Some say the industry is maturing, but a bubble may be getting ready to burst.
There was a lot of activity and noise last week in the world of online business lending. The OCC announced that they will move towards chartering fintech companies, Harvard Business School released a comprehensive report on the State of Online Lending, authored by Karen Mills of Harvard and Brayden McCarthy of Fundera, and the Federal Reserve hosted a conference on Financial Innovation to Households and Small Businesses where I was honored to speak.
This activity paints a picture of a maturing industry that has come a long way with innovation and is doing a lot of good to help small-business owners. In fact, in the Harvard report, the authors recommend what they consider to be sensible regulations for the industry.
I think regulations are important, but they need to be based on a clear picture of what is being regulated and the current situation. That’s where I differ with the authors. They suggest that the Wild Wild West of online lending is winding down, and the industry is stabilizing and moving forward. Rather than a maturing industry, I argue that we are on the verge of a bubble that is showing signs of bursting.
It’s almost impossible to write about online lending with hard facts. The lenders are not required to report on their volume or activity so it’s often anyone’s best guess about how many lenders there are, and how much money is being lent or advanced. Nor is there published data on default rates, delinquencies or loan losses, making it that much harder to know the full impact to the marketplace.
What we do know is that most of the activity in the space takes place issuing short term high interest cash advances or loans to small-business owners with the promise of funding in 24 – 48 hours. If you’re curious, enter small-business loan into a google search, and you will be welcomed with dozens of very appealing offers. The ads won’t tell you that the price tag is 50 – 200% APR.
While on one hand, it’s fantastic that these sources of capital are available quickly, the converse is that they often create intense cash flow pressure for the business owner once they take them. They are forced onto a treadmill of multiple renewals that eventually catches them in a debt trap that is very difficult to pull out of. In my loan brokerage, we regularly get phone calls from business owners who have fallen into this trap, and it’s too late to pull them out.
The rosy picture of a maturing online business lending industry doesn’t address what happens to these business owners now. We don’t know what happens as the lenders in the space start heading for trouble.
Just in the last few weeks we’ve seen signs of trouble in the industry. It has been reported that Dealstruck, a company that made a valiant effort to offer better pricing and more innovative products than the typical online player has ceased new originations. An announcement of a management shakeout was made at one of the largest players, CanCapital, as they dealt with higher than expected delinquencies.
We’re getting phone calls from customers of these lenders who are afraid that their lines are being shut down, and that they will have to close their doors. From their perspective, nothing is rosy.
Karen Mills, Senior Fellow at the Harvard Business School and former Administrator of the US Small Business Administration commented that, “There is no doubt that the rise of online lending to small businesses has promise, and for that reason it’s important we ensure responsible growth. Small businesses need a loan market that guarantees transparency and fairness, and one that reins in bad actors. As we’ve said in our paper, regulators and policy makers need to take action, but they must do so by striking the balance between effective, commonsense safeguards that empower borrowers to make informed decisions, while not creating burdensome oversight that would stifle innovation.”
Perhaps my perspective is biased. The urgency and despair in the voices of the small business owners who are caught in the debt trap of these short-term high interest loans is difficult to hear. Yes, innovation is great, but any rational business person will tell you that APR’s north of 50% are not sustainable.
As point of reference, occasionally my firm does broker on-line loan products, but it makes up a very small percentage of our overall portfolio, and we highly advise against it.