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PCBB Banc Investment Daily May 22, 2014
Banc Investment Daily
May 22, 2014

Scratching Beneath The Surface

Most of us are aware of the predatory nature of payday loan companies and the damage that they can do to cash-strapped individuals who often end up in an ever-increasing morass of debt. We welcome the CFPB attacking the most blatant practices of shady operators, not only from social conscience but also because they ultimately add to the image problems of the entire financial industry.
There are also firms that make short term commercial loans. As bankers, we know there are business borrowers who don't qualify for a bank loan with the more stringent lending requirements of the post-financial crisis world. So what kind of organizations do this kind of lending and are they bad news or just businesses providing a necessary service? We took a look at one such firm, OnDeck, as they have been getting quite a bit of press lately. On their web site we found references from the Better Business Bureau and that the company is backed by Google Ventures. This doesn't look like Honest Bob's Easy Terms Payday Loans.
Broadening our review to the online commercial lending space at large, we find many of these companies boast cutting-edge analytics and software, which allows them to make loans that banks might consider too risky. They are clearly paying themselves well for taking on the risk, but these are loans to businesses that probably don't qualify for a bank loan, so are they really competition to banks?
For some community banks, the answer is probably yes, as can be seen in a recent Coleman Report. It tracks the SBA loan industry and the report finds there has been a significant decline in the volume of SBA loans under $150,000 and that the average SBA loan size has increased. This likely indicates smaller loans may be going online into these portals vs. historical channels.
Many of these companies are also quick to exploit the message that customers should not use banks. Among testimonials we found there was a story of a small company that was in danger of being shut down if they couldn't immediately repay a $50,000 loan - even though they had never been late on a payment. The conclusion of the article quoted the OnDeck CEO who said, "The banks have failed Main Street businesses." While he is certainly promoting his business in saying that, we think it ignores the great work done by community banks in supporting small business owners over the years.
Consider as well that there are problems with these commercial lenders themselves. Many rely upon loan brokers to channel customers to their products and of course the brokers are paid a commission. From what we found, the commissions are generally in the range of 15% to 17%. Given that most of the loans currently flowing through these portals are short term (generally 6 months) and that this commission is on top of a typical interest rate of 15% to 20%, the annualized rate jumps.
Compounding these issues, we would expect quite often borrowers probably can't pay the loan back in six months so it ends up extending for another term. Given private lenders making commercial loans are not subject to usury laws, it is also all perfectly legal.
Many of these commercial online portals are just beginning to dip into small business lending so there is much more yet to come on this subject in the future. In the meantime, we will just have to wait and see how it all works out and where they eventually end up.