A frequent topic of conversation I’ve been sharing with commercial lenders over the past year has been the emergence of private investor-led companies that are competing with banks for small business loans. Hopefully you’ve read some of the several stories offered here about them, ranging from the broad list of this category:
- Merchant cash advance companies, such as CAN Capital, who recently crossed over $4 billion in total funding, a billion of which was funded in about 15 months;
- Business lending companies, such as OnDeck Capital and IOUCentral, who transact with customers strictly online;
- Intermediaries, such as Boefly, Lendio and Fundwell, who connect borrowers to select lenders based on pre-determined screening;
- Peer-to-peer lenders, such as LendingClub, whose volume of facilitated loans recently hit the $5 billion benchmark and have steered into business lending.
Some of these companies represent threats to market share of commercial banks, although what they are taking away today is limited to smaller credits that would mostly be funded by credit cards. That could change in the months ahead.
Some of these companies also represent opportunities for small business lenders to partner with companies with innovative technology, data and market reach.
I remind you about this sector today because there’s a new conference organized to inform interested parties about the innovative funding sector and provide a full range of discussion about what you need to know. It targets bankers and is intended to bring the up to speed about the technology, innovations and new ideas that has diverted about $100 billion of capital financing away from them.
Interested? The event is AltLend: Innovative Finance for Small Business. It’s in Las Vegas, September 23-24, and offers perhaps the most comprehensive opportunity to date to learn about the largest competitor looming on the horizon of commercial lenders.
In the last two week, innovative business loan sourcing company Lendio.com has demonstrated how technology can make them a commercial banker’s best friends to increase deal productivity, and at the same time fill that capacity with an even greater deal flow. They are working both ends of the supply and demand equation.
On July 9, Lendio announced that they were making their business loan prospect management tool, called PipelineTM, available to banks for free. Lendio works with thousands of banks to match up business owners seeking financing. Loan applicants provide an application profile that gets screened for specific lender search demographics.
PipelineTM helps smaller banks who are transitioning into more digitized process to take advantage of better information management and client contact, which will help loan officers ultimately close more deals.
Then on July 16, Lendio announced that they were opening access to their lending networks to other loan brokers around the country. Essentially, these additional referrals will accelerate their own deal origination traffic. Lendio hopes to peel the attention of these broker’s from dozens of other online business lenders and merchant cash advance funders.
When brokers take deals directly to a lender, their deal is in the hands of a single decision-maker, but by working through Lendio, the broker can get access to more lenders simultaneously so to leverage their time and deal approval success.
What does this mean for SBA lenders? Lendio manages to see a fair amount of transactions that are ripe for SBA loan products. Their profile culls information from business owners to sort them according to likely qualification and the likely lending product that will meet their needs.
Of course you have to be registered with Lendio to access their loan referrals, and if not, guess you better start dialing that phone on your desk.
Access to capital, especially access by small privately held companies, is a component business of growth. According to Pepperdine University’s 2014 Capital Markets Report, while nearly 89% of business owners report having the enthusiasm to execute growth strategies, only 46% report having the necessary capital resources to successfully execute them.
Among the smallest businesses (those with less than $5 million in revenue) that sought bank loans in the previous three months, only 39% in the same study reported they were successful in securing a loan. It is also quite common for these small company owners to be turned down for loans and not know exactly the reasons why.
The Pepperdine’s study cited the top ten reasons lenders rejected business loan application. Weak economy? Bad credit? Poor management? Nope, none of those reasons even made the top five. In fact, seven of the top ten reasons combined only accounted for 40 percent of the failed loans. See graph below.
Number one? It was the “quality” of the applicant’s earnings or cash flow. Cash flow quality refers to the source and sustainability of operating cash. There’s a difference between cash generated from profitable sales and other cash coming from non-recurring sources like the sale of assets.
The quality can also be measured by the obvious tightness of a company’s cash position, which may be exposed by late payments to vendors or other lenders. This reason was cited by almost 30 percent of reporting business owners.
Number two? Twenty-three percent of failed applications cited insufficient collateral as the reason for loan declination, and 13 percent failed due to an existing heavy debt load.
Newtek Business Services, Inc. announce Wednesday that its lending subsidiary, Newtek Small Business Finance, has approved over $1.0 billion in loans since 2003. Who is Newtek? They were the 12th largest producer ($) of SBA loans in FY 2013, who has been quietly climbing the ranks since 2010.
Barry Sloane, Chairman, President and Chief Executive Officer commented, “We are extremely proud to have approved over $1.0 billion SBA 7(a) loans. Over the past 11 years, we have systematically built our lending platform with strict adherence to our stringent underwriting guidelines, intense focus on the credit quality of our loans and our signature top-notch customer service. This winning formula has enabled us to withstand multiple lending cycles and emerge as the largest non-bank lender in the U.S.
While plenty of other SBA lenders have achieved (and busted) the $1 billion benchmark before, Newtek sets itself apart through an alternative history and alternative strategy. For starters, the company was organized only in 1998. They entered SBA lending as an expansion to operations as they geared up into many other business lines to offer clients a one-stop shop form many services.
In addition to lending, Newtek offers more value to its clients, as a payroll service provider, merchant processor, website service provider, insurance, ecommerce services and even cloud storage.
To have climbed up to the $1 billion watermark in only 11 years is an admirable accomplishment, particularly since that included the five years since 2009, a more challenging time for SBA lending. They’ve climbed steadily in the ranks from #46 in FY 2008 ($49 million) to #21 in FY 2011 ($130 million) to #12 last year with $199 million of production. More than half their SBA lending volume has been booked since 2009.
Congratulations to Barry Sloane and Newtek.
In 2013, CAN Capital funded nearly $1 billion through their merchant cash advances, a crowning feat after spending 10 years to distribute $1 billion, 3 years to distribute the second $ billion, and 2 years to fund their third $ billion. But that rate of growth has now been eclipsed.
Lending Club, announced this week that it has facilitated over $5 billion dollars in consumer and business loans since inception, $1 billion of which was facilitated just in the last quarter ending June 30, 2014.
“This milestone brings us another step closer to our goal of transforming the banking system, one billion at a time,” said Lending Club founder and CEO Renaud Laplanche. “We believe we can make the system more cost-efficient, more transparent and more customer friendly, and are committed to offering cost efficient products that help people achieve their financial goals.”
Lending Club is a peer-to-peer lending platform that facilitates people seeking credit to get their request in front of other persons seeking to invest in these kinds of consumer and business loans. Lending Club evaluates each application and grades it, which provides the investor with an indication of risk and determines the ultimate loan pricing.
Commercial lenders might think they must deal with too much paperwork, but non-bank loans are actually recognized as a security in the eyes of the Securities & Exchange Commission (SEC). That means that a registration filing must be submitted by Lending Club to them for each and every loan. Their average loan size is just shy of $14,000, meaning that in the second quarter alone, they filed over 71,400 security registration notices with the SEC.
The average investor participation of each investor on these loans was not readily found on their website, but Lending Club’s online investment discussions encourages investors to diversity their portfolios. As an example, this information cited the example of spreading a $5,000 investment over 200 loans with $25 each.
More than 150 years after the Emancipation Proclamation and 169 years since annexation of Texas, business lenders still discriminate against African American and Hispanic business owners. In last Wednesday’s AdviceOnLoan, I wrote about how racial discrimination continues to plague business lending, costing lenders precious deal flow and potential clients their entrepreneurial aspirations.
Lending is about using capital to make more capital. Letting blind prejudices or blatant discord interfere with your mission to distribute capital to qualified borrowers, which also means you aren’t doing your job. Worse, when purposeful, it’s against the law.
And let’s be honest – I’m aiming these remarks at friends who share my Caucasian ethnicity. Living in Atlanta, whose history is littered with predatory treatment of others from non-white races going back to the Creek and Cherokee Indians, you encounter a lot of conversation about race. It’s complicated to be sure, but it’s also easy to address head-on, particular when performing your job.
What do we do to correct these conditions? As promised last week, here’s a few suggestions that can be a good starting point for most readers:
1. Admit there’s a problem. Lending discrimination is documented across all lines of lending from home mortgages, auto financing, credit cards and even SBA loans. The disparaging statistics haven’t changed much since the 1990s, despite a generation of new lenders and pointed efforts by FNMA, GNMA, SBA and others to reach out to these communities. SBA’s impact is limited because they don’t make or buy loans.
2. Be the change. Purposely seek to bridge these gaps – or opportunities – by cold calling your way into introductions, coffee meetings and lunches with minority real estate brokers, CPAs, attorneys and the other kinds of professionals where you seek out relationships that yield referrals and offer services. Be serious and start a dialogue about how you can help their clients.
3. Staff up. If you’re a manager, introduce some diversity into your business development team by hiring people who are part of these minority communities where you need connections to new business. These new hires can also serve as an ambassador to introduce your staff to someone unlike themselves, to start getting better acquainted with a larger world out there.
Based on the remarks about this topic made recently by SBA Administrator Maria Contreras-Sweet, Orson Aguilar contributed some thoughtful remarks in the American Banker that can supplement my list.
There’s plenty more to say on this topic, but I’d like to hear your thoughts, below or through email at Director@SBFI.org.
Now get out there and do the right thing.
According to Washington Post’s J.D. Harrison, new academic research reveals that minority entrepreneurs are treated significantly worse than their white counterparts when seeking financing for a small business. The study asserts that these conclusions are true even when all other variables — their credentials, their companies, even their clothes — are identical.
Conducted by Utah State University, Brigham Young University and Rutgers University, the study featured nine businessmen—three white, three black, and three Hispanic. Similar in size and stature, donning the same outfits, and armed with similar education levels and financial profiles, they visited numerous banks seeking a roughly $60,000 loan to expand the very same business.
Once inside the bank, their experiences were not so similar. The Hispanic and black business owners were provided far less information about loan terms, offered less application help by loan officers, less frequently handed a business card, and asked more questions about their personal finances.
One question they weren’t asked as frequently? Their name.
An SBA Office of Advocacy report found that Hispanic and black entrepreneurs tend to start companies with less money than white entrepreneurs, and rely more heavily on their personal wealth than on outside lenders or investors.
Meanwhile, when they do seek bank financing, they are less likely to be approved than whites, even when controlling for factors like credit history and business type, the study found.
If they are approved, the differences don’t end there. Two years ago the Federal Reserve released data showing that minority business owners pay interest rates on average 32 percent higher than what their white counterparts pay.
Discrimination-whether unconscious or inherent-remains a significant problem in business lending as well as a barrier for economic growth. What should business lenders do to take this problem head-on?
Read this column next Wednesday morning for some suggestions of how to address this persistent, gnawing problem that holds back loan growth for banks and economic vitality for thousands of entrepreneurs.
How do you read or interpret a FICO score? Most banks make a minimum credit score part of the check list of metrics included in their loan approval standards and possibly credit grading, but do you ever take a closer look behind what that score really means? You should.
New York Times’ Gretchen Morgenson wrote a good article about some of the costs consumers (read that “business owners”) incur through faulty FICO scores that are published with impunity by the three major credit agencies. Besides higher interest rates and denied credit, inaccurate reports cost precious time for consumers to track down mistakes they didn’t make and convince a bureaucratic, automated and unconcerned credit reporting agency to correct it. That can take years.
An FTC study of consumer credit reports found at least five percent of all reports contained errors. Of the consumers that disputed their report with the bureaus, only 80 percent received a modified report and only 10 percent saw their score improve. But five percent of those score changes were for +25 points and some more than +100 points.
Why should business lenders care?
Blindly accepting FICO at face value to judge business loan applicants is a long term mistake, chiefly because the score was developed for mortgage lending. Most lenders misunderstand what the report conclusions really mean. Did you know only 35 percent of the score composition was determined by debt repayment? Did you know many borrowers improve their FICO score by getting another credit card or borrowing even more money?
Arguably the FICO Small Business Scoring improves business lender information, but we don’t know how much of that score is based on the basic FICO. Judging applicants too quickly based solely on their FICO score likely costs your bank business it would rather fund.
That said, SBA’s adoption of a scoring model for very small loans less than $350,000 is still a good idea to me, because generally it allows the lending process to scale this market sector, at least so far as those who’ve cleared FICO unscathed. And SBA’s minimum score is fairly low, perhaps taking into account the faulty metrics that many recognize with FICO.
Either way, SBA lenders should take the time to figure out what’s behind bad FICO scores and assure themselves correctly as to whether it’s a bad risk or a bad report.
The Financial Services and General Government Subcommittee of the U.S. Senate Appropriations Committee put forth an encouraging markup bill yesterday appropriating a lower overall SBA budget ($896 million with higher authorizations for both the 7(a) program ($19 billion) and 504 program ($7.5 billion) for fiscal year 2015. The government’s budget year is from October 1 through September 30.
This level of 7(a) funding seems to provide sufficient room for growth next year, which is consistent with the trajectory achieved year to date in FY 2014, where after a sluggish start, the program seems to be heading to reach its total appropriation of $17.5 billion by year end.
The 7(a) program got off to a slow start in FY 2014 start thanks to the government shutdown which shuttered the SBA for the first 17 days. Restoring the authorization to $19 billion would enable it to expand fully in the range of its record year in FY 2011, when more than $19.6 billion loans were approved.
More encouraging though maybe the $7.5 billion authorization included for the 504 program. That program is in disarray at the moment with flagging loan demand, Congressional gridlock on the question of reinstituting the 504 refinance authority and even a high profile change of command at NADCO, the 504 industry trade association.
The need for a significantly higher authorization isn’t reflected in current program usage, which is visibly slipping from FY 2013. There had only been about $2.6 billion loan approved through May 30th.
Apparently the appropriators are anticipating a recharged 504 program in FY 2015 led by restoration of the ability to refinance commercial mortgages. The effort toward 504 refinancing has been stuck in the House of Representatives for more than a year.
It’s a long way from a markup bill to the president’s signature, but this bill is a good starting point for SBA financing programs for 2015.
Thanks to a timely series of articles by Forbes.com, whose aired a list of the best and worst ten franchise companies in each of three distinct categories, based on the initial investment required to get into business.
Why is that timely? Because in a few weeks I’ll be presenting a webinar for business lenders on how to underwrite loans for franchise businesses. Check it out and register by clicking on Coleman Report.
In a good article by Tom Post, the business case for franchising is easy to discern.
Franchising has made an extraordinary impact on small business ownership in the U.S. According to a IHS Global Insight report prepared for the International Franchise Association, this year an estimated 770,000 franchise establishments will employ 8.5 million Americans and create $840 billion in output. And that sum is about 3.5% of the total U.S. GDP.
Franchising is a vital part of the American entrepreneurial landscape. In collaboration with FRANdata, Forbes created the first-ever critical list of the best and worst franchise companies in each of three cost categories: Up to $150,000, $150,001 to $500,000 and over $500,000.
FRANdata created the evaluation methodology that’s fully described in an accompanying article. Written by Peter Schwarzer, their director of research, it’s a thorough process they’ve employed to ensure that this project is not just another sales volume ranking, total unit count domination or other kind of ‘beauty contest.’ Read more about how this ranking was determined here.
So who makes the cut (or gets cut)? You can read a detailed profile about one best and most recommended franchises (#2) “Right at Home” by clicking on the link.
See a graph listing the 10 Best Franchises in each category below.
Likewise, check out a profile of one of the worst (#4), Curves, which has already drawn plenty of attention from disgruntled small business owners and their SBA lenders.
See a graph listing the 10 Worst Franchises in each category below.
If want a detailed listing of all of the worst franchises, check out a website called “Unhappy Franchisees,” where they’ve been invited to post a response. All 30 names are named there.
If your bank lends to franchise companies, all of these articles will make worthwhile reading, even if you aren’t lending to these specific companies. Learning about how many franchises do very well while others do very poorly can be instructive about how business lenders might react to future requests for funding.
Graph listing the 10 Best Franchises according to Forbes.com
Graph listing the 10 Worst Franchises according to Forbes.com