Thursday, January 9, 2014

Alternative Lenders

I found an interesting article in the Wall Street Journal on Alternative Lenders to small businesses.  Some highlights with comments.
With Credit for Businesses Tight, Nonbank Lenders Offer Financing at a Price

When Khien Nguyen needed $180,000 to open his 13th nail salon near Philadelphia in November, he didn't go to a bank. Mr. Nguyen's credit score had dropped during the recession, so he figured a bank would put him through weeks of aggravation, then reject him.

He turned instead to one of the nonbank, short-term lenders that have been gaining traction since the financial crisis. The lenders cater to small businesses, often at high cost.

Delaware-based Swift Capital reviewed his financial records and social-media sites such as Yelp and Facebook for reviews, then dispatched someone to one of his salons to pose as a customer. Swift wired him the money a few days later....
About two dozen such nonbank lenders—including OnDeck Capital Inc., Kabbage Inc. and CAN Capital Inc.—lent about $3 billion collectively last year, double the 2012 total...
Banks generally require solid credit scores and spend weeks reviewing financial statements, tax returns and business plans.
This is one interesting theme of the article -- use of social media and other internet data mining to develop information about credit worthiness and move quickly.
Biz2Credit, an online loan broker for small businesses, says an analysis of loan applications made in December through its website showed big banks approved 18% of loan applications by its customers in December, while small banks approved 49%.
Various nontraditional lenders have stepped into the void...
Alternative lending to small businesses expanded during the financial crisis as bank credit dried up....
In 2008, when the financial crisis hit, sales at Robin's Nest Floral and Garden Center in Easton, Md., dropped by 15%, according to owner Ken Morgan. The 30-year-old company needed $50,000 for a shipment of Christmas decorations. "I went to the bank, where I'd always done business on a handshake, and they were scared and having their belts tightened," he says. He was turned down. ...

It is so heartwarming as an economist to see, even if slowly, all the adjustments we expect. Banks not lending (or forced not to lend)? Someone will start a new business model to fill in the void. 

But there is nothing that stops a bank from using new sources of information, streamlining loan approvals and so forth. So if regular banks are not doing it, and if new businesses that want to serve this market  are organizing as something other than new "banks," it raises the interesting question, what's wrong with regulation or competition in banking?
Mr. Nguyen is paying 14.9% interest over the loan's six-month term—the equivalent of about 30% annually ...
Interest rates on such loans can run in excess of 50%, on an annualized basis, much higher than on conventional bank loans. Usury laws limiting interest rates generally don't apply to the short-term lenders. Some of the loans are originated in states that don't cap interest rates on commercial loans. Others are structured as private contracts between two businesses. ...
Ah, usury, predatory lending consumer protection and all that. That gives us a hint here of the regulatory roadblocks. Now we know why the loans are short term. Wouldn't it be nice if Mr. Nguyen could get a long term loan?

For small and very short loans, quoting the price as an annualized interest rate doesn't really make much sense. The fixed cost of the transaction and the fixed, non-time dependent, probability of repayment seems much more important.
Speaking at a recent Small Business Administration conference, Treasury Secretary Jack Lew said the government wants to "do more to knock down barriers to financing,'' ...
Hmm. I'm curious which barriers he has in mind, and how many are erected by the self-same government. Isn't the same government behind tightening bank lending standards, limits on bank entry causing these new businesses to have to spring up, interest rate caps, "consumer protection" and more?
Peer-to-peer online-lending platforms channel funds from ordinary investors to borrowers. Private investment partnerships, including hedge funds, make direct loans to struggling businesses, often with costly strings attached. ...
Unlike banks, the short-term lenders don't take deposits, so they need other sources of capital to fund the loans. OnDeck has an $80 million credit facility from a syndicate that includes Goldman Sachs Group Inc."They have a successful business model that we like," says a Goldman spokesman.

This fall, OnDeck secured another $130 million from, among others, KeyCorp.  Adam Warner, president of Key Equipment Finance, says loans to OnDeck and to CAN Capital are "a way to diversify our small-business lending."
I found this especially interesting. It's often said that banks just must "transform" deposits to loans, that there is something eternal and magical about deposit funding for risky business lending. Not true apparently, and that gives me heart for my view that real banks could support lending just fine if they had to raise money as equity or long term, non-runnable debt. I wish the article had more about the capital structure of these "banks."


  1. "Speaking at a recent Small Business Administration conference, Treasury Secretary Jack Lew said the government wants to do more to knock down barriers to financing,' ..."

    That is easy - to ease the burden on lenders raise the pretax cost of financing, to ease the burden on borrowers lower the after tax cost of financing.

  2. Loan sharking is a new model business? And it warms economists hearts?

    1. What warms economists hearts is that, since the days of Adam Smith, the idea that people are pretty good at finding ways to engage in mutually beneficial trades is confirmed over and over, even when the government does its best to prevent them from doing so.

  3. Monetary policy is not going to work as hoped if the lending channel is broken. One major purpose of the Fed's purchases of MBS is direct intervention in the lending channel for home mortgages. The Fed intervened in the markets for commercial paper to help the very large companies who borrow there but have done nothing for the small business sector - the Fed just keeps pushing harder and harder on that string.

    (There may be perfectly reasonable reasons why a bank was reluctant to lend to Khien Nguyen and even with fully functioning credit channels a bank might have been reluctant to lend him money.)

  4. I am a U. of C. Ph.D. running an alternative lending business. My standard rate for loans secured by first mortgages on real estate is 13%, but I have also made real estate loans at 30%. Loans secured by inventory or equipment can go higher than that. My loan sizes range from $10,000 to $7 million. I have financed apartment building operators, renovators and builders, house flippers, house builders, crop dusters, airlines, ice cream makers, lettuce growers, gold refiners, pawnshops, dairy operations, heavy machinery traders, mining engineers, restaurants, stores, film makers, casinos, waste recyclers, hospitals, gas stations and machine shops.

    My loans are all short term, but not because of regulations - most states have no usury limits for business loans, short term or long term. I go short term because it minimizes risk and pays more. (some borrowers will pay 2% origination fees for 30 day loans)

    My capital structure is pretty simple - I lend my own money, but it is tied up in real estate, so I borrow from bank lines of credit secured by the real estate. I could sell the real estate and lend the money directly, but I don't want to pay capital gains taxes.

    Bankers sometimes refer loans to me, saying that the loans are good but their regulators wouldn't like them. My borrowers often eventually obtain bank financing, but the process takes so long that they need me for periods ranging from a day to a couple of years.

    My impression is that this business works because of heightened regulator scrutiny of banks that began after the crisis. There are a lot of positive NPV projects that are not being funded. This observation seems to contradict the Summers/Krugman view that real interest rates are so high that businesses are unwilling to borrow. It appears to me that they are very willing to borrow, but regulators are keeping traditional lenders from lending.

  5. There are lots of ways that (some) people use to get around barriers. and they often vary in how they work depending on the size or amount put together.

    Nguyen certainly did not have triskaidekaphobia, and with 12 stores was actually wealthier than most americans who would want a loan to start their own business or just get a car, etc.

    one version that pools money at a smaller (albeit poorer) level is an Arisan

    from wiki:
    An "arisan" is a form of Rotating Savings and Credit Association in Indonesian culture, a form of Microfinance

    Generally the arisan is a social gathering that takes place at a fixed interval (this being an informal social network this may be variable), at each member's home in turn. The rotating arisan holder (drawn by lots) receives payment from each other member and provides food for those members. In the course of the arisan the amount paid to other members will equal the amount received when the arisan is held.

    The arisan can vary from an essential form of credit in poorer social circles, funding an otherwise unaffordable business venture, wedding, or large purchase, to a purely social gathering for rich housewives with the money incidental (although the amounts can be considerable). As a source of finance it represents an alternative to bank loans and other forms of credit.

    this system avoids interest payments
    its social media without the electronics. :)

    the electronics just increases the range, the basics remain

    the idea here is that money pooled, like water, has more power. each person in the arisan gets a turn and its social nature helps insure that people keep their paying. while the values dont get into the six figures, the amounts can be substantial for people a bit lower down on the food chain than Nguyen. with such things and the social network, they tend to do quite well.

  6. The alternative finance industry has existed for years. They often use the technique called asset based lending, which relies on the value of, and strict policing of secured credit (liens on accounts receivable, inventory, etc.). They are often able to lend without strict credit analysis. They often flourish when conventional bank credit is not available.

    Here is a 2010 WSJ article on the practice:

    Many of the lenders mentioned in that article are BHC subsidiaries, but are not banks.

  7. Good post, great statement of David Barker. Lenders are changing both towards previous profiles (private lenders funded America's "discovery" expeditions or the Crusades) and direct lending funds. Great, good oportunities in the market for them and a shrinking pie for us (banks). Market vs regulations (Yes, I'm a UoChicago Booth MBA).


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