basic safeguard comes with determining that the company claiming to fund the deal really has the capital to do it and isn’t just shopping the file to real funders. Tucker advised using Internet searches to turn up evidence that the supposed funder really isn’t another ISO or broker. Searches should reveal press releases on equity rounds that direct funders have received, for example. If open-ended Web searches don’t produce satisfying results, check state registrations, he said.
ISOs and brokers can also prevent backdooring by avoiding sub-agent status, Tucker cautioned. “I don’t know why guys would want to be a broker to a broker,” who could steal commissions, he observed. One exception to the sub-agent problem comes with agents who are just entering the business and are receiving training from a broker, Tucker said. In another exception, sub-agents may find another broker has competitive advantages that aren’t easy to duplicate – like a $20,000 monthly marketing budget to generate sales leads, he continued. Or perhaps the other broker gets low base pricing from a funder that allows for reduced factor rates without sacrificing part of the commission.
Brokers and ISOs can also protect themselves from backdooring – and just in general – by maintaining their relationships with merchants, even those who’ve been denied funding from four or five sources, Zapata said. An increase in revenue or jump in credit worthiness can qualify them a few months later, and other brokers or funders may be soliciting them in the meantime, he said.
Then there’s the possibility of collective action against backdooring. An association or some other entity representing the industry could compile a database of companies accused of backdooring, Tibbs said. “Just as there’s a black list of merchants that have been red-flagged from getting merchant cash advances, there should be some type of database of funders that frequently backdoor deals – that way, ISOs know to stay away from them,” she maintained.
The database would also prompt owners and managers of direct-funding companies to crack down on employees who use nefarious tactics, Tibbs continued, because the heads of companies would want to stay off the list.
But finding the financial support and staffing for such a database might prove difficult, according to Tucker. He noted that the card brands, such as Visa and MasterCard, maintain a match list of merchants barred from accepting credit cards. But the card brands have vast resources and a keen interest in the list, he said.
Requiring funders to pay to register might discourage ISOs and brokers from posing as funders, Tibbs suggested. But that, too, would require an infrastructure and would demand financial investment, sources said.
Still, everyone interviewed agreed that the industry should police itself with regard to backdooring instead of inviting federal regulators to enter the fray. “The federal government will mess with pricing without understanding every merchant can’t get low factor rates because there’s too much risk on the deal,” Tucker warned.
Perhaps extending the protection period in funding applications would help guard ISOs and brokers, Zapata said. But he cautioned that making the time period too long could interfere with the free market.
Keeping backdooring in perspective also makes sense, Zapata said, noting that merchants often receive multiple funding offers because everyone in the industry is basing phone calls on the same Uniform Commercial Code filings regarding distressed merchants.
Is Online Lending Really Just Offline Lending?
October 19, 2015
Two weeks ago the Wall Street Journal postulated that online lending’s biggest beneficiary was the U.S. Postal Service. “In July alone, Lending Club mailed 33.9 million personal-loan offers,” it said. “The average monthly volume of personal-loan offers sent through the mail has more than doubled in two years to 156 million in the year through July from 73 million in the same period in 2013,” it added.
These figures have some people concerned that there is no network effect for these lending platforms. Last month, Timothy Puls, an equity analyst for Morningstar, said that the value of a company like Lending Club doesn’t grow just because more users are on the platform. That means a continuous stream of marketing is essential since they’ll always need to find new borrowers to sustain the business.
To illustrate how sensitive lenders are to this, OnDeck CEO Noah Breslow spoke to the increasing competitiveness of direct mail in their 2nd quarter earnings call and argued their strategy was to “break through the clutter” and “better communicate our value proposition.” Analysts on the call were concerned by that, which prompted a question by Christopher Brendler of Stifel, Nicolaus & Company during the Q&A session.
Question by: Christopher Brendler of Stifel, Nicolaus & Company
You mentioned in the direct channel about a response rate, talking about a response rate to direct mail. Can you talk about the response rate that you are seeing in that channel? It seems like from an outsider’s perspective we’ve gotten more competitive and it sounds like you’ve had a little bit of a struggle there. We just want to see if there is any color you could add on what the competitive environment is having on the direct channel.Answer by: Noah Breslow of OnDeck
I think what we are seeing really is just an intensified set of activities and you can’t really isolate it down to any single or couple of competitors but it’s sort of both in the offline direct mail channel, we are seeing increased mail volumes over where they were six months ago. And then in the online channel we are seeing increased bidding and so forth for Google Adwords and the like.
Nothing to worry about when it comes to that mail stuff though right? Google Adwords, facebook, instagram, and snapchat are where the real action comes from for online lenders, you might think.
According to Marlette Funding CEO Jeffrey Meiler, that’s not the case. In the WSJ, he admits that 90% of the billion dollars in online loans they’ve originated have come from offline channels.
And maybe that’s because the term online lender might be a red herring. Online lenders don’t only exist in cyberspace, they have offices in the real world just like banks do. And sure, they have websites, but then again so do banks. When you start to boil it down, online lenders look a lot like every other business in existence today. And while it may not be typical for a small business owner to walk into the office of an online lender to get funding, several lenders have said this happens. And for the brokers that arrange business loans, it’s pretty common for them to visit the actual businesses and meet with the owner(s). Not a very online experience…
It may be fashionable to say what separates banks from online lenders is that you have to walk into a bank to apply for a loan, but that’s often just not the case. Most banks offer loans through the form of credit cards both online and through direct mail and they’ve been doing this for decades. The only difference is now they’re competing with other lenders that don’t have local branches for the customer to walk into it, the online lenders. And maybe that’s what the difference is, being branchless could be what defines an online lender.
For now though, a heck of a lot of online lending seems to be originated offline.
Stop Saying Alternative Lending Isn’t Regulated
October 7, 2015
I cringe every time I hear someone say that alternative business lending or merchant cash advances are completely unregulated. It’s true as a generality that there are fewer restrictions on commercial transactions than there are on consumer transactions, but fewer doesn’t mean none. If you are operating your funding business with the impression that it’s all unregulated, then you’re probably doing it wrong and should hire a lawyer (or several) immediately.
Things like interest rates, truth in advertising, and the banking system are already regulated. Who can invest and what has to be disclosed in an investment is regulated. Email marketing and telemarketing are regulated. The ACH network is regulated. Credit card processors and payment networks are regulated. Credit reporting and the process of declining someone for credit is regulated.
As de-banked as merchant cash advances and non-bank loans look, they all go through the traditional banking system and still obviously operate under state and federal laws just like everyone else. That means compliance with the OCC, OFAC, FED, FCC, FTC, SEC, IRS, state regulatory bodies and more. So when critics say there are no regulations in place for these products, one has to wonder what the heck they’re talking about.
In the context of merchant cash advances, there’s a pervasive myth that the process of purchasing future assets is really all just a loophole to charge Annual Percentage Rates (APRs) in excess of state usury caps. I can’t speak on behalf of all purchase agreements in general since every financial company structures theirs differently, but in a true purchase of future assets, it is literally impossible to calculate an APR. It’s not just a matter omitting the word loan from the agreement either, it’s the uncertainty of the seller’s future sales to which the agreement ultimately hinges upon (among other factors), that make such a calculation indeterminate even if one wanted to generate one just for comparison’s sake. These are purely commercial transactions that fall under the umbrella of factoring and they have no basis for comparison with loans. Oh, and they’re not new.
According to wikipedia, “factoring’s origins lie in the financing of trade, particularly international trade. It is said that factoring originated with ancient Mesopotamian culture, with rules of factoring preserved in the Code of Hammurabi [about 4,000 years ago]. Factoring as a fact of business life was underway in England prior to 1400, and it came to America with the Pilgrims, around 1620.”
While the subtle nuances of merchant cash advances may only be a couple decades old, the system on which they’re based precedes the arrival of Jesus. That makes the concept understandably new… if you’re a Stegosaurus.
But here in modern times, the courts in many states have reviewed these agreements and generally respect the arrangements when they are well-defined and compliant with state and federal laws. There’s that regulation thing again…
For funding companies that deal in actual loans, the industry is heavily regulated. The non-bank lenders we hear about on a daily basis have to acquire state licenses where applicable or forge partnerships with chartered banks to create a relationship in which the banks themselves are the ones that actually originate the loans. That means despite the excitement and fanfare of tech-based disruption, many of these lenders are really just servicing loans made by traditional banks. Kind of a bummer, isn’t it?
And when it comes to sales tactics, it’s important to remember that deceptive advertising is already illegal.
The regulation and compliance hurdles in FinTech are cumbersome even if some of the companies involved in the business appear scrappy and amateurish. According to a report that was recently published by accounting firm KPMG, titled Value-Based Compliance: A Marketplace Lending Call to Action, they offer a non-exhaustive list of federal legislation and networks:
- Anti-Money Laundering (AML)
- Bank Secrecy Act (BSA)
- Blue Sky Laws
- Card Act (CARD)
- Dodd-Frank Wall Street Reform and Consumer Protection Act
- Electronic Funds Transfer Act (EFTA)
- Electronic Signatures in Global and National Commerce Act (ESIGN)
- Equal Credit Opportunity Act (ECOA)
- Fair and Accurate Transactions Act (FACTA)
- Fair Credit Reporting Act (FCRA)
- Fair Debt Collection Practices Act (FDCPA)
- Fair Housing Act (FHAct)
- Financial Crimes Enforcement Network (FinCEN)
- Gramm-Leach Bliley Act (GLBA)
- Know Your Customer (KYC)
- Service Member Civil Relief Act (SCRA)
- Truth in Lending Act (TILA)
- Unfair, Deceptive or Abusive Acts or Practices (UDAAP)
- USA Patriot Act
Completely unregulated you say? You are sadly mistaken. =\
What The BFS Capital IPO Announcement Means for the Industry
September 29, 2015
Under the Jumpstart Our Business Startups (JOBS) Act, “an emerging growth company may confidentially submit to the Commission a draft registration statement for confidential, non-public review by the Commission staff prior to public filing.”
According to the New Yorker, this process “allows companies that are thinking about going public to test the waters—they can gauge investor reaction, get feedback from the S.E.C. on their filings, and so on—before deciding if they want to go ahead with an I.P.O. If a company goes through that process publicly, and then decides to abandon the offering, its reputation gets damaged, even though it often makes sense for a company not to go public. Do it privately, and no one gets hurt.”
That’s what makes BFS Capital’s announcement (formerly Business Financial Services) that they had filed a confidential draft registration so bold. Companies normally choose this method if they don’t want anyone to know what they’re up to. But BFS is a different funder than the ones that came before them. OnDeck submitted their original draft registration confidentially for example and actually tried to keep it a secret.
“The initial public offering is expected to commence after the SEC completes its review process, subject to market and other conditions,” states BFS’s September 25th release.
The intent to go public follows a recent rebrand and the announcement that they had crossed $1 billion in funding since inception.
The most shocking part about a BFS IPO is that it’s not a CAN Capital IPO. While CAN is both older and larger, the industry has heard no word about a CAN Capital IPO since rumors leaked in Bloomberg almost an entire year ago. Back on November 20th, 2014, it was reported that the “New York-based company could be worth as much as $2 billion in the share sale.”
There was kind of a universal expectation that CAN Capital would go public immediately after OnDeck and Lending Club. Some insiders have pointed to OnDeck’s disappointing reception and performance as the reason CAN has delayed moving forward. OnDeck is currently trading at less than 50% of its IPO price and is facing a lawsuit from its own shareholders over it.
Others have said that CAN Capital isn’t waiting for anything because the company doesn’t actually need to go public. Long reported to be profitable and self-sustaining, opening themselves up to the volatility and fickleness of the public markets may not be worth the additional capital.
And still more have pondered if CAN Capital has what it takes to excite investors. Unlike some of the brand new tech startups that dominate the headlines, CAN has been operating since 1998, a time when only 42.1% of American households had computers and only 26.2% had Internet access. Of course the company has evolved and these days is as tech-equipped as their young brethren but a 17-year old lender may not be as easy to sell in a market obsessed with companies such as Uber, Snapchat and Airbnb.
BFS Capital was founded 13 years ago in 2002 so they’re not exactly new either. And their CEO, Marc Glazer, has led the company since its beginning.
BFS has been expanding however both here in the U.S. and abroad. In the U.K., they operate under the name Boost Capital. Meanwhile, independent financial brokerage firms such as Entrust Merchant Solutions are being acquired and rolled up into their organization.
What makes BFS different from OnDeck and Lending Club is that BFS also does merchant cash advances, not just loans. The only other publicly traded company that is significantly involved in merchant cash advances is Enova International and that’s only due to their recent acquisition of The Business Backer. The investor uncertainty surrounding lenders and marketplace platforms might not carry over to a company that got its start by purchasing future credit card processing receivables 13 years ago.
It would be safe to say that there’s a whole group of industry insiders who feel that Lending Club is a poor representative sample of the tech-enabled business financing space and that OnDeck’s unique model prejudices investors into thinking all lenders are like them. A BFS Capital IPO could in effect set the record straight for the industry and revive the IPO plans of their peers and competitors.
It might actually take a BFS IPO for us to finally see a CAN IPO, not that there aren’t plenty of other quality candidates right behind them.
What would a BFS Capital IPO mean for the industry? Perhaps a chance at redemption. There’s a lot of great things happening in this industry and investors ought to know about them.
Yellowstone Capital to Drive Job Growth in New Jersey
September 11, 2015
According to Business Facilities Magazine (BF), NYC-based Yellowstone Capital is considering a move to Jersey City and was approved for up to $3.3 million in Grow NJ tax credits over 10 years.
Grow NJ is a New Jersey job creation program that is designed to give the state a competitive economic edge against surrounding states.
BF says that Yellowstone Capital would create 45 jobs.
The move would loosen the grip that Manhattan’s financial district has on the fast growing alternative business financing industry. Currently located at 160 Pearl Street, just steps away from Wall Street, Yellowstone surprised many industry insiders several months ago when their lifetime funding figures of $1.1 billion were published on the industry’s leaderboard.
A move to the Garden State would not be surprising in the midst of all the infrastructural improvements the company has made in 2015.
Stock Slump Makes Marketplace Lending Look Like Safe Haven
September 2, 2015
The premium might be gone in peer-to-peer lending, but a step forward is definitely still better than three steps back. Probably the most frustrating thing for long term investors in the stock market is the day-to-day volatility. Some of it’s rational, and some of it’s just, well, who knows…. it’s the stock market.
It’s a hopeless feeling to see your stock portfolio balance drop substantially all because something is happening in China. But if you’ve diversified your overall investment portfolio beyond just stocks, it’s not all bad right now. It’s actually a bit of a golden era.
On Lending Club, my portfolio’s Adjusted Net Annualized Return is 8%. On Prosper, my Annualized Return is 11%, though that portfolio is younger and smaller. And then there’s my merchant cash advance portfolio which is beating both of those by a long shot.
These investments are a wonderful balance to the stock market because they don’t care what’s happening in China either. It’s times like these though when you need to be patient and not overreact. The easy mistake to make right now is to substantially reallocate your portfolio so that the majority of your capital is in marketplace loans.
LendingMemo’s Simon Cunningham believes that having 20% of your portfolio in peer-to-peer lending investments is reasonable.
And Lend Academy founder Peter Renton told Equities.com last year that, “The official word from the platforms is that you should not invest more than 10 percent of your net worth.” He also went on to say that some people are putting half their life savings into this and that it’s probably not a good idea.
And he’s right. As volatile as stocks can be, your steep loss today can be erased by a rally tomorrow. With notes backed by the performance of loans, a loss today can’t just rally back tomorrow. When the loans go bad, the money is gone and thus the risk of loss is a little bit more permanent since you can’t just ride it out.
In that same interview, Renton said, “If there were another 2008 or 2009 now, I feel very confident that my returns would remain positive. I’m earning close to 12 percent right now. If there were another 2008-9 right now, I might go down to 6 percent.”
I think that’s probably a best case scenario in a worst case scenario. Everyone should plan for events or contingencies that will lead to losses. If there were no possible outcomes that could lead to losses, then the market has obviously mispriced the loans and I don’t believe that has happened.
One nightmare scenario to consider for example, is if the loans are invalidated by a court. Oddly enough, this very possibility is being discussed after the outcome of the Madden v. Midland ruling which hurt the reliance on chartered banks to originate loans. Lending Club’s CEO answered concerns over that by saying they were protected by their choice of law provision, a safeguard that just recently proved to be imperfect.
As Patrick Siegfried, Esq, wrote, “Last Thursday, the Attorney General of North Carolina was granted an injunction against Western Sky Financial and CashCall prohibiting them from offering any loans to North Carolina consumers or collecting on any outstanding accounts in that state.” The companies pointed to their choice of law provisions that supposedly made the rates permissible. This practice is actually commonplace for alternative lenders. But Siegfried said, “Because the Attorney General was not a party to the agreements, the court found that the Attorney General was not bound by the agreements’ choice of law. Therefore it could enforce North Carolina’s usury laws against the defendants.”
Now however remote the possibility of judicial or regulatory invalidation of loans, it is sobering possibilities like these that should prevent anyone from putting half their life savings into marketplace lending. It is a nice complement to a portfolio of stocks, but not a replacement for one.
Over the last week, my marketplace lending portfolios have been a bright spot and a source of optimism in a news cycle and market that has suddenly turned bearish. I’m tempted to reallocate my investments accordingly, but I’m not going to.
Hopefully you won’t make any impulsive maneuvers either…
Alternative Lending Becoming Less Alternative
August 23, 2015
Alternative funders are looking a little more like bankers these days, but that’s not to say they’re developing a taste for pinstriped three-piece suits and pocket watches on gold chains. They’re promoting bank loans, applying for California lending licenses and contemplating the unlikely possibility that one day they’ll obtain their own bank charters.
“It’s what everybody’s talking about,” said Isaac Stern, CEO of Yellowstone Capital LLC, a New York- based funder. “If it’s not in their current plans, it’s in their longer-term plans over the next three to five years.”
Funders promote bank loans to drive down the cost of capital, sell a wider variety of products, offer longer terms and bask in the prestige of a bank’s approval, said Jared Weitz, CEO of United Capital Source.
Loans allow for much more customization than is possible with merchant cash advances, noted Glenn Goldman, CEO of Credibly, which was called RetailCapital until a little less than a year ago. The name changed as the company began offering loans in addition to it original advance business. It’s now working with three banks.
While the terms don’t vary much with advances, borrowers can pay back loans daily, weekly, semi-monthly or monthly, Goldman said. Loans can also include lines of credit that borrowers draw down only when they choose. Interest rates on loans can vary, too, he said, and loans can come due after differing periods of time.
Besides that flexibility, loans also offer familiarity among merchants and sales partners – unlike the sometimes baffling advances, Goldman said, adding that “everybody knows what a loan is, right?”
Loans have so many advantages over advances that Credibly expects its loan business to grow more quickly than its advance business, said Goldman, who was formerly CEO of CAN Capital.
Those advantages are also encouraging other advance companies to form partnerships with banks to provide merchants with loans that aren’t subject to state commercial usury laws, said Robert Cook, a partner at Hudson Cook LLC, a Hanover, Md.-based financial services law firm.
The advance company markets the loan to the customer, the bank makes the loan, and the advance company buys it back and services it at the rate the bank is allowed under federal law, Cook said. The bank doesn’t lose any capital, it takes on virtually no risk and it profits by collecting a few days’ interest or a fee, he noted.
Where the bank’s located can make a big difference. A bank based in New York, for example, can charge only 25 percent interest no matter where the customer resides, while New Jersey allows banks to collect unlimited interest anywhere in the country, Cook said.
But the partnerships funders are forming with banks could face a threat. The United States Court of Appeals for the Second Circuit ruled in May in Madden v. Midland Funding LLC that a non-bank that buys a loan cannot charge interest set where the bank is located but must instead charge interest according to the laws of the state where the consumer is located, Cook noted. That could mean a lower rate.
In Cook’s view the case was poorly argued, the decision was wrong and the ruling may be reversed, “but it has to trouble someone who is thinking about starting up a bank partnership,” he said.
The court was asked whether the rules that apply to a national bank also apply to the non-bank that bought the loan, Cook maintained. That’s not the question, he asserted. The argument should have been that the idea of “valid when made” should take precedence. It states that a transaction that’s not usurious when it’s made doesn’t become usurious if a party takes action later – like reassigning the note, Cook said.
Meanwhile, offering bank loans isn’t the only way alternative funders are coming to resemble banks. Some are obtaining what’s formally called a California Finance Lenders License that enables them to make loans in that state.
California began requiring the license in response to lawsuits over the cost of advances. The state has published a licensee rulebook that’s about the size of an old-school New York phone book – the kind kids sat on to reach the dining room table, according to Yellowstone’s Stern, who completed the licensing process three years ago.
Getting the license took 15 or 16 months and required lots of help from the legal team at Hudson Cook, Stern said. The state investigated his back- ground and fingerprinted him. The cost, including lawyers’ fees came to about $60,000, he recalled.
“Man, it was like pulling teeth to get that license,” Stern said. Keeping it’s not easy, either. “We guard that thing fiercely,” he maintained. “They’ll take away your license if you even sneeze the wrong way.”
The hassles have paid off, though, because Yellowstone now deals directly with California customers instead of sharing the profits with other companies licensed to operate there. What’s more, companies that don’t have licenses are sending business Yellowstone’s way.
Retaining the profits from loans is also prompting some funders to contemplate applying for their own bank charters. But Cook, the attorney from Hudson Cook, sees little or no chance of that happening.
Federal bank regulators are reluctant to grant charters to mono-line banks – institutions that perform only one financial-services function, Cook said. “It’s risky to put all your eggs into one basket,” he maintained.
Regulations make forming or acquiring a bank so difficult for businesses that want to make small loans at high rates, Cook said. “If that’s going to be their business plan, they’re not going to get a bank.” A state charter requires the approval of the Federal Deposit Insurance Corp., which isn’t likely, he noted.
Utah industrial banks and Utah industrial loan companies are insured by the Federal Deposit Insurance Corp. but aren’t considered bank holding companies, Cook said. However, that’s a regulatory loophole that may have closed and thus may no longer offer a way of becoming a bank, he noted.
Clearly, the complications surrounding bank loans, lending licenses and bank charters mean that becoming more bank-like requires more than a pinstriped suit.
