Greek Tragedy-Lesson for Lenders Everywhere

By Charles H. Green

Today Greek citizens will be voting in a national referendum on whether to accept the final terms offered by the Troika–the International Monetary Fund (IMF), European Union, and EU Central Bank–to rework the financial bailout that has been a European obsession for most of the past five years. A restart was required due to the inability of the nation to meet schedule debt payments on June 30, and has been in negotiation for the past six months.

The outcome of this vote is pivotal, and may very determine who will govern this nation Greek flagand whether it will continue to be a part of the European Union in the years ahead.

When the original terms of the Greek bailout were established in 2010, austere fiscal terms were imposed that curtailed the government’s spending, rolled back public pensions and raised taxes. During the financial problems roiling Europe in the wake of the global financial crisis, a short-sighted obsession of many government officials called for severe public spending cuts along with immediate debt retirement, that continues to be felt across the continent in a form of a prolonged recession in many economies, and lackluster performance in the few growing economies.

The Greeks have suffered mightily under the terms of austerity. The results? Since 2008, Greece’s gross domestic product has shrunk more than 20 percent, and unemployment stands today at more than 25 percent. Greece’s debt totals about 175 percent as a percentage of GDP and still trending upward. One other outcome was that in January, the population threw out their government and elected a radical coalition who ran on the pledge that “enough is enough,’ and promised to end the austerity measures that promised to punish Greece for years to come.

When the topic of the Greek crisis is raised in many quarters globally, invariably someone chimes in about the “corruption, checkered tax system and irresponsible spending,” which led to the crisis in the first place, right? So how does that explain Spain? Or Ireland? Or Finland? Yep, all of those economies are in the doldrums even without a debt crisis, and one wonders why.

Lenders sometimes get better outcomes by taking losses earlier

The reasons are many, but needless to say that all are missing an important monetary tool which could contribute to the restoration of a healthier economy: local currency. By binding 19 nations together under a common currency without the fiscal tools needed to provide for responsible management of the common economy was a recipe for this kind of crisis. Ah, but that’s all history, so the best plan today is to recognize the shortfalls and work to correct some of the imbalances baked into the original blueprints.

In the current system, too many nations continue to act in their own best interest rather than watching out for the larger picture. Germany’s Angela Merkel and the Bundestag (German parliament) have been the leading antagonists in this Greek tragedy, and coincidently, It’s the German banks holding the most exposure to the Greek debt. The obvious question might to ask, why did they approve loans totaling about $43,000 per capita to a nation so well known for “corruption, checkered tax system and irresponsible spending.”

The answer to that question is a zero-sum game–they are where they are, and after five year’s of choking the Greek economy, have only made the probable default more ominous, rather than getting closer to resolution.

What is the solution? Recognize a losing hand and change your tactics to winning as much of the remaining pot as possible.

The idea of coming out whole on bad loans–driven by legitimate, indisputable facts and obligations–sometimes will not happen for an endless list of reasons. That’s the risk of the business we’re in. But sometimes lenders take it upon themselves to elevate a loan default to some kind of morality play, and they–having been the ‘god’ that granted loan approval–suddenly assume the righteous position of meting out eternal punishment.

That’s an emotional and generally pointless position that more often than not, accelerates and deepens loan losses, rather than leading to full recovery.

In Europe, loosening the noose around the Greek gevernment’s neck would help expand their economy, which in turn would produce more tax revenues, and alas, provide assurance that they will have the means to payback their debt obligations. Recognition that a portion of this debt is ultimately uncollectible and writing it down now, would lower the interest burden on Greece and accelerate how fast lender recovered the remaining balance.

Lenders everywhere might take notice of this scenario and watch how it plays out–it’s likely that a similar situation is lurking in your portfolio as well.

How does the Greek citizenry feel about this situation? We’ll likely get a pretty good idea tonight after the votes are counted, but needless to say, no one is happy about the situation. Whatever the outcome of the current crisis, it will be they who bear the burden of either several more years of an onerous economy laden with steep debt payments, or devaluation of their economy by a return to the Drachma, if the threatened expulsion from the Eurozone is effected.

The real tragedy is that most of the pain could be avoided if some parties honestly assessed the reality, and worked to recover what’s possible, rather than take down everyone and wind up with less.

What do you think? Comment on this page or write me at Director@SBFI.org.

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Celebrate America (But Get the History Straight)

By Charles H. Green

Happy birthday, America. Our nation was formed by virtue of the written declaration of the 2nd Continental Congress, which was comprised of representatives of the thirteen colonies, and on this day in 1776, started an extraordinary experiment in governance that is 239 years old and counting. No other government has held as long.

But to be sure, recognize that our own United States had a rather cantankerous beginning

'American Flag,; Eric Legge, 1999

‘American Flag,; Eric Legge, 1999

that many choose to ignore when raising the patriots, revolution or Constitution to defend their present day point of view. I believe that history–real history–matters and that more people should get their facts straight. Too many loyal Americans today can’t even identify their own two U.S. Senators

So what are we celebrating when we give adage to the ‘Fourth of July?’ Technically, I guess we celebrate the Declaration of Independence, signed on this day, but to be sure, the ‘what,’ ‘who,’ and ‘how’ of our independence were far from settled on that day. Essentially, we had only openly declared war on the mightiest nation on earth, Great Britain, and set ourselves apart from them as a sovereign nation on the faith of receiving adequate financing and military support from their arch enemy, France.

Lost to many is the fact that only a year before the signing of the declaration, during the ‘First Continental Congress,’ of the twelve colonies represented, two vocally disapproved of the idea of abandoning the Crown, and the remaining ten were evenly split between achieving legislative equality with Britain or full independence.

Confederation vs. federal government

What is sure is that from the beginning of the nation in 1776, it took nearly five years for the colonies–rebranded ‘states’ by then–to agree on a federal governing body of laws, the Articles of Confederation,’ and they became effective only six months before the end of the revolution.

It took another six years for the states to finally agree that a stronger federal government was really called for and to decide to write a Constitution, which was finally adopted toward the end of 1788.That Constitution went into effect March 4, 1789 when the first Congress opened, and remains with us today with a relative few amendments.

In our current media, we hear many talking heads (who often are untrained by way of law) squawk with a high degree of certainty about our Constitution, what it says and what it really means. Given the number of times in our history when the Supreme Court of the land has changed their view of what is ‘constitutional’ or not, I think I’d park my certainty at the door before elevating myself to being such an intuitive scholar.

Commercial lenders can appreciate a couple of financial details about the new nation–the first ‘Superintendent  of Finance (today known as the Secretary of Treasury) was Robert Morris, who was honored in the naming of “Robert Morris Club.”  The club was an association formed in 1914 to facilitate the exchange of credit information, and was later known as “Robert Morris Associates,” and in 2000 became the Risk Management Association.

One interesting omission of the Continental Congress was that, although granted the authority to borrow money to fight the war, it was not granted authority to impose taxes or import duties with which to repay the debts. This topic became quite contentious throughout the life of the Congress and was not resolved before the new Constitution was adopted.

Alexander Hamilton, the first Secretary of the Treasury, finally convinced Congress that the federal government should assume the war debt of several states, and set about an orderly plan to repay them. On January 1, 1791, the United States was indebted $75,463,476, of which $18.3 had been assumed from the states.

What are we arguing about today?   

So you think there is too much government bureaucracy today? Between 1775-1789, the Continental Congress created 3,294 committees! More than three-quarters of them only had three members, but still, that meant they created nearly 19 committees each month. If you’re thinking we still have that many federal committees, think again and count the real list.

Needless to say, the disagreements continue to this day over virtually every topic in government imaginable, including an ongoing battle over the original division of federal powers vs. states’ rights.

I think it’s fair to say that our conservative countrymen favor the world as it used to be (or how they perceived it used to be), and as ‘Republicans,’ instinctively seek governance in accordance with the ‘rule of law.’

Our liberal–or progressive–countrymen are more inclined to favor their view of the world as it should be, and as ‘Democrats,’ instinctively seek governance in accordance with the majority rules.

Wherever you sit, I believe it’s important to note what may be the essence of our Constitution and national identity: You are entitled to express your dissent about anything, but you must respect the rule of the majority about everything.

America ain’t perfect, but a better system hasn’t been found anywhere else yet. And that’s worth celebrating.

What do you think? Comment on this page or write me at Director@SBFI.org.

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Credit Unions to Expand Business Lending

By Ravinder Kapur

Proposed changes by the National Credit Union Administration (NCUA) will allow credit unions to increase lending to business by doing away with the requirement for borrowers to personally guarantee repayments and also by removing the current stipulation that loan value cannot exceed 80% of the collateral security offered against the loan. An article in the American Banker reports that the proposal is a draft and the NCUA will accept comments for 60 days before preparing a final version.

Currently, if a credit union wants to waive the personal guarantee requirement for making NCUAa loan, it has to take permission from the NCUA. Approval is also required if the loan amount exceeds certain caps. Despite these restrictions, business lending by credit unions has increased sharply over the last decade and seen a near fourfold increase to reach a level of $51.7 billion by 2014.

The changes will seek to further boost business lending by credit unions by increasing the amount that can be loaned to a single borrower and also by removing the limit on an institution’s lending towards construction and development activities. However, the statutory limit for business lending of 12.5% of the credit union’s total assets would remain in effect.

Jim Nussle, president and chief executive of the Credit Union National Association, has said that there is a need to address the statutory cap issue as more than 1,000 credit unions are at or near this limit. In March, Representatives Ed Royce (R-CA) and Gregory Meeks (D-NY), introduced the Credit Union Small Business Jobs Creation Act in Congress., which seeks to lift the cap on business lending by credit unions to 27.5% of total assets. Another bill, the Credit Union Residential Loan Parity Act, seeks to exempt loans secured by non-owner occupied one to four-family houses from counting against the cap.

These bills have been opposed by the American Bankers Association, who have written to the House Appropriations Committee stating, “Banks are taxed while credit unions are tax subsidized. This critical distinction should guide all consideration of credit union powers expansion initiatives.”

The spread and reach of credit unions gives them an immense advantage. If they have greater flexibility in their lending norms and are able to make quicker decisions, they can rapidly expand their share of the business lending market. Of course, there would be a need to closely monitor borrower defaults.

The NCUA reported that since 2010, poorly managed business lending contributed to at least five credit union failures, costing its share insurance fund $141 million. Larry Fazio, director of the NCUA’s office of examination and insurance said about the proposed changes, “They will change the conversation so examinations can focus on the people, policies and systems needed to do business lending safely.”

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Investors are Funding SME Credit That Banks Shun

By Ravinder Kapur

Small businesses are increasingly turning to online alternative lenders like LendingClub, IOU Financial.com and Dealstruck to finance their working capital and term loan needs. This, in turn, is creating an opportunity for investors to buy these loans which can yield relatively high returns. Investors can choose the risk profile of the borrowers whose loans they are purchasing and selecting riskier borrowers can get them a correspondingly higher return on their investment.

The share of alternative lenders in the small business finance market is currently Investorminuscule. A recent Forbes article cites a Morgan Stanley study that found small business loans by alternative online lenders in 2014 totaled $5 billion while the debt outstanding from small businesses was $4.4 trillion. But, alternative lender loan volumes are expected to grow 50% per year through 2020, providing an increasing pool of borrowers whose loans investors can buy.

An investor who puts money into loans originated by Lending Club to small business borrowers has the option of spreading their risk by selecting from a detailed list available online. The available loan grades are classified from A to G, with corresponding borrower interest rates of 7.58% to 25.01%. An investor may choose the borrower profile which corresponds to their risk appetite. If a borrower falls behind in the loan payment, Lending Club carries out recovery activity on behalf of the investor and charges them on the basis of an established fee structure.

This arrangement is working well for small business borrowers, alternative lenders and investors who buy the loans. Many of the borrowers have a sound credit profile with an established credit history and have been referred to alternative lenders by banks who are not interested in financing them, because the loan amount is below the bank’s threshold.

Karen Gordon Mills, a Senior Fellow at Harvard Business School and former head of the U.S. Small Business Administration, commented on this phenomenon in a paper published last year about SME finance. Bank lending data reveals that loans less than $1 million account for only 25% of banks’ commercial lending, down from 40% in 2005 and 52% in 1995. This trend has created an attractive opportunity for alternative lenders and, in turn, for the investors who buy the resulting loans.

Investors who have been quick to identify this new opportunity can earn annual returns exceeding 10%. Small business borrowers pay a much higher rate, with the average annual percentage rate (APR) in the range of 15% to 40% and more. The loan originator keeps 17.5% to 20% of the interest and of course there’s the default rate to consider. Investors who select the right loans and keep their write-offs down will continue to benefit from these investments. With an increasing number of online lenders actively courting small business borrowers, there seems to be ample opportunity for investors in this area.

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Our Kingdom for a Bailout

By Amaresh Gautam

When an economy suddenly goes into recession, the public’s initial panic invariably gives way to anger. There’s a tendency to find a scapegoat, someone to blame for the fiasco. In the Great Recession, the blame landed on Wall Street banks that made complicated financial products that no one understood, which eventually collapsed under the weight of their collective weakness.

The greedy corporations, who used such products to lower their borrowing costs or worse, AIGobtain funding that economically should have not been available, got a lesser part of the blame. Similarly, credit agencies, which continued to give healthy ratings to these derivative products long after their uncertain risks were exposed, also got a limited portion of the blame.

The anger was particularly severe against those financial institutions that were bailed out by the government, albeit relatively few were actually responsible for the mischief. Hundreds of smaller banks were caught up in the crisis and suffered without really contributing to the root causes of the crash. But the public rightly were incensed that the government socialized the risks (and resulting costs) of the evil deeds of these private financial corporations, who stood to profit alone from these operations when they succeeded.

In defense of the government, it’s worthy to note that the bailout proceeds weren’t handed out randomly without qualification, strict conditions, and a significant cost. The thousands of banks that received funding through the Troubled Asset Relief Program (TARP) agreed to accept several operating conditions that restricted the use of the funds, submit to additional reporting requirements and pay expensive dividends for use of the funding that staved off an under-capitalized balance sheet.

Much like injured people must pay for an ambulance ride to the hospital, all funding distributed to rescue the financial sector had strings attached to ensure that there was an appropriate price paid for the benefit of the rescue. Given the circumstances and risks, the cost should have been appropriately high, but how high is a matter of opinion.

Now, after some seven years, a U.S. judge has found that the treatment meted out by the government to insurance company A.I.G. was too harsh. According to the court, the government behaved like a loan shark, forcing A.I.G. to accept severely harsh conditions, although otherwise the company would have likely defaulted on their insurance contracts, and not been able to pay out settlements on the cascading level of claims on their credit default insurance book.

A.I.G. needed a bailout, and in order to save it, the U.S. Treasury Department and Federal Reserve required that the company issue the equivalent of 80 percent of their common stock in exchange, a disproportionately large part of its kingdom for the money. Whether that was a reasonable price to pay in the face of collapse into bankruptcy might lie in the eye of the beholder.

In the court of the land, the plaintiff’s view that the government did behave too harshly won the day, but in the middle of the financial crisis, the popular sentiment was such that a similar treatment to other financial institution would have certainly been cheered by the taxpaying public. And that divided outlook leads to a bigger question–what is the federal government expected to do in the next recession, which will come sooner or later?

Part of the government’s behavior will be dictated by the financial regulatory reforms that were rolled out in the aftermath of the crisis. However, a larger part of the government’s response to next crisis will be dictated by the popular sentiment that prevails during the recession, which will most likely consist of anger directed somewhere.

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EX-IM Bank Will Expire, But Return

By Charles H. Green

Ok, so my headline today is a combination of news of the day and a prediction of the future. Congress has in fact recessed for the July 4th holiday and will not return into session until afterwards, so the EX-M Bank charter will expire at midnight tonight (June 30th). No lightning storm, best intentions or even the Supreme Court will change that fact now.

But mark my words, the EX-IM Bank will rise from its brief place in the ashes and be Krashreinstated, with full authority retroactively granted. House Financial Services Committee chair Rep. Jeb Hensarling (R-TX), the leader to kill the EX-IM Bank, may be relishing this victory for the moment, but the larger truth is that the Republican Party is at war with itself over this issue.

And once again, as with the budget, deficit ceiling, and trade policy, this fight boils down to traditional, business-oriented establishment Republicans and the newer, insurgent Tea-Party members, whose rise to power has been fueled by mostly libertarian interests.

Why am I so sure the Establishment will win and the EX-IM Bank resumes its normal operations? One word: jobs.

The trouble with the extreme right-wing of the Republican majority is as old as the party itself. While Democrats over time have largely viewed their party as a big tent, with room for everyone’s interest, their inevitable conflicts were usually settled behind doors in smoke-filled rooms. Republicans consider themselves “principled,” but really have been more about interests representing the status quo. They have always felt safe excluding plenty of people, so long as nothing disrupted ‘business as usual,’ especially big business.

Don’t believe me? Listen to the business community’s interest in most social issues, such as civil rights, gay marriage and religious ‘freedom.’ They want no part of the divisiveness brought on through the discrimination promulgated by those who tell others how to live their personal lives.

But with conservative politicians, there are a lot of differing ideas as to what “conservative” really means, and which notion of ‘conservative’ is the correct one. The Tea Party arose through the amalgamation of many narrow interests, each of which individually were actually misaligned with a majority of the Grand Old Party, such as the ‘limited government’ crowd, fundamentalist Christians, libertarians, and social bigots.

While none of these extreme ideals were necessarily strangers to the GOP, they were tolerated to build a majority for the Establishment, who viewed big business as boss. Read “American Theocracy” by Kevin Phillips for an unadulterated description of how these interests convalesced into the Republican Party. And Phillips should know–it was his idea in support of electing Richard Nixon.

While the numbers and fervor of the Tea Party were welcome, their ideological extreme views and tactics have upset business as usual in Congress, and has disrupted previously non-controversial tools of governing that both parties cooperated on in order to run the country.  Like what? The debt ceiling, the Highway Trust Fund, flood insurance, the military-industrial complex, trade policy and many other mundane agencies, policies and practices that were rubber stamped for decades. Count the EX-IM Bank in that list.

The reality? Our federal government was founded for business, and it is in the business of protecting, promoting and promulgating business. Many of the original colonies had no interest in a central government, but knew that the collective force of the colonies were needed to establish a safe environment to conduct business. Think of trading with other countries, fighting pirates to protect trade vessels, guard ports, issue patents and provide courts to settle disputes between merchants from different colonies. The federal government’s operations were originally financed with tariffs on imported goods.

The extreme right’s interpretation of the Constitution generally reads that our government should be limited to what’s described in it verbatim. That’s nice philosophy, but a more pragmatic view might acknowledge that 1) most Americans disagree in thousands of unique instances; 2) we wouldn’t have microwave ovens or the internet were that ever strictly adhered to, nor entered WWI, WWII, Korean War, Vietnam War, etc.; and 3) for over two centuries, the ‘cat’s out of the bag’ as to that line of reasoning.

With the EX-IM Bank, there’s a more compelling, if pragmatic, case to make: trade competitors in every major developed economy in the world provide export financing for their manufacturing sector, including China, whose financing over the past two years exceeded our EX–IM Bank’s total volume over the last 80 years.

Hence, the Establishment Republicans will have to push back others in their caucus to reverse the lapse of the EX-IM Bank charter in the face of what big business wants–led by a coalition of more than 46 business trade associations–who finance many Republican campaigns and have a strong interest in the robust availability of export financing.

Said one conservative standard bearer (and presidential candidate), Lindsey Graham (R-SC), “Conservatives have declared war on the EX-IM Bank: It’s been ideologically ‘unpure.’ But until you get the Chinese, the Germans and the French out of the EX-IM business, I’m not going to unilaterally disarm.”

What do you think? Comment on this page or write me at Director@SBFI.org.

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Small Business Lender Live Oak Bank’s Parent Plans IPO

By Ravinder Kapur

Live Oak Bancshares, the parent company of Live Oak Bank, has announced plans to go public and aims to raise $86.3 million in the offering according to a report in the Triangle Business Journal. The proceeds are intended to be used for supporting organic growth, expansion into new industry verticals and to develop a new online lending platform for the origination of loans less than $350,000.

Live Oak Bank is a small business lender with a loan portfolio spread across all 50 states. Live Oak BankSince its inception in 2007, it has provided financing totalling $2.9 billion to new and existing businesses across the U.S. Recently WilmingtonBiz reported that in April of last year, Live Oak Bancshares had announced its intention to start the IPO process, but had shelved its plans after it tied up a private investment from Wellington Management.

In the 12 months ended September, 2014, Live Oak Bank was the country’s second largest lender by dollar volume for the SBA’s 7(a) program. In its SEC filings, the bank stated that its loan default rate, compared among a group of 292 SBA 7(a) lenders that originated 300 loans or more with a total loan value exceeding $25 million, was the lowest at 1.52%. The bank ranked fifth in terms of charge-off rates, achieving a level of 0.35% for the same period.

The bank has a unique approach to small business lending and currently focuses its efforts on only 10 of the more than 1,000 industries identified in the NAICS list of industrial sectors. The bank’s website lists these 10 verticals as veterinary, self-storage, wine and craft beverages, agriculture, family entertainment centres, dental, medical, funeral home, pharmacy and investment advisory. The bank attributes its ability to keep default rates of its borrowers under control to its intimate knowledge of these small business verticals.

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To Err Positively is Human, Also Being an Economist

By Amaresh Gautam

It is human nature to err on the side of the optimism., and the trait is even praised at many places. Employers want employees with a positive mindset. Books, like “The Secret,” vouch for the power of positive thinking. The tendency to err on the side of optimism is the reason why there are so many start-ups, while statistically it doesn’t even make sense to start a company.

Rationality is almost an ideal. Psychologists know that people’s happiness depends on Optimismsome sort of positive delusional bubble, which should not be burst unnecessarily.  Economists are supposed to a rational lot, however, they too have a tendency to err on the side of optimism. That explains why so many predictions about the recovery of American economy are proving false with passage of time.

The string of soft data in the first quarter of 2015 raises concern about U.S. economy’s recovery. Foreign cross currents, declining oil prices and a more cautious domestic consumer all suggest that economic growth may drag along for a while longer than most people thought was a reasonable prediction. There have been improvements in the labor market, but perhaps market watchers would be better off waiting for some more positive signals from the same.

They should also wait and see if the Fed’s Open Market Committee (FOMC) will be able to move steadily towards the two percent inflation target. The FOMC’s current stand is that it will not stick to any pre-set policy, but rather act according to the signals it receives. While that sounds like the pragmatic thing to do, such a stance could lead to more volatility.

Small business lenders should pay close attention to FOMC communications in the coming months, as they try to make sense of the data signals to finalize some sort of policy response. Lenders are wise to remember that economists, like other humans, tend to err on side of optimism, even if they are the best brains working for the government.

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GE Capital to Retain $90 Billion Financing Unit in Sell-off

By Ravinder Kapur

In April GE announced that it was selling off its massive financing arm, GE Capital, to escape being classified as a ‘systemically important financial institution’ (SIFI), and to concentrate on its core business of manufacturing capital goods. However, a recent report in The Economist, highlighted that the company will be still be keeping the $90 billion unit. which finances its medical equipment, power generation gear and airplanes.

Financing is a key element of the package that many capital goods manufacturers offer GEthose customers who do not have the ability to buy outright on attractive terms. GE was one of the first companies to realize this and owes a large part of its success to this strategy, known in the trade as ‘captive finance’ unit.

When an airline announces the purchase of planes from Boeing, the transaction may actually be a sale to GE Capital, which then leases the planes to the airline. GE has an added benefit in the deal, as 85% of Boeing planes have engines that are manufactured by either GE or one their joint ventures.

A large number of the medical scanners manufactured by GE, a product in which it is a market leader, are on lease to hospitals and other institutions that do not have a practice of buying such equipment outright. When the company introduces a new model, it takes back the outdated unit and replaces it with the upgraded version. Meanwhile, the old unit is leased to another institution. The financing arm plays a key role in this chain of transactions.

GE is making rapid progress in selling off parts of its $500 billion finance company. It recently put a $40 billion portfolio of corporate loans up for sale. Earlier in April, as reported by BloombergBusiness, GE had entered into an agreement with Blackstone Group LP and Wells Fargo & Co. to sell most of its real estate portfolio for $23 billion. In a letter to shareholders prior to the company’s annual meeting, the company’s chairman Jeff Immelt said, “GE is an industrial company first and foremost. GE Capital must enhance our industrial competitiveness, not detract from it.”

The financing unit, which the company valued at $82.5 billion at the end of last year (implying a return on capital of 8.4%), lags behind the industrial operations, which earn 14%. As reported by the Financial Times, GE has set a target of reducing the share of earnings from financial services from the level of 42% last year to 25%. The steps taken by the company to avoid SIFI status may also result in improved returns for its shareholders.

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Mills: Alternative Lenders Rescue SME Finance

By Ravinder Kapur

Loan volumes to small businesses dropped precipitously by 18% during the recession and have not recovered since, despite growth in the economy and employment. The number of community banks, which traditionally supply 40% of loans to small businesses, fell from 14,000 in the early 1990’s, to 7,000, and their tally continues to decline. This has had a marked negative effect on small firms as 48% of loan applications by them to community banks are approved as compared to 13% of applications to big banks.

Traditional banks, which are the chief source of capital for small businesses, are reluctant Karen Mills, Harvard Business Schoolto extend finance as they find it uneconomical to extend small loans. Nerdwallet spoke with former SBA Administrator, Karen Gordon Mills, about the options available to small business owners who require finance and whether it was advisable for them to take loans from the growing number of alternative lenders.

Speaking about the role played by online alternative lenders, Karen Mills said, “…their growth is rapid, but they are still only a small portion of the total market. It’s actually quite an interesting case study. It’s an instance where entrepreneurs are actually stepping in and driving innovation to solve a problem for other entrepreneurs and small business owners. And, they are doing what entrepreneurs do best–they are disrupting. And in this case disruption is happening in an industry that hasn’t changed much in the last 30 years.”

Accessing loans from the online platforms of alternative lenders is much simpler and faster than getting them from banks. An additional advantage is that there is much less paperwork involved and a potential borrower can complete the process and get a decision online. While the rate charged by these alternative lenders is usually higher than that of banks, many small businesses value the speed and simplicity of the lending process and are willing to pay a higher cost of capital for it.

But Karen Mills advises small business owners to exercise due caution when taking loans from alternative lenders, “Last, look at what others have to say about the online lenders you’re considering. You really do need to comparison shop and learn from other small business owners’ experiences. Be sure you have mapped out a realistic forecast that allows for all the loan costs and makes sense for your business.”

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