OCC’s Report Highlights Risks Banks Face

The National Risk Committee of the Office of the Comptroller of the Currency (OCC) has issued its Semiannual Risk Perspective for Fall 2015 in which it has cautioned national banks and federal savings associations about the various categories of risks they face. In the OCC’s view the main areas of concern are strategic, underwriting, cybersecurity, compliance and interest rate risks.

Comptroller of the Currency, Thomas J. Curry, expressed his unease with the current OCCpractices that many banks are following, “As the economic cycle turns, we see banks and thrifts reaching for yield and growth, sometimes extending their reach at the expense of sound underwriting, strong risk management, and adequate loan loss provisioning.

“OCC examiners will be paying close attention to each of those areas in the coming months. As I’ve mentioned previously, in the area of credit risk, the warning lights are flashing yellow. Regulators and bank management need to act now to prevent those risks from becoming reality. We can’t afford to wait until the warning lights turn red.”

He pointed out that competitive pressures can lead to banks acquiring customers who are not really creditworthy. In their search for new business and higher yields, banks and thrifts are allowing longer maturities, approving a greater number of underwriting exceptions and accumulating concentrations, especially in commercial real estate.

The precipitous fall in oil prices has led to a rise in the number of problem energy loans. While losses have been moderate till date, it is likely that some regions will experience a negative impact because of the downward trend in the energy sector. Texas, North Dakota, Pennsylvania, Louisiana, Colorado, Wyoming, and Oklahoma have already suffered from a significant reduction in drilling activities and new projects.

The expected increase in interest rates could also expose banks to great risk. Many banks have built up a large deposit base at low-interest rates. As rates rise, depositors may move their money to investments that give them a better return. Each bank would need to understand how an increase in rates would affect it and work out a suitable strategy to counter the possible negative effects that may arise.

Banks also need to closely monitor the risks associated with cybersecurity and compliance. Thomas J. Curry advised banks to be vigilant in these areas while referring to the consequences of being lax about these issues, “We can’t allow the federal banking system to be compromised by hackers or used by criminals or terrorists. We saw in the aftermath of the financial crisis that there is a price to be paid for ignoring compliance.”

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Small Businesses Plan to Slow Down Their Pace of Investment

Borrowings and investments by small businesses are expected to slow down in 2016 after showing strong expansion over the last year as the impact of external factors such as geopolitical instability, the coming presidential elections and the Fed’s rate increase is felt. As private enterprises take a conservative approach and defer expansion, it is also expected that the default rate for small business credit will remain below average levels.

These are the highlights of the forecast for 2016 made by PayNet, a provider of credit PayNetratings for small businesses that also maintains a proprietary database of small business loans, leases and lines of credit encompassing over 23 million contracts worth more than $1.3 trillion.

October 2015 saw the Thomson Reuters/PayNet Small Business Lending Index, which measures seasonally adjusted originations decrease 5% from a level of 137.9 in the prior month to 131.7. A comparison of the October 2015 index with the same month a year ago reveals a similar level of originations. Since February 2010, this is only the second instance that the Business Lending index has failed to increase over the prior year’s figure.

Additionally, in October 2015, the rolling three-month Business Lending index decreased 3% from September, the second consecutive month of decline since March 2014.

The Thomson Reuters/PayNet Small Business Delinquency Index (SBDI) continued to remain strong with 31-90 days past due levels remaining constant at 1.19% in October 2015. The delinquency level decreased 6 bps in October 2015 from the level a year ago, representing the fifth month of year-over-year decreases after 12 continuous months of increases.

October 91-180 days past due data was at 0.25%, the same level that was reported in the previous month and an all-time low for this time series.

A review of the regional credit risk data reveals that it is lowest in the Midwest and highest in the Southeast. In the 30-90 days category, Ohio, Texas and Michigan show rising loan delinquencies with increases of 8 to 20 bps, a rise of about 11% over the same month last year. The specific sectors responsible for these increases are retail in Ohio, farmers in Texas and health care providers in Michigan.

PayNet forecasts a slight increase in default rates in 2016. In 2014, the historical default rate of all small businesses combined registered an all-time low of 1.4%. It is expected that this will rise to 1.6% a result of rising interest rates and a growing economy.

Overall, the outlook for small businesses in 2016 is one where they will concentrate on maintaining their existing level of operations and refrain from going in for any major expansion in capacity. After the presidential elections when there is a better understanding of the issues affecting private companies, they may be in a better position to decide their future strategy.

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Small Business Lending to Minorities Gets a Boost

Minority-owned businesses find it difficult to access capital as they have fewer assets to use as collateral for loans from banks and other institutions. A report in Next City states that U.S. Small Business Administration (SBA) loans to African-American borrowers declined 47% between 2009 and 2013 while total SBA loan volumes grew by 25% (see Editor’s note below).

PewResearchCenter’s study on wealth inequality has found that black households saw a AA SB Loan Fundmassive erosion in their relative net worth in the three years from 2010 to 2013. Their report, based on data from the Federal Reserve’s Survey of Consumer Finances, finds that the wealth of white households was 13 times the median wealth of black households in 2013, compared with eight times the wealth in 2010.

In an effort to boost economic opportunities for minority-owned businesses, VEDC, a small business lender, has initiated a $30 million loan fund with a $3 million grant from the JPMorgan Chase Foundation. The National African-American Small Business Loan Fund will provide financing for businesses across all industries in New York City, Chicago, and Los Angeles.

VEDC, a nonprofit which was formerly known as Vitalize Van Nuys Inc., was founded in 1976 and has loaned in excess of $360 million to 100,000-plus businesses. Its president and CEO, Robert Barragan is keen to increase the company’s financing volumes to minorities, “As a direct small business lender and a leading intermediary of SBA loan programs, VEDC has a 39-year track record of providing business services to small businesses in low and middle-income communities and especially in communities of color.”

“Approximately 20% of our existing portfolio serves the African American community. With JPMorgan Chase’s seed funding, we look forward to helping more small businesses in our effort to further narrow the lending gap,” continued Barragan.

New York, Chicago, and Los Angeles have a total of 268,000 African American-owned businesses. The National African American Small Business Loan Fund will offer both short and long-term loans of amounts ranging from $35,000 to $250,000. Importantly, the Fund will also provide borrowers with assistance in running their businesses with inputs on networking, marketing, business plan development and financial consulting.

African-American entrepreneurs who are denied SBA loans will find the National African American Small Business Loan Fund a highly suitable alternative. About 7% of the country’s small businesses are African-American owned, but African-Americans constitute only 2% of loan approvals in the SBA’s 7(a) program. The newly constituted fund should help to rectify this imbalance to some extent.

VEDC’s vice president for national strategic initiatives says, “We believe we can do more. We believe we should do more. We also want to demonstrate to the marketplace that it’s not a situation of lack of demand, it’s that there isn’t a creative product suite out there that can really address the needs of this demographic.”

Editor’s Note: SBA lending to borrower’s identified as African-American reached a low point in 2012, and have climbed every years since, including a significant +35% bounce in the recently ended FY 2015. See more information here.

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Online Lending Industry May See a Shakeout

According to Frank Rotman, a venture capitalist with investments in several alternative lenders including Social Finance, Prosper Marketplace, Orchard Platform and Avant, some of the companies in the online lending industry use credit policies that may not stand the test when there is an economic downturn.

Also a blogger at fintechjunkie.com, Frank Rotman, a former banker, is one of the three

Frank Rotman, QED Investors

Frank Rotman, QED Investors

founding partners of the venture capital firm, QED Investors. In a recent interview with American Banker, he said that many new online lenders do not have staff with adequate credit expertise.

Some firms hire data scientists instead of trained credit professionals and this can result in the formulation of credit policies that are based on statistics collected in a period when the economy is doing well.

Meanwhile, the banking sector, which has traditionally been the provider of finance to small businesses enjoys several clear advantages over online lenders. Frank Rotman describes these, “They have a cost of funds advantage that no one is ever going to beat. They basically have free money.”

“The second thing they have is a data asset that’s really, really valuable. They have near-complete information on money going in and money coming out of a small business’s bank account, which is data that a lot of the other lenders would die to get their hands on.”

“The third advantage is a large number of existing customers that they can tap into who are already onboarded into their system,” said Rotman. While online lenders can take quicker decisions and they have access to better technology, these advantages may not be enough to ensure their success.

Another reason investors should be concerned about this channel is that there may be a consolidation in the online lending industry. The fact is that there’s a tangible risk that the projected demand for small business loans that new market entrants have been forecasting going into the alternative lending business sector may not actually materialize.

Many private firms are content to continue operating at their existing scale of business and have no desire to expand. Due to this, they would not require additional funding and many of the new lenders would be unable to achieve the economies of scale necessary to survive and ultimately become profitable.

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Fundera’s Data Shows Shift in Small Business Loan Maturities

Fundera, a fintech marketplace that arranges loans for small business borrowers, announced the results of a lending survey conducted in the fourth quarter of 2015 that reveals medium-term loans are gaining market share while the proportion of short-term loans is getting lower. The collated data shows that in the fourth quarter, dollar amounts in the medium-term loan category increased by 15% while declining by 9% for short-term loans.

Fundera’s started collecting transaction data from small business borrowers in February, Monthly calendar2014, and through Q3 2015 shows that medium-loans accounted for 32% of funded dollar amounts while short-term loans comprised 34% of dollar value. Comparable data for Q4 2015 reveals that in this three-month period, short-term loan volumes had fallen to 24% of dollar volume while medium-term loans rose to 47%.

The rise in short-term loan volumes coincides with OnDeck and CAN Capital, two of the largest fintech finance companies, introducing lower-rate, multi-year products for small business borrowers, a shift in their lending strategy. The move to medium-term loans is of benefit to borrowers as these are normally available at lower APRs.

Fundera CEO, Jared Hecht, offered his analysis of the shift, saying, “Seeing two of the industry’s most prominent short-term lenders introduce multi-year products is an indication that it is an indispensable part of the SMB product mix. These short-term lenders will now be able to help their own customers graduate into longer-term loans instead of potentially losing them to competitors. It also signals that the medium term loan category will become increasingly competitive, which should benefit the business owner at the end of the day.”

The report issued by Fundera is based on the 1,900 loans mediated between February 2014 and December 2015. The lenders that Fundera works with include CAN Capital, OnDeck, bizfi, Funding Circle, Lending Club, Dealstruck and Prosper in addition to a number of other prominent companies in the alternative lending sector.

Fundera’s data confirms that alternative lenders play an important role in providing finance to those small business borrowers who find it difficult to access funds from the traditional banking sector. Although there are few borrowers who manage to secure funds if they have both poor credit scores as well as low revenues, there are many customers who have mid-level credit scores and annual revenues in the middle category who are able to obtain funds from alternative lenders.

Only about 6% of borrowers have credit scores below 580 while approximately 28% have scores in the 620 to 660 range. Less than 25% of customers have credit scores above 700. Annual revenues also play a critical role in helping lenders decide on the creditworthiness of a borrower. According to Fundera’s data, a negligible number of customers had revenues less than $50,000. About 35% of borrowers had revenues in the range of $100,000 to $300,000.

Their data also reveals that a wide range of small businesses use alternative lenders to meet their finance needs. Borrowers classified under the ‘merchandise’ sector and those categorized under ‘restaurant/café/bar lounge’ make up about 8% each of the total of 1,900 loans.

Consultancies and marketing companies make up an additional 5% each. Customers in other fields account for the remaining borrowers. There are 65 industry categories that have used Fundera’s platform to find the best lender indicating the diversity of borrowers who are accessing funds from the alternative financing sector.

Alternative lenders are playing an increasingly important role in financing small businesses. For many business owners who are rejected by banks, they are the next best option. Another reason that small businesses find online lenders attractive is that they have highly automated approval processes and can decide on a loan application and fund it in a matter of days. In addition to these features, they require less paperwork to confirm their underwriting. Business owners find this to be a very appealing.

But with new online lenders entering the market at a rapid pace, small business borrowers are faced with the problem of deciding which alternative lender can best meet their needs. Marketplace companies like Fundera that match borrowers with lenders serve an important role in helping to sort out choices available.

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Big Banks Use Fintechs to Access Small Businesses

Large banks are keen to provide loans to the country’s 27 million small businesses and in pursuit of this end, JPMorgan has recently joined hands with OnDeck and Bank of America has entered into a partnership with Viewpost. JPMorgan’s small business lending volumes are already fairly extensive with at least $19 billion having been extended in new credit to companies in this category in each of the last three years.

Jamie Dimon, JPMorgan’s CEO, succinctly explained why banks want to join forces with

Image courtesy of Forbes.com

Image courtesy of Forbes.com

fintechs when he said that there is “stuff we don’t want to do or can’t do” anymore. The American Banker reports that JPMorgan will use OnDeck’s software and credit appraisal techniques to decide on some small-business loan applications.

The loans would remain on JPMorgan’s books and the bank would retain the right of refusing to finance a borrower proposed by OnDeck. This arrangement would help the bank to reduce its cost of servicing as it would move away from paper-based loan applications in favor of an online model that would be both more economical and faster.

Mary Jane Rogers, chief communications officer at JPMorgan, explained some of the benefits that would accrue to the bank through this tie-up with OnDeck, “Partnering was a faster way to accomplish what we want to accomplish, which is a streamlined, super-fast, disruptive-customer-experience way of delivering small-dollar credit [up to $250,000] to small business owners.”

Bank of America has also partnered with a fintech but has adopted a different approach. Its small-business deposits division has three million customers. BOA has tied up with Viewpost, a service that automates small businesses’ billing processes.

Viewpost is building a network of small business payors and payees to help users track the status of their invoices. This service benefits billers as it gives them an idea about when they can expect payment while payors gain as they have the option of making payments earlier and receiving a discount.

This partnership will enable B of A to help its small business customers, who cumulatively hold $80 billion in deposits with the bank, manage their cash flows. Viewpost has also entered into similar arrangements with U.S. Bancorp and Fifth Third Bancorp.

The fact that JPMorgan and B of A have entered into partnerships with fintechs is an acknowledgement that this new industry has a lot to offer to the traditional banking sector.

Importantly, these arrangements benefit not only the banks but small business customers as well. JPMorgan’s loans to small business borrowers will be made using the bank’s credit policy and pricing. This will give entrepreneurs the benefit of lower bank rates and the efficiency and speed that alternate lenders offer. The service that Viewpost offers will be a boon for companies as it will help them manage their cash flows and save on interest costs.

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Regulators Jointly Caution CRE Lenders

In a joint statement the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency have reminded financial institutions to exercise prudence in their commercial real estate (CRE) lending activities.

This communication has been prompted by the observations that the agencies have made, Federal Regulatorswhich reveal that CRE loans have been underwritten using less stringent norms than in the past. Currently, these loans have longer maturities, extended interest-only payment periods and guarantor requirements that are less onerous.

The growth of lending activity in this sector has resulted in historically low capitalization rates and rising property values. Overall, the quality of CRE portfolios held by lending institutions remain strong with non-performing loans and charge-off rates remaining at acceptable levels. All these factors have led to a rise in the CRE concentration levels at many institutions.

The joint statement calls upon all national banks and federal savings associations to review their policies and practices related to CRE lending in view of the increased lending activity in this area. Financial institutions have also been asked to maintain risk management practices and capital levels that are in line with the nature of their loans to this sector.

Lending institutions have been asked to provide their boards and management with regular information about changes in market conditions and whether the practices followed by the bank are in tune with the current requirements. The agencies have specifically said that there is a need to assess the ongoing ability of the borrower and the project to service the debt that is taken especially when it is converted from interest-only to amortizing payments.

It has been clarified that these guidelines pertain to CRE loans where funds are used to acquire, develop or construct properties and where the source of repayment is the sale of the property or the cash flows from third-party rent or lease payments. The statement issued by the agencies does not apply to loans and lines of credit where real estate is taken as collateral.

The agencies have said that in 2016 banking supervisors will continue to watch CRE loan portfolios carefully and review the lending activities associated with this sector. Special attention will be paid to those banks and federal savings associations that have increased the level of business in CRE lending activity.

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Lender Credit Requirements Confuse Business Owners

Most every business needs funding to get started and subsequently to meet its commitments to suppliers, for payments to employees and to get it over lean periods as it builds up to a sustainable level of profitable sales. While successful business owners become such by figuring out how to meet their financial needs, the process of obtaining funds from third parties during this portion of the business startup is difficult, and is typically one of trial and error.

One of the principal reasons a large number of businesses fold is that they are not able to Question Mark signsecure adequate funding to meet their requirements. According to a survey by the Small Business Administration (SBA), 50% of businesses close down within five years of being established and only one-third survive 10 years or more. This survival rate has remained fairly constant over the last two decades.

Lenders are naturally wary of advancing funds to firms that may not be in a position to repay them, and one of the critical tests they must meet for lenders is to demonstrate their ability to make the money work. Writing in the Huffington Post, Jared Hecht, CEO and co-founder of Fundera, a company that connects small businesses with providers of finance has tried to better described these criteria that lenders look for when underwriting various categories of loans, for small business owners.

The obvious problem, as lenders know, is that requirements vary widely determined by the borrower and their situation, the lender and their credit culture, and the nature of the loan product being used for a particular purpose. There’s no universal rule book, and no absolute standard way every lender reacts to the many different criteria faced with underwriting a commercial loan.

One of the primary conditions for most lenders is that the borrower should have been in business for a certain minimum time period. The number of years that a firm should have been in existence varies due to many factors, but most often depends on the loan product and how the funds will ultimately be used.

Most participating lenders using the SBA’s 7 (a) loan program recommend that the borrowing company should have been operational for at least two years, although that’s far from universal. If a firm borrows using the merchant cash advance option, it may be eligible for a loan even if it had been in existence for a mere five months.

What if a borrower has previously declared bankruptcy? Lenders do not automatically disqualify a small business for this reason, but they do require that a certain minimum period to have elapsed since the borrower has been out of bankruptcy. Most loan providers need a minimum of three years to elapse before an entrepreneur can be considered for a loan, but even that may be dependent on how the bankruptcy turned out.

Again, short-term lenders and merchant cash advance companies have less stringent criteria and often require only one year to have passed since the bankruptcy. If a firm is borrowing using invoice financing, this criteria does not apply at all since the loan is repaid by the invoice.

Another common criteria used extensively by most lenders is the personal credit score of the small business borrower. A startup loan would generally require a minimum FICO score in the 700 range, while an entrepreneur borrowing under the SBA 7(a) loan can have a score as low as 640, according to Hecht. Short term loan providers and invoice financiers are satisfied with an even lower score and consider 500 to be adequate.

Small business borrowers would do well to spend time studying the requirements that different lenders have for advancing funds, but the truth is, merely checking off a few of the definitive metrics used by lenders in no way guarantees loans approval.

These conditions, which brings considerable inconvenience, confusion and inefficiency to the process of commercial lender.

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Small Business Borrowers Find New Financing Sources

Private enterprises traditionally met their financing needs by approaching community banks, a situation that changed after the great recession of 2008. The consequential legislation affected community banks adversely, requiring them to devote a great deal of management time and to incur large expenses to comply with new regulations.

A wave of bank consolidations served to alienate small business borrowers from the Dollar Signsinstitutions that they had maintained relationships with over the years. Additionally, large banks steered business borrowers who required lower amounts towards credit cards and mortgage borrowing, areas that are more profitable for banks.

This change was accompanied by the emergence of alternative lenders who charged much higher rates of interest as compared to community banks, but made finance available in a matter of days. These nonbank lenders used technology to develop credit appraisal systems that worked automatically using data that was available online. Among the greatest benefits they offered was that they obviated the need for loan applicants to submit any paper documents.

This page has published a considerable amount of information concerning the rising ‘fintech’ sector, but for new readers or those choosing to tune in more slowly, there’s a report in TribLIVE describes how institutional investors and big banks became hidden partners in peer-to-peer lenders in their search for higher yields. Morgan Stanley Research has projected that marketplace lenders, who currently have 2.1% of the market will expand to 10% of U.S. lending by 2020. While banks report lower volumes from small business lending they are indirectly earning higher yields through their partnerships with peer-to-peer lenders.

Lael Brainard, a member of the Board of Governors of the Federal Reserve addressed the Third Annual Community Banking Research and Policy Conference in St. Louis and spoke about the increasing volumes of business that online lenders are underwriting, “In recent years, online alternative lenders have also made inroads into small business lending. There has been a lot of speculation about the effect of this sector on traditional banks: Will it disrupt their activities, broaden their reach, or maybe a little of both?

“…In aggregate, the outstanding portfolio balances of these lenders have doubled every year since the mid-2000s. It is estimated that online alternative lenders originated $12 billion in 2014, with unsecured consumer loans representing $7 billion and small business loans accounting for approximately $5 billion. While this amount represents only a small fraction of U.S. unsecured consumer and small business lending overall, the rate of growth is notable.”

Alternative online lenders have made major inroads into small business lending and their financing volumes are expected to continue rising rapidly. Their technology platforms give them a significant competitive advantage over traditional banks who find it difficult to compete especially as they are hampered by complex regulations.

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Ex-Im Bank Resurrected, But Fight is Far From Over

The 81-year-old EX-IM Bank is functional again after an interval of five months in a major victory for President Obama’s Administration. During the period after the bank’s charter expired, several American companies lost out on export orders due to lack of support from this agency. But the bank’s operations will remain severely constrained as its five board positions are currently staffed only by chairman Fred Hochberg and vice-chairwoman Wanda Felton.

In a report carried in the New York Times, Mr. Hochberg clarified that despite the lack of a Export-Import-Bankboard quorum, the agency can again start accepting and reviewing applications of any size for loans, loan guarantees and credit insurance for their foreign buyers. It can also provide working capital to small businesses to purchase material required to manufacture goods against export orders, and approve transactions up to $10 million.

At the time the EX-IM Bank closed on June 30, about 200 transactions worth $9 billion were in the pipeline.

Many Republicans are against the re-opening of the bank as they contend that it favors certain corporations over others and lets Washington decide which companies will succeed. Heritage Action for America, a conservative group, says that in FY13 Boeing, GE, and Caterpillar received 87% of EX-IM loan guarantees and that the bank provides export financing for just 0.009% of America’s small businesses. It also maintains that 98% of exporters do not receive assistance from the EX-IM Bank.

Heritage also maintains that in reality EX-IM subsidies benefit countries like China, Venezuela, Cuba and Russia whose state-owned airlines have received $16 billion in subsidized financing since 2009.

Senator Mark Kirk of Illinois is on the Senate banking committee and is one of the Republicans who considers the EX-IM Bank to be indispensable to American exporters. He defied the committee’s chairman, Senator Richard Shelby, to press for the bank’s reopening. Explaining his position, he said, “American workers should be on a level playing field with competitors around the world. We brought the Export-Import Bank back to life so more American made products–not jobs–move overseas.”

During the period when the bank was inactive, three satellite manufacturing deals went to Canada and France as American companies were unable to offer competitive terms.

Representative Jeb Hensarling of Texas, chairman of the House Financial Services Committee is confident that one day the EX-IM Bank will be closed. He says that if he was the C.E.O. of a Fortune 50 corporation, he would think twice before building his long-term business plans based on EX-IM financing.

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