Small-Biz Online Lenders Aim to Dodge Consumer-Loan ‘Nightmare'

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By Gregory Roberts

July 19 — Online marketplace lenders would face significantly higher regulatory hurdles if most of their loans to small businesses were reclassified as consumer loans, as the Treasury Department has recommended, an industry representative and a legal expert told Bloomberg BNA.

“I would have to do everything differently,” Parris Sanz, chief legal officer of the marketplace lender CAN Capital, of New York, told Bloomberg BNA. “I can't give you a rundown of all the various moving parts that would be affected, but I can tell you for sure that it would be significant.”

The Treasury Department released a report in May about online lenders that raised fresh concerns about small-business lending. Officials discussed the need for greater transparency and noted that small-business loans under $100,000 “share common characteristics with consumer loans, yet do not enjoy the same consumer protections.”

The industry is pushing hard to head off the suggestion.

“They’re very smart in being concerned about that,” said Richard Eckman, a partner at Pepper Hamilton LLP in Wilmington, Del. “There are a whole host of consumer laws that apply to loans that are for personal, family and household purposes; that’s sort of the definition of a consumer loan.”

Lending is regulated by numerous federal and state laws — some of which apply to both consumer and business loans, while others govern only loans to individual consumers and do not affect loans to businesses. The federal consumer protection law that ranks as the biggest concern of marketplace lenders such as CAN Capital, which cater exclusively to small businesses, is the Truth in Lending Act (TILA).

“TILA, in particular, is onerous,” Eckman, a specialist in marketplace-lending law, said in an e-mail.

TILA Requirements Numerous

The act includes a welter of disclosure requirements, dispute-resolution rules and other provisions that, Eckman said, would be expensive and time-consuming to satisfy. And it's a strict-liability statute, potentially imposing repeat penalties for technical violations, he said.

“You would have to build a compliance function in your company,” he said. “It would cost them more money and it would limit their ability to be creative because they would have to do things a certain way.”

Applying TILA to small-business loans would be a “nightmare” for lenders like CAN Capital, Eckman said.

“It's really like peeling back an onion, when you think of all the things that a consumer lender has to go through,” he said. “To foist that on a small-business lender that has never had to go through it, that’s a tall order,” he said.

“It would fundamentally change the nature of the business,” Sanz said. “We would have to work those costs through the business and for us, that would almost certainly change our decision-making in order to remain a viable business — and that would mean restricting access to capital for small businesses.”

CFPB Eyes Sector

Looming over the discussion is the Consumer Financial Protection Bureau (CFPB), created by the 2010 Dodd-Frank Act with broad authority to regulate consumer financial services. The CFPB has not yet stepped into marketplace lending, although in April, the bureau named Grady Hedgespeth to a new position as assistant director for the Office of Small Business Lending Markets.

“They're very aggressive, obviously, in terms of their jurisdiction,” Eckman said.

Marketplace lenders accept loan applications online and apply computerized formulas to evaluate them and render a decision within hours or days on whether to grant the loan. The technology reduces underwriting costs and eliminates overhead expenses that banks incur for operating branches, and has allowed for more loans of smaller amounts to businesses and consumers — a sector banks had largely abandoned.

At CAN Capital, the underwriting of loans for small-business borrowers goes beyond the owner's credit score to look at the business' cash flow, bank accounts, tax returns, credit history and other factors via a proprietary algorithm, Sanz told Bloomberg BNA. CAN Capital joined this spring with OnDeck, Kabbage, PayPal and other small-business-centric marketplace lenders to lobby for preserving the distinction between consumer and small-business borrowers. And in May, CAN Capital, OnDeck and Kabbage formed a separate initiative to develop a standardized tool for providing more transparency about interest rates and fees for their loans.

Borrowers Not Alike

In testimony before a House Financial Services subcommittee July 12, Sanz highlighted differences between consumer borrowers and small-business borrowers seeking loans from marketplace lenders. Consumer borrowers, he said, tend to use the loan proceeds to pay off high-interest credit-card debt. Small businesses, he said, use the money “to drive the economy, through the creation of new jobs, expansion, remodeling, managing cash flow.”

Another difference, Sanz told the subcommittee, is the relative savvy and awareness of the borrowers.

“We also see in our customer base a very high level of sophistication,” including “people who have been running businesses for decades, who are managing revenues in the millions of dollars,” he said.

“Our industry and the small-business community we serve are especially concerned about calls by some public officials to regulate small-business loans in the same way as consumer loans,” Sanz testified. “Commercial loans have consistently been regulated differently from consumer loans for multiple reasons, including the role of commercial credit as a driver of the economy and the sophistication of the users.”

In his appearance before the full House Financial Services Committee in March, CFPB Director Richard Cordray said, “There are areas where the line between commercial and consumer lending is blurry.”

Cordray also said that if it were up to him, the bureau “would seek to protect consumers but also small businesses, who often operate in the marketplace with no more clout than individual households.”

Letter To Lew

On May 3, 16 members of the committee's Republican majority and three of its minority Democrats, along with House Small Business Committee Chairman Steve Chabot (R-Ohio), sent a letter to Treasury Secretary Jack Lew sounding themes that foreshadowed Sanz's testimony. The Treasury Department at that time was preparing its report on marketplace lending, and the House members wrote that they wished “to raise concerns with recent comments by public officials that seem to indicate a preference to regulate lending to small businesses and consumers similarly.”

“[W]e believe it is important for the Department to carefully study and understand key distinctions between commercial and consumer lending markets,” the letter said. “Mistaken efforts to conflate these categories would restrict the availability of capital to small business owners.”

The Treasury Department issued its report May 10, putting forth several recommendations. The first is, “Support more robust small business borrower protections and effective oversight.”

“[S]trong evidence indicates that small business loans under $100,000 share common characteristics with consumer loans yet do not enjoy the same consumer protections,” the report said in the recommendation. That cap would cover 90 percent of small-business loans, Sanz said in his committee testimony.

Advocates Urge Protections

Elsewhere in the report, the department said that in response to its request for information for the report, “Consumer advocates argued that many small business borrowers should be treated as consumers.”

“With online marketplace lenders catering to the capital needs of micro and small businesses, advocates noted that these borrowers have similar needs for safeguards,” the report said.

“There’s no reason why small businesses shouldn't have the same protection as consumers,” Lauren Saunders, associate director of the nonprofit National Consumer Law Center, in Washington, told Bloomberg BNA.

Dory Rand, president of the Woodstock Institute, a Chicago nonprofit advocating for economic empowerment for minorities and the poor, told Bloomberg BNA she supports applying TILA-like requirements to small-business lenders using financial technology on online platforms.

“The research has shown that these small-business owners who borrow smaller loans, under $100,000, are not that sophisticated and at times they really don’t understand the fine print, the hidden terms and conditions that we see in the typical fintech loans to small businesses,” she said. “These contracts are very opaque. The fees and terms are hidden in a way that really makes it impossible for the borrower to do any kind of comparison shopping.”

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