“A Bad Solution in Search of a Problem”: SBFA’s Response to the New York Disclosure Bill
August 6, 2020
“It’s actually shocking to me how tone deaf those who claim to represent our industry are when it comes to policy,” is how Steve Denis, Executive Director of the Small Business Finance Association, described the Innovative Lending Platform Association’s response to and influence over the drafting of bill A10118A/S5470B. Known as New York’s APR disclosure bill, S5470B has been passed by the state legislature, and if signed by Governor Cuomo, will require small business financing contracts to disclose the annual percentage rate as well as other uniform disclosures.
Speaking to AltFinanceDaily over the phone, Denis expressed disappointment with both the bill as well as comments made by ILPA’s CEO, Scott Stewart, in a recent article.
“Small businesses in New York are struggling right now,” the Director noted. “They’re waking up every single day wondering if they should even stay open or close permanently, and companies and organizations in our space are using their resources to push a disclosure bill that nobody has asked for. There’s no widespread issue with disclosure. There’s been no outpouring of complaints to regulators. No bad reviews on Trustpilot. This is a really bad solution in search of a problem. We have real problems right now, we should be coming together as an industry to help solve them. We want to make sure that capital is available to small businesses on the other side of this pandemic, and this group of tone deaf companies are spending resources trying to push a meaningless disclosure bill that’s just going to hurt the access to capital for real small businesses who are grinding and trying to figure out how to stay open. It’s unbelievable.”
The SBFA showed AltFinanceDaily a list of issues and complaints made to the New York legislature regarding S5470B. According to the trade group, these were largely ignored and the bill was pushed through with the issues left in. Among these were problems relating to definitions and terms. No definition for the application process is included, nor is there one for a finance charge. As well as this, one senator was quoted using the term “double dipping” to refer to consumers refinancing debts that have prepayment penalties; which Denis said was “creating a whole new term that’s never been used or defined before, and applying it to commercial finance, something that’s never been done.”
Accompanying these complaints was one regarding how APR is calculated, as S5470B includes two different calculations for this, producing different results while not clearly defining when to use each.
When asked why he believes these issues were allowed to remain in the language of the bill, Denis was baffled.
“I think that the companies and organizations that support this legislation don’t fully understand what’s actually in the bill. […] They have no problem pounding the table and taking credit for its passage, but I guess they don’t realize it will subject them and the rest of the alternative finance industry to massive liability, massive fines—upwards of billions of dollars worth of fines.”
Denis’s fear going forward is that funders in New York will tighten up their channels going forward or cease funding entirely, given the increased riskiness of funding under the terms of S5470B if Cuomo signs it into law. Before that happens though, the Director mentioned that he believes there will be legal challenges to the bill in the future, saying that its wording is just too unclear and poorly drafted. Adding to this, Denis said that he believes many members of New York’s state government are aware that this bill is imperfect and were comfortable with the thought of it being edited once passed. Looking forward, Denis wants the SBFA to be deeply involved in those edits, saying that they’re willing to work with the Governor, the state assembly, and the New York Department of Financial Services.
“We’re for disclosure, we think there should be standard disclosure. … Our message to the Governor’s office is ‘Let’s take a step back.’ The Department of Financial Services needs to look at our industry, they need to get to know our industry. They are the experts that understand the space, they understand disclosure, and they understand what they need to do to bring responsible lending to New Yorkers. And we would like to work with the NYDFS and a broader industry to put forward a bill that’s led by the Governor and the Governor’s office that brings meaningful disclosure and meaningful safeguards to this industry.”
Breakout Capital is BACK
July 17, 2019
SecurCapital Corp has acquired the lending business of Breakout Capital Finance.
Breakout was founded in 2015 by Carl Fairbank, a former investment banker, and quickly made a splash in the burgeoning small business lending industry. The company has raised significant capital and is a principal member of Innovative Lending Platform Association (ILPA), a trade group that among other things, created SMART Box, a uniform loan disclosure meant to enhance transparency across the industry.
Earlier this year, however, the company suspended originations.
But that’s poised to change. The deal with SecurCapital, a supply chain and financial service provider headquartered in California, means that Breakout is on track to resume originations as early as next week, according to the company. And there’s other changes afoot.
Tim Buzby, who previously served as the company’s CFO is now the President & CEO. Buzby is well primed for the job. He’s a former CEO of Farmer Mac, a company he spent 17 years with.
Carl Fairbank, who previously served as CEO of the lending business, will provide strategic guidance during the transition, the company reports. He will no longer have a day-to-day role.
“After four years as Founder and CEO of Breakout Capital Finance, this transaction begins the next chapter of Breakout Capital’s lending business,” Fairbank is quoted as saying in a company announcement. “SecurCapital is also committed to the proliferation of best practices to drive change in the broader market. I believe Breakout Capital, in partnership with SecurCapital, is now well positioned for substantial growth, especially with its commitment to FactorAdvantage.”
Fairbank is reportedly shifting his focus toward driving innovation in artificial intelligence, machine learning, and blockchain.
Breakout Capital has also hired McLean Wilson, former CEO of Charleston Capital (fka Drift Capital Partners), an asset manager in the SME space, and former CEO of inFactor, a factoring company, as Chief Credit Officer.
In an interview with Breakout’s new CEO Tim Buzby and VP Jay Bhatt (who has been with the company since the very beginning), they said that the company’s risk criteria and credit box will remain the same as it was previously, with potential to even expand it down the road. The company pressing the originations pause button from approximately February to July, therefore, shouldn’t be interpreted as a weakness of the company’s business model. Rather the acquisition and changes should suggest the opposite.
Steve Russell, CEO of SecurCapital, commented, “We’re delighted to have found a highly respected team and innovative business model in the small business finance space. I share the founder’s vision of the massive potential of the FactorAdvantage lending solution and believe we now have the platform and capital to rapidly grow this industry-changing product. We couldn’t have found a better business to complement SecurCapital’s strategic vision for empowering small businesses.”
Two SecurCapital executives have also been placed on Breakout’s board of directors.
Buzby confirmed that operations will resume as normal. The business address and business name will remain the same with one notable difference; That being that the name has been shortened from Breakout Capital Finance to Breakout Capital. It’s also now being operated by a subsidiary of SecurCapital.
Less Than Perfect — New State Regulations
December 21, 2018
You could call California’s new disclosure law the “Son-in-Law Act.” It’s not what you’d hoped for—but it’ll have to do.
That’s pretty much the reaction of many in the alternative lending community to the recently enacted legislation, known as SB-1235, which Governor Jerry Brown signed into law in October. Aimed squarely at nonbank, commercial-finance companies, the law—which passed the California Legislature, 28-6 in the Senate and 72-3 in the Assembly, with bipartisan support—made the Golden State the first in the nation to adopt a consumer style, truth-in-lending act for commercial loans.
The law, which takes effect on Jan. 1, 2019, requires the providers of financial products to disclose fully the terms of small-business loans as well as other types of funding products, including equipment leasing, factoring, and merchant cash advances, or MCAs.
The financial disclosure law exempts depository institutions—such as banks and credit unions—as well as loans above $500,000. It also names the Department of Business Oversight (DBO) as the rulemaking and enforcement authority. Before a commercial financing can be concluded, the new law requires the following disclosures:
(1) An amount financed.
(2) The total dollar cost.
(3) The term or estimated term.
(4) The method, frequency, and amount of payments.
(5) A description of prepayment policies.
(6) The total cost of the financing expressed as an annualized rate.
The law is being hailed as a breakthrough by a broad range of interested parties in California—including nonprofits, consumer groups, and small-business organizations such as the National Federation of Independent Business. “SB-1235 takes our membership in the direction towards fairness, transparency, and predictability when making financial decisions,” says John Kabateck, state director for NFIB, which represents some 20,000 privately held California businesses.
“What our members want,” Kabateck adds, “is to create jobs, support their communities, and pursue entrepreneurial dreams without getting mired in a loan or financial structure they know nothing about.”
Backers of the law, reports Bloomberg Law, also included such financial technology companies as consumer lenders Funding Circle, LendingClub, Prosper, and SoFi.
But a significant segment of the nonbank commercial lending community has reservations about the California law, particularly the requirement that financings be expressed by an annualized interest rate (which is different from an annual percentage rate, or APR). “Taking consumer disclosure and annualized metrics and plopping them on top of commercial lending products is bad public policy,” argues P.J. Hoffman, director of regulatory affairs at the Electronic Transactions Association.
The ETA is a Washington, D.C.-based trade group representing nearly 500 payments technology companies worldwide, including such recognizable names as American Express, Visa and MasterCard, PayPal and Capital One. “If you took out the annualized rate,” says ETA’s Hoffman, “we think the bill could have been a real victory for transparency.”
California’s legislation is taking place against a backdrop of a balkanized and fragmented regulatory system governing alternative commercial lenders and the fintech industry. This was recognized recently by the U.S. Treasury Department in a recently issued report entitled, “A Financial System That Creates Economic Opportunities: Nonbank Financials, Fintech, and Innovation.” In a key recommendation, the Treasury report called on the states to harmonize their regulatory systems.
As laudable as California’s effort to ensure greater transparency in commercial lending might be, it’s adding to the patchwork quilt of regulation at the state level, says Cornelius Hurley, a Boston University law professor and executive director of the Online Lending Policy Institute. “Now it’s every regulator for himself or herself,” he says.
Hurley is collaborating with Jason Oxman, executive director of ETA, Oklahoma University law professor Christopher Odinet, and others from the online-lending industry, the legal profession, and academia to form a task force to monitor the progress of regulatory harmonization.
For now, though, all eyes are on California to see what finally emerges as that state’s new disclosure law undergoes a rulemaking process at the DBO. Hoffman and others from industry contend that short-term, commercial financings are a completely different animal from consumer loans and are hoping the DBO won’t squeeze both into the same box.
Steve Denis, executive director of the Small Business Finance Association, which represents such alternative financial firms as Rapid Advance, Strategic Funding and Fora Financial, is not a big fan of SB-1235 but gives kudos to California solons—especially state Sen. Steve Glazer, a Democrat representing the Bay Area who sponsored the disclosure bill—for listening to all sides in the controversy. “Now, the DBO will have a comment period and our industry will be able to weigh in,” he notes.
While an annualized rate is a good measuring tool for longer-term, fixed-rate borrowings such as mortgages, credit cards and auto loans, many in the small-business financing community say, it’s not a great fit for commercial products. Rather than being used for purchasing consumer goods, travel and entertainment, the major function of business loans are to generate revenue.
A September, 2017, study of 750 small-business owners by Edelman Intelligence, which was commissioned by several trade groups including ETA and SBFA, found that the top three reasons businesses sought out loans were “location expansion” (50%), “managing cash flow” (45%) and “equipment purchases” (43%).
The proper metric to be employed for such expenditures, Hoffman says, should be the “total cost of capital.” In a broadsheet, Hoffman’s trade group makes this comparison between the total cost of capital of two loans, both for $10,000.
Loan A for $10,000 is modeled on a typical consumer borrowing. It’s a five-year note carrying an annual percentage rate of 19%—about the same interest rate as many credit cards—with a fixed monthly payment of $259.41. At the end of five years, the debtor will have repaid the $10,000 loan plus $5,564 in borrowing costs. The latter figure is the total cost of capital.
Compare that with Loan B. Also for $10,000, it’s a six month loan paid down in monthly payments of $1,915.67. The APR is 59%, slightly more than three times the APR of Loan A. Yet the total cost of capital is $1,500, a total cost of capital which is $4,064.33 less than that of Loan A.
Meanwhile, Hoffman notes, the business opting for Loan B is putting the money to work. He proposes the example of an Irish pub in San Francisco where the owner is expecting outsized demand over the upcoming St. Patrick’s Day. In the run-up to the bibulous, March 17 holiday, the pub’s owner contracts for a $10,000 merchant cash advance, agreeing to a $1,000 fee.
Once secured, the money is spent stocking up on Guinness, Harp and Jameson’s Irish whiskey, among other potent potables. To handle the anticipated crush, the proprietor might also hire temporary bartenders.
When St. Patrick’s Day finally rolls around—thanks to the bulked-up inventory and extra help—the barkeep rakes in $100,000 and, soon afterwards, forwards the funding provider a grand total of $11,000 in receivables. The example of the pub-owner’s ability to parlay a short-term financing into a big payday illustrates that “commercial products—where the borrower is looking for a return on investment—are significantly different from consumer loans,” Hoffman says.
SBFA’s Denis observes that financial products like merchant cash advances are structured so that the provider of capital receives a percentage of the business’s daily or weekly receivables. Not only does that not lend itself easily to an annualized rate but, if the food truck, beautician, or apothecary has a bad day at the office, so does the funding provider. “It’s almost like the funding provider is taking a ride” with the customer, says Denis.
Consider a cash advance made to a restaurant, for instance, that needs to remodel in order to retain customers. “An MCA is the purchase of future receivables,” Denis remarks, “and if the restaurant goes out of business— and there are no receivables—you’re out of luck.”
Still, the alternative commercial-lending industry is not speaking with one voice. The Innovative Lending Platform Association—which counts commercial lenders OnDeck, Kabbage and Lendio, among other leading fintech lenders, as members—initially opposed the bill, but then turned “neutral,” reports Scott Stewart, chief executive of ILPA. “We felt there were some problems with the language but are in favor of disclosure,” Stewart says.
The organization would like to see DBO’s final rules resemble the company’s model disclosure initiative, a “capital comparison tool” known as “SMART Box.” SMART is an acronym for Straightforward Metrics Around Rate and Total Cost—which is explained in detail on the organization’s website, onlinelending.org.
But Kabbage, a member of ILPA, appears to have gone its own way. Sam Taussig, head of global policy at Atlanta-based financial technology company Kabbage told AltFinanceDaily that the company “is happy with the result (of the California law) and is working with DBO on defining the specific terms.”
Others like National Funding, a San Diego-based alternative lender and the sixth-largest alternative-funding provider to small businesses in the U.S., sat out the legislative battle in Sacramento. David Gilbert, founder and president of the company, which boasted $94.5 million in revenues in 2017, says he had no real objection to the legislation. Like everyone else, he is waiting to see what DBO’s rules look like.
“It’s always good to give more rather than less information,” he told AltFinanceDaily in a telephone interview. “We still don’t know all the details or the format that (DBO officials) want. All we can do is wait. But it doesn’t change this business. After the car business was required to disclose the full cost of motor vehicles,” Gilbert adds, “people still bought cars. There’s nothing here that will hinder us.”
With its panoply of disclosure requirements on business lenders and other providers of financial services, California has broken new legal ground, notes Odinet, the OU law professor, who’s an expert on alternative lending and financial technology. “Not many states or the federal government have gotten involved in the area of small business credit,” he says. “In the past, truth-in-lending laws addressing predatory activities were aimed primarily at consumers.”
The financial-disclosure legislation grew out of a confluence of events: Allegations in the press and from consumer activists of predatory lending, increasing contraction both in the ranks of independent and community banks as well as their growing reluctance to make small-business loans of less than $250,000, and the rise of alternative lenders doing business on the Internet.
In addition, there emerged a consensus that many small businesses have more in common with consumers than with Corporate America. Rather than being managed by savvy and sophisticated entrepreneurs in Silicon Valley with a Stanford pedigree, many small businesses consist of “a man or a woman working out of their van, at a Starbucks, or behind a little desk in their kitchen,” law professor Odinet says. “They may know their business really well, but they’re not really in a position to understand complicated financial terms.”
The average small-business owner belonging to NFIB in California, reports Kabateck, has $350,000 in annual sales and manages from five to nine employees. For this cohort—many of whom are subject to myriad marketing efforts by Internet-based lenders offering products with wildly different terms—the added transparency should prove beneficial. “Unlike big businesses, many of them don’t have the resources to fully understand their financial standing,” Kabateck says. “The last thing they want is to get steeped in more red ink or—even worse—have the wool pulled over their eyes.”
California’s disclosure law is also shaping up as a harbinger—and perhaps even a template—for more states to adopt truth-in-lending laws for small-business borrowers. “California is the 800-lb. gorilla and it could be a model for the rest of the country,” says law professor Hurley. “Just as it has taken the lead on the control of auto emissions and combating climate change, California is taking the lead for the better on financial regulation. Other states may or may not follow.”
Reflecting the Golden State’s influence, a truth-in-lending bill with similarities to California’s, known as SB-2262, recently cleared the state senate in the New Jersey Legislature and is on its way to the lower chamber. SBFA’s Denis says that the states of New York and Illinois are also considering versions of a commercial truth-in-lending act.
But the fact that these disclosure laws are emanating out of Democratic states like California, New Jersey, Illinois and New York has more to do with their size and the structure of the states’ Legislatures than whether they are politically liberal or conservative. “The bigger states have fulltime legislators,” Denis notes, “and they also have bigger staffs. That’s what makes them the breeding ground for these things.”
Buried in Appendix B of Treasury’s report on nonbank financials, fintechs and innovation is the recommendation that, to build a 21st century economy, the 50 states should harmonize and modernize their regulatory systems within three years. If the states fail to act, Treasury’s report calls on Congress to take action.
The triumvirate of Hurley, Oxman and Odinet report, meanwhile, that they are forming a task force and, with the tentative blessing of Treasury officials, are volunteering to monitor the states’ progress. “I think we have an opportunity as independent representatives to help state regulators and legislators understand what they can do to promote innovation in financial services,” ETA’s Oxman asserts.
The ETA is a lobbying organization, Oxman acknowledges, but he sees his role—and the task force’s role—as one of reporting and education. He expects to be meeting soon with representatives of the Conference of State Bank Supervisors (CSBS), the Washington, D.C.-based organization representing regulators of state chartered banks. It is also the No. 1 regulator of nonbanks and fintechs. “They are the voice of state financial regulators,” Oxman says, “and they would be an important partner in anything we do.”
Margaret Liu, general counsel at CSBS, had high praise for Treasury’s hard work and seriousness of purpose in compiling its 200-plus page report and lauded the quality of its research and analysis. But Liu noted that the conference was already deeply engaged in a program of its own, which predates Treasury’s report.
Known as “Vision 2020,” the program’s goals, as articulated by Texas Banking Commissioner Charles Cooper, are for state banking regulators to “transform the licensing process, harmonize supervision, engage fintech companies, assist state banking departments, make it easier for banks to provide services to non-banks, and make supervision more efficient for third parties.”
While CSBS has signaled its willingness to cooperate with Treasury, the conference nonetheless remains hostile to the agency’s recommendation, also found in the fintech report, that the Office of the Comptroller of the Currency issue a “special purpose national bank charter” for fintechs. So vehemently opposed are state bank regulators to the idea that in late October the conference joined the New York State Banking Department in re-filing a suit in federal court to enjoin the OCC, which is a division of Treasury, from issuing such a charter.
Among other things, CSBS’s lawsuit charges that “Congress has not granted the OCC authority to award bank charters to nonbanks.”
Previously, a similar lawsuit was tossed out of court because, a judge ruled, the case was not yet “ripe.” Since no special purpose charters had actually been issued, the judge ruled, the legal action was deemed premature. That the conference would again file suit when no fintech has yet applied for a special purpose national bank charter— much less had one approved—is baffling to many in the legal community.
“I suspect the lawsuit won’t go anywhere” because ripeness remains a sticking point, reckons law professor Odinet. “And there’s no charter pending,” he adds, in large part because of the lawsuit. “A lot of people are signing up to go second,” he adds, “but nobody wants to go first.”
Treasury’s recommendation that states harmonize their regulatory systems overseeing fintechs in three years or face Congressional action also seems less than jolting, says Ross K. Baker, a distinguished professor of political science at Rutgers University and an expert on Congress. He told AltFinanceDaily that the language in Treasury’s document sounded aspirational but lacked any real force.
“Usually,” he says, such as a statement “would be accompanied by incentives to do something. This is a kind of a hopeful urging. But I don’t see any club behind the back,” he went on. “It seems to be a gentle nudging, which of course they (the states) are perfectly able to ignore. It’s desirable and probably good public policy that states should have a nationwide system, but it doesn’t say Congress should provide funds for states to harmonize their laws.
“When the Feds issue a mandate to the states,” Baker added, “they usually accompany it with some kind of sweetener or sanction. For example, in the first energy crisis back in 1973, Congress tied highway funds to the requirement (for states) to lower the speed limit to 55 miles per hour. But in this case, they don’t do either.”
2019 Alternative Finance Predictions
December 21, 2018
With 2019 approaching, AltFinanceDaily asked executives in the funding and payments industry if they had any predictions for the new year. We kept it pretty open-ended and received forecasts regarding technology, regulations, and the evolving relationship between fintech companies and banks. And yes, we also asked a few lawyers in the small business lending space for their two cents. Below is what they had to say:
“The hype around cryptocurrencies is nearly gone, and it’s time to focus on the more interesting part of it – the blockchain technology. In 2019 we expect to see first use-cases of such technology for logging and sharing data among lenders. There is a true potential for real-time data sharing which will help lenders avoid lending to clients which just took similar loans from other lenders, in a decentralized and anonymous way. This will allow the industry to overcome one of the challenges quick loan approvals bring: real time loans stacking.”
Ido Lustig, Chief Risk Officer, BlueVine
“We look forward to big changes coming. Four years ago banks still were not sure about Fintech firms. Now the banks are approaching alternative lenders trying to figure out various partnership options. We think in 2019 we will see banks engage in various levels of mutually prosperous partnerships…We believe new products will be launched in 2019 that will continue to support small business growth. And as the Alt Lenders are able to access cheaper cost of capital, it will give more options to small business owners.”
Robert Gloer, President and COO, IOU Financial
Given the explosive growth of MCAs and the fact that MCAs have evolved from an early stage industry to a mainstream industry – MCAs have been around for decades – we expect regulation of the industry to become a reality. At 6th Avenue Capital, we believe regulation will be healthy for the industry and will reduce the industry’s bad actors, allowing those institutions that practice transparency and industry best practices to thrive.
As a former Chief Compliance Officer, I set up the company with regulation in mind. In fact, we are the only firm to be a member of both ILPA and SBFA, both organizations that are active participants working with regulators to help create a regulatory environment beneficial to both SMBs and SMB funders. The need for alternative credit, and access to fast capital, continues to grow and the industry is not going away with regulations. The winners in the MCA space will be those that adopt sound practices early.
Christine Chang, CEO, 6th Avenue Capital
“We will likely continue to see state efforts to enact disclosures in MCA and small business lending transactions. We will also likely see efforts at the state level to ban practices viewed as aggressive by elected officials. These efforts will lead to a weeding out of the weaker players in the space and will strengthen the companies dedicated to compliance and customer service.
Catherine Brennan, Partner, Hudson Cook
“A business slowdown (possible but hard to predict, at least by me) will test the effectiveness of algorithm-based credit granting. I am not optimistic. Mid-market banks might start to purchase MCA-type technology and try their hand at selling it, albeit at a lower cost.”
Robert Zadek, Of Counsel, Buchalter
“Older, more traditional SMBs will broaden their lending horizons. In 2017, 30% of business owners looked for a small business loan online. The 70% who didn’t are predominantly older, and more traditional in their approach to seeking financing. In 2019, we will see a more aggressive push by SMB lenders to tap into a more mainstream audience of business owners who have not been looking online for financing options. This will be driven in part by increased competition between the SMB lenders, and a larger push by those lenders to market themselves to a broader audience of SMBs.”
Charles Amadon, VP of Business Development & Strategic Partnerships, BlueVine
“In 2019, we’ll see more and more retailers offer flexible, pay-over-time financing options and promotional 0% tools to drive sales and make gifting more affordable for customers. As customers continue to look for online pay-over-time options, we can expect to see savvy [merchants] taking advantage of these trends to both improve performance and meet the expectations of the modern shopper.”
Kate Levin, Vice President of Merchant Success, Bread
“Large corporations, from card payment organizations right through to banks, are making significant investments in reinventing themselves. I think some of them will be very successful in doing this…like Marcus by Goldman Sachs and also First Data’s Clover product. These both demonstrate that long-established companies are starting to really get it right when it comes to being innovative with fintech. I believe in the next five years, we’ll see other huge companies begin to get it right with fintech.”
Simon Black, CEO, PPRO
Commercial Financing Disclosures Bill – June 25 CA Assembly Debate, Video, and Transcript
July 21, 2018Commercial Financing Disclosures Bill – Assembly Banking and Finance Committee
[0:00:03]
Limon: We didn’t put any time limits on it, but I will ask for brevity in comments that are made. So, with that, I will have you begin, Senator.
Glazer: Thank you, Chair Limon. Senate Bill 1235 would give to small business owners many of the same protections that our country’s truth in lending laws have given consumer borrowers for more than half a century. This bill would require lenders and finance companies to provide clear and consistent disclosure to small business owners when they offer them financing and when they close a deal. This information would help small business owners understand the cost and the consequences of the financing options available to them in the rapidly evolving commercial lending market. Until now, our truth in lending laws have applied only to consumer finance. Business owners were left to fend for themselves on the theory that they were sophisticated merchants who understood the world of finance. Increasingly, however, that is no longer true. Today’s small business owners are often immigrant entrepreneurs struggling to get their enterprises off the ground with little knowledge of the finance industry. Traditional banks, meanwhile, are no longer interested in making smaller loans. Instead, that space is being filled by innovative lenders offering an array of financial options. This new online lending industry is bringing capital to people who badly need it, but there are abuses. This bill offers a modest measure, disclosure to help level the playing field for small business owners. It would make California a leader in placing the interests of small business owners on par with the big players in the financial industry. Now, if you borrowed money for a house or a car or simply taken out a personal loan or used a credit card, you’ve seen the kind of disclosures that this bill would require. They tell you how much you’re borrowing, all the fees you’ll be paying, how long it will take you to repay the loan, and the annual annualized interest rate. The lenders know all this information already. Some of them even disclose it in the financial markets when they package their small business loans and sell them as securities. All we’re asking is that they disclose the same information to their customers. What’s good for Wall Street should be good enough for Main Street. How this bill has undergone extensive changes since I first introduced it in February, we’ve taken suggestions from many of the players in this industry and for most of the opponents, but will never satisfy everyone. Many of the companies that lend to small business simply do not want to disclose the terms of their loans to their customers. And many consumer finance advocates want this bill to precisely mirror the laws that govern consumer lending even if that might not be practical for the business lending market. Let me finish up. I think we’ve struck the right balance in this bill. It requires clear consistent disclosure, but does not restrict the kind of financing that lenders can offer and will not lead to any loss of access to capital in the small business world. With me today are Robyn Black representing the California Small Business Association and Caton Hanson who is a cofounder of nav.com, a company that helps small business owners navigate the tricky new online lending marketplace.
Hanson: Thank you, Chair Limon and members of the committee, for allowing me to share my support of this bill. My name is Caton Hanson, cofounder and chief legal compliance officer at nav.com. Now, as a small business credit and finance platform used by more than 370,000 business owners in the United States including 35,000 in the State of California, I’m speaking to you today because I believe this bill is an important step towards helping small business borrowers more easily compare sources of capital, which ultimately means more successful business in California. Consider the impact this legislation can have. Small business employs nearly half of all of California State’s employees. But according to the U.S. Department of Labor, 100,000 California small businesses close each year. And the data show a top reason these businesses fail is due to poor credit arrangements. I cofounded Nav for the very reason of bringing transparency and efficiency to business financing credit. I come from a small business family. My grandfather started a pool plastering company in Southern California 1948. My cousin runs the same business today. Growing up, I watched my father work a full-time job and run a small business on the side. As a small business owner of 2 businesses prior to Nav, I’m intimately aware of the help this bill would provide small business owners. I’ve seen their struggle on a daily basis and have been in their shoes. I know what it’s like to feel like the success of your business hang on whether you have the right financing or not. Transparency and efficiency are essential in the business lending world. If you haven’t experienced it, it’s easy to say the borrower will figure it out.
[0:05:00]
They know what they’re doing. The reality is that small business owners are not financial experts. These are not Fortune 500 companies we are talking about. In fact, 75 percent% of all small businesses employ one or fewer people. These are businesses without a finance department. running a business and having to perform finance, HR, sales, product development is extremely taxing. Business owners can’t spend hours and hours trying to decipher loan disclosures. That’s why an annualized cost of capital needs to be a part of this legislation. It’s the best method we have to create a quick applies to apples cost comparison. We’ve had this protection for consumers for years. It’s already settled law. The bill’s opposition claim an annualized cost of capital will confuse borrowers. The fact is that an annualized rate, which includes all costs, will simply reveal how expensive some of these products can be. If this forces them to explain the difference between short term versus long-term capital and the effect that has on an annualized rate, then so be it. It’s better than the current system that puts all the burden on the small business owner. We’ve already agreed that using an annualized rate is the best way for consumers to compare loans. Why should it be different for small business owners? Most reputable business lenders already provide an annualized rate because they know it’s the best way for a borrower to compare loans and terms. Alternative lenders such as Kabbage, OnDeck, and SmartBiz Loans are using tools such as a SMART box to provide necessary disclosures. They know it’s the right thing to do. This bill is just a way to standardize and require this across the industry so that the few bad apples can’t continue to deceive business owners. This bill isn’t about regulating the cost of business loans or trying to harm business lenders, which we wouldn’t support. There are legitimate times when a triple digit annualized rate is a smart decision for a business owner, but the business owner deserves to have a clear way of comparing products and knowing how much it’s going to cost them. If the terms are transparent and the business owner makes a bad decision, then it’s on them. To claim educating a small business owner on the true cost of capital is a harm to them is simply ridiculous. Unlike the opponents, we have nothing to gain by passing this bill. We just know it’s the right thing to do. We also believe it can become a model for the entire country and will positively impact millions of business owners, their families and communities. On behalf of the 100 team members at Nav along with our 35,000 small business customers in the State of California, I urge you to pass the bill. Thank you.
Limon: I will ask for a quorum. Before we finish up, if we can just call a quorum.
Speaker: Limon.
Limon: Here.
Speaker: Limon here. Chen. Acosta.
Acosta: Here.
Speaker: Acosta here. Burke. Gabriel.
Gabriel: Here.
Speaker: Gabriel here. Gloria. Gonzalez Fletcher.
Gonzalez Fletcher: Here.
Speaker: Gonzalez Fletcher here. Grayson.
Grayson: Here.
Speaker: Grayson here. Steinorth.
Steinorth: Here.
Speaker: Steinorth here. Stone. Weber.
Weber: Here.
Speaker: Weber here.
Limon: Thank you. We’ll have you proceed.
Black: Good afternoon, Madam Chair and members of the committee. Robyn Black on behalf of the California Small Business Association. We are a nonpartisan nonprofit organization representing small business in California. Many of you were at our luncheon last week with your honorees. We love small business. We celebrate small business. And we really wanna thank the Senator for bringing this bill forward. As all of you know, access to capital is the most important challenge facing small business in California and startup businesses in particular in California as has already been stated. That transparency that this bill would provide for small businesses looking for that kind of capital specially in the new markets online is something that’s really important. I won’t repeat everything that’s already been said, but informing the consumers, giving them the transparency that is already there for consumer loans in California, providing it for small businesses, many of whom are not as sophisticated in the finance laws and the understanding what the true cost of a loan or borrowing money can be. This will go a long way to help those individuals. So, on behalf of the California Small Business Association, we thank you for your time and we urge your aye vote.
Speaker: Thanks, Robyn. Thank you.
Limon: Any opposition? Or support. Sorry. We’ll start with support. If you could please state your name and association.
Speaker: [0:09:31][Inaudible] On behalf of the Small Business Finance Association, support of the bill.
Limon: Any additional support? All right. Those in opposition.
[Talk Out of Context]
[0:09:59]
Patterson: Good afternoon, Madam Chair and members of the committee. My name is Ann Patterson. I’m a partner at Orrick, Herrington & Sutcliffe, an outside council for the Innovative Lending Platform Association. I feel like I’m in theater at the round here. [Laughter]. We’re here regretfully in opposition to SB-1235 because of the inclusion of the untested new metric, the ACC, that is in the bill. The ILPA is the leading trade association for small business lending and service companies and our members include OnDeck Capital, Kabbage, and The Business Backer. I wanna start by making it clear that we do not oppose SB-1235 subjective here and its attempts to create disclosures. We absolutely support transparency. And actually, as the witness from Nav mentioned, all members of the ILPA already provide borrowers with a comprehensive disclosure. It’s called the SMART box. It looks a little bit like the Schumer box. Or for those of you more familiar with Cheerios, the nutritional label on the back of that. We spent about 18 months developing the SMART box and worked in consultation with small businesses to identify the metrics that were most meaningful to them when they were trying to compare between financial products and then you can see those metrics reflected here. We have total cost of capital at the top, which is usually ranked as one of the highest and most meaningful for folks. We disclosed APR (annual percentage rate), average monthly payments, cents and dollar, and whether there are any prepayment penalties. So, I’m sure you probably can’t see this from here. I’m happy to provide— I brought copies if people would like to see it more closely. So, we did make these disclosures voluntarily because we want our small business customers to be informed so that they can pick the right financing product for their use cases and we do believe I think, as the author and the other witnesses, that transparency is critical to that. But we strongly SB-1235’s inclusion of this untested new metric, the ACC or EACC, because we believe that it will frustrate rather than facilitate an apples to apples comparison across products. And here is why. Let me find my little card. [Laughter]. As you can see, APR and ACC look a lot alike. They’re both percentages, which is gonna cause confusion for borrowers. And these two here, APR and ACC, are for the exact same loan. One 6-month 50,000-dollar loan with the exact same interest and fees. As you can see, APR 33.6, ACC 22.63. One’s looking a lot higher than the other for the exact same loan with the same costs. So, this is basically ACC is APR, but smaller. That to us is sort of like introducing a new food measurement for example where I can look at Cinnabon and say, “Oh, it doesn’t have 900 calories anymore. It has 600 calories.” And I think just like that would drive people to make bad food decisions. This ACC is gonna potentially mislead borrowers into choosing potentially more expensive products because they’re gonna conflate APR and ACC. And the danger is gonna occur here because borrowers are gonna be comparing different products. One quoted with APR and one ACC. Lots of things are still gonna be quoted in APR. The Schumer box in your credit card is still gonna have APR. And I can tell you the credit that small business customers are gonna confuse them when they’re looking at one that says APR 33 and one that says this. And it’s just lower. It’s like buying the Cinnabon. Right? Suddenly, you’re gonna pack the one that looks lower even though in fact it’s not the actually less expensive product. It’s just a different metric entirely. So, the problem is going to I think not go away over time with this because we are gonna continue to live in an ecosystem where APR remains, you know, the prominent metric. So, people are going to be really doing apples to oranges comparisons between APR and ACC. And for us, this isn’t actually just speculation. I think I mentioned we did a lot of homework when we developed SMART box over 18 months. And one of things we did is actually considered putting a second percentage metric, the AIR, into the SMART box. So, it would have had one more percentage here. And when we shared that with small business customers, it immediately caused confusion. They’re like “Which one is the real one? Which one is the right one?” And so, it just led to a ton of questions. And so, we ultimately said only one percentage-based metric on this because it’s just gonna confuse people. And so, I think the concern for us is that we’re either now in a position as the ILPA of having to drop APR entirely and replace it with this new metric, which is untested from our perspective. I don’t know anyone who’s ever used it. I don’t know if there had been any studies on whether or not it actually kind of works over time. So, we either are going to replace it or we can go back to a situation where we are gonna have to have 2 percentages on the SMART box again, which we know based on our own back information does cause confusion for people.
[0:15:07]
So, in closing, we support the concept here. We believe in transparency and disclosure, but we are very concerned that this metric will be confusing for people. I’m happy to answer any questions.
Limon: Thank you.
Fisher: Thank you. Chair Limon and committee members, thank you for the opportunity to present testimony today regarding SB-1235. My name is Kate Fisher. And I am here today on behalf of the Commercial Finance Coalition, a group of responsible finance companies that provide capital to small and medium sized businesses through innovative methods. We support California’s efforts to provide business financing disclosures. CFC members already disclose the cost of financing and welcome all of the disclosure requirements of SB-1235 except for one. That is the estimated annualized cost of capital disclosure. For clarity, we do not oppose disclosure. Instead, we’re advocating for an effective and accurate disclosure. Our concern is that requiring any annualized percentage for financing that is not alone will mischaracterize the underlying transaction. Senator Glazer’s bill recognizes that requiring an estimated annualized cost of capital disclosure does not make sense for other non-loan products such as commercial leasing or invoice factoring. Commercial leasing is completely exempt from SB-1235. And invoice factoring is exempt from the annualized cost of capital disclosure. That is because commercial leasing and invoice factoring are not loans, but SB-1235 proposes to require an annualized cost of capital disclosure for future receivables factoring, also not loan. This is illogical. Future receivables factoring is fundamentally different from a loan. The business pays only a percentage of its receivables. For example, when wildfires swept across California last fall, a business that was damaged and could not operate would owe nothing. Because the transaction is not a loan, any APR or annualized cost of capital disclosure would only confuse and mislead small business owners. I’m very optimistic that California can lead the way in providing businesses with disclosures that are helpful and not misleading. For example, the disclosure in SB-1235 that would require the disclosure of total dollar cost of financing, which is currently in the bill in Section 22802 (b) (3). Thank you.
Limon: Thank you. Any other witnesses in opposition? Please state your name and association. All right. Hearing or seeing none, members, we will turn it over to you. Any questions or thought Assembly Member Grayson?
Grayson: Thank you, Madam Chair. I was hearing the testimony about APR versus ACC and it was almost like you— It sounded like it was apples and oranges, right, compared between the two. So, as long as the consumer or in this particular case the business owner that was seeking a commercial loan was aware that they were apples and oranges, then as long as they were aligning the apples together or the oranges together and comparing the right rates, then there wouldn’t be confusion. Is that right?
Patterson: I think that if people got past the similarities between them and actually sort of dug in, they could potentially say, “Okay. ACC is basically computed completely differently and is designed to be a different metric.” I think the hard part is when you just see APR, ACC and you see rates. People are making quick decisions and I think they’re gonna see 36%, 23% and just go with that. One of the other things I think that’s problematic here is that the underlying differences— I wouldn’t even begin to try to explain because trying to say why APR is computed one way and why ACC is computed the other way is gonna be complicated and take up a lot of time on the phone where people try to understand which one is the real one that they’re supposed to be looking at.
Grayson: Sure. So, if we were comparing products—
Patterson: Yes. Uh-huh.
Grayson: …whether that product from three different lenders was using APR, then I would have a fair comparison between.
Patterson: Yes. Apples-apples.
Grayson: So, if I had all three providers also providing an ACC and they were being compared strictly amongst just ACC, there would be a fair comparison.
Patterson: I would be. And I think the challenge that they will have in doing straight up real-time and apples to apples is going to be that credit cards will never be using an ACC.
Grayson: Right.
Patterson: They’re off doing their TLA, you know, program with the Schumer box and they’re gonna continue to use APR. A lot of small businesses rely on that. So, they’re gonna have an orange, an apple, maybe a couple apples. Maybe a pair. No. Just apples and oranges.
Grayson: I love fruit.
Patterson: You’re gonna have to try to figure. [Laughter]. You’re gonna try to figure it out. So, I don’t think there’s gonna ever be kind of a true, you know—
[0:20:01]
Grayson: Madam Chair, if I may, and I don’t wanna—
Limon: Yeah. No.
Grayson: …take up too much time and I know I have members here that may have concerns or questions. If I may to the author ask a question of what was the motivation to depart from an APR and come up with this new untested ACC?
Glazer: Thank you for the question, although I wouldn’t agree with the untested part. But originally in my bill, I did have APR and opponents came in and said, “We don’t want you to have APR because APR changes with every payment you make. It changes the number.” And they said it creates legal vulnerability for us to add that to use APR. And I said, “Okay.” The purpose here is not to curtail small business lending. We need that capital out there. The only issue I want is disclosure and I don’t wanna create legal liability. So, I said, “Okay. Because APR changes with every payment, let’s come up with another metric that’s not a new metric, but a metric in the world of business that says let’s take a snapshot in time of what that would cost over the course of a year.” And that’s why we annualize cost of capital (ACC). It’s not based on whether you make more payments this month or less payments next month. It’s one snapshot, thereby providing a fair estimate without legal vulnerability and a very simple standard and that’s where ACC has come from.
Grayson: You said without legal vulnerability because I know that’s been one of the concerns of ACC is that you could draw a figure out there and it actually not be the exact figure and it creates liability on the lender’s part. What have you done to be able to mitigate that liability?
Glazer: Because in the bill, it says an estimate. It says an estimate, an annualized cost of capital. So, that’s the required disclosure and that is something that I think provides appropriate legal protection for any lender who is providing that capital and that proposal too.
Grayson: So, within their disclosure, you’re saying if you put estimate on there, then that would help mitigate it.
Glazer: And I certainly haven’t heard any criticism on those terms in regard to ACC.
Grayson: All right. Thank you.
Glazer: Thank you.
Limon: Any other questions or thoughts? Vice Chair Chen.
Chen: Thank you, Madam Chair. I do want to say that, you know, as a Republican, one thinks that is always a concern is government overreach. This bill doesn’t do that. You know, my opinion, this is a bill which is helpful for the lender. It’s helpful for the consumer. It is information that is helpful in which will prevent them from making decisions that will be financial duress for them in the future. So, I appreciate bringing this bill forward. So, with that said, I’d be happy to move the bill.
Limon: [0:22:37][Inaudible]
Gabriel: Yeah. So, I was just curious for the opponents of the bill. If you’re opposed to ACC and you’re opposed to APR, is there a metric that you would recommend and suggest?
Patterson: Well, all of the members of ILPA do disclose APR now. So, we’re not opposed to APR. I think there were people in the business community. Let them speak.
Fisher: Yeah. Thank you. The total dollar cost of financing, which is not a percentage, but tells the small business owner this is how much the money will cost, that is the best metric and particularly because the goal is to provide a measurement that works across different products. So, that measurement works whether it’s a loan or a sale.
Gabriel: And is that something that’s already required to be disclosed?
Fisher: No. I mean, not by law. It is required to be disclosed by contract so that the customer understands what kind of financing they’re getting. And the members of the group I represent do provide disclosures like that.
Patterson: I would say that when we developed the SMART box and did a survey of small businesses part of that. Total cost of capital was something— Dollars and dollars out, at the end of the day, that is what is most meaningful to them. I’m not suggesting annualized metric or whatever. The problem with annualized metrics generally is that the shorter the term of the loan, they just look a lot— if it starts to fall apart under year. But to the point that you made, total cost of capital is something that business owners say is the metric and it’s why it’s at the top of our SMART box.
Limon: Assembly Member Weber.
Weber: Just wanted to get some clarity. Now, this SMART box that you have, how long have you had the SMART box? I mean, is this something that small businesses have access to and have for years or it’s something new?
Patterson: We launched it in June of 2016. So, it’s been around for 2 years.
Weber: Okay. But it’s not required.
Patterson: It is not. It’s a voluntary industry model. Anybody who joins the ILPA must disclose it as part of that membership. So, you have some of the larger lenders like OnDeck and Kabbage using it, but it is not mandatory. It’s not mandated by any government.
Weber: Okay. Okay. So, therefore, it’s kind of an uneven thing in terms of who has access to it or whether or not people know what the real cost of their loans are.
Patterson: Yes.
[0:25:00]
There’s no mandate to make these disclosures. That’s correct.
Weber: Okay. And the industry initially was opposed to APR and I assume they still are. I would imagine. Has there been some revelation—
[Crosstalk]
Fisher: Thank you. The financing companies that don’t offer loans, but offer a type of factoring program, they are opposed to any type of annualized metric because those types of transactions don’t have a term. The business only pays a percentage of its revenue as that revenue is created. So, the transaction will take as long as it takes the business to generate the revenue that they will then deliver to the company.
Weber: Okay. And I assume that any new system that you come up with will be untested. I mean, that’s the nature of something new. If it was not, it would be old rather than being something new. So, I’m not necessarily persuaded by the untested element of it. I think there needs to be some transparency. I was surprised that there wasn’t that much transparency in terms of commercial loans. I just assume everybody had transparency and knew what a loan cost. And so, I found it rather incredible that it didn’t happen. I’m not sure I’m convinced that ACC is the best thing, but I haven’t heard anybody tell me thing else. I know people don’t like the APR very much, but I think I heard that ACC is so horrible. I’m probably gonna support this as it goes forward with hopes that whatever problem there is you guys will work it out before it gets to the floor. I’m not sure that I will vote for it on the floor, but I do wanna give life to this so the conversation can continue because I think it is very important especially for small businesses. So, I’ll second the motion that was made.
Limon: Thank you, Assembly Member Weber. And I think we have Assembly Member Acosta and then Assembly Member Gabriel.
Acosta: Thank you very much. I kind of appreciate the discourse today. You know, I appreciate Senator Glazer coming by and having some significant conversations around this. It is a complicated issue when you’re talking about introducing a new metric by which consumers which— I know we’re calling them business owners, but they’re still people and they still have credit cards, and auto loans, and mortgages. And all these things are calculated somewhat differently. So, I think there is an opportunity here for more disclosure. I share my colleague’s— from San Diego— sympathies that this may not be the best answer because these things are all calculated differently whether it’s, you know, traditional factoring, whether it’s future receivables. My concern has been that as a consumer and a small business owner because they’re still individuals, they’re still people that you’re on one side of the fence and you’re getting a credit card offer or a small business loan offer from one entity on your credit card. It popped up on my screen from one of my bank statements the other day. And then over on this side, we’re doing something entirely different. And I’m concerned that there will be confusion there. I think of you have made attempts to try to address this. I think that we need good disclosure in this realm. Can you tell me just for the record the sunset date on this? We have a sunset of what?
Glazer: 4 years.
Acosta: 4 years. So, I’m not thrilled with no disclosure. I’m not sure this is 100% percent the way to go. But I think that given the fact that APR doesn’t work, ACC may not work, we gotta try something. You seem to be very interested in making something work. So, I really encourage you to work with, you know, the opposition to try to fix things to their liking and to really try to find something that small business owners can sink their teeth into. You know, maybe you’re gonna invent something new here that’s gonna carry throughout the rest of the country. I don’t know. I’m not 100% comfortable with the discrepancies that small business owners are gonna be finding themselves, but it’s a step. And so, I’m gonna be taking a look at this. I may lay off at this moment, but I’m leaning towards supporting your bill today just so we can continue to work on this, but I’m reserving judgment on the floor for what the final product is. Thank you.
Glazer: Thank you.
Limon: Assembly Member Gabriel and then Assembly Member Gloria.
Gabriel: Yeah. I just wanted to associate myself with the comments of my colleague from San Diego. I appreciate, Senator Glazer, your effort to do this and bring transparency to the space. I think that’s a very worthwhile objective. I’m inclined to support you today to continue the conversation, but then I’m gonna reserve judgment on the floor just to help myself understand this a little bit better, but very much appreciate what you’re trying to do here and thank you for bringing this bill forward.
Glazer: Thank you.
Gloria: Thank you, Madam Chair. And Senator, thank you for the bill today. I’m reading it furiously after being substituted just a few hours ago.
[0:30:01]
Sorry. It’s why the pass the medium-sized box. Right? I know you bring up a common sense approach here legislating. I was struggling with the conversation in terms of different metrics. I think I heard that part a bit. Forgive me if I missed the portion when you addressed one of the other things. In my quick read of this, what was somewhat troubling to me is the 4th page of the committee analysis talking about the ability or lack thereof to provide oversight or enforcement on this. It would seem to me then if we’re looking out for small businesses, we’d have to have some way of trying to actually enforce what you’re to do with this bill. It’s difficult for me to vote for something that says what it says here in terms of having— It’s either silent or it’s impossible to hold folks accountable so on and so forth. Can you speak to that and why the bill is at its current state with these comments?
Glazer: Absolutely. Thank you, Assembly Member. There are some that we like to regulate and the thing that we in our conversations about it that we’d rather start with this step of disclosure and not licensing and not regulation. And the hope would be that the marketplace can act appropriately, disclose appropriately and that can be the end of it. But under current law, if you have a contract dispute, you have the same remedies under this bill as proposed as you would in any other circumstance that you have today. And our public law enforcement officers have that same ability if they see violations to engage is appropriate. So, the same remedies that exists today, you know, are in place with the exception of regulation. And it was my view that— ‘cause you get folks from all sides on these kinds of things. And it’s a new engagement because it is the Wild West today. There is no requirement We heard from witnesses that she does this and they do that. There is no requirements anywhere in this space in California or across the country. And so, it was at that context that my feeling was— And we took a lot of amendments to narrow this bill and I can go through those. The first step should be a simple disclosure mechanism with a sunset and we can evaluate it as it goes. I don’t wanna curtail the lending market, whatsoever. But if we have bad actors that continue to not follow those rules, then I’m very open to trying to see what else is required. And that’s why we’ve taken a small step today that you see in front of you.
Gloria: So, this is not a matter of this will be addressed in a future committee or before it to the floor. It is the intent to leave it sort of open at least at this point.
Glazer: Again, given the various players in this space, the smaller step to me would seem to be the more appropriate step. No. It is not my intention to put a new regulatory framework under this bill. I think that makes it more difficult. And listen, if we didn’t have the opposition to APR from the start, we might be in a different place today, but I’ve tried to accommodate opposition and that’s why you have the narrowness of this bill before you.
Gloria: Okay. Thank you.
Glazer: Okay.
Limon: Assembly Member Gonzalez Fletcher.
Gonzalez Fletcher: And obviously, I don’t know what the opposition was to APR. All of this is new to me. I’m fairly new to this committee, but I am concerned with kind of— I don’t wanna say unsophisticated. But you know, my father has had small businesses and has made determinations whether he put something on a credit card versus takes out some sort of loan. Is the ACC always going to be smaller than the APR? I really know nothing about these things.
Glazer: It depends on the duration. It’s meant to say over 12 months. There’s a lot of loans and this is part of the problem in that space, is I say you need $1,000 for a pizza oven repair.
Gonzalez Fletcher: Right.
Glazer: And I say to you “Listen, I’ll give you $1,000. It will cost you $200.” And this is what the opposition said. The small business people wanna know what that total cost. Well, it’s $1,200 to get $1,000 now and you have to pay it back when? Well, you have to pay it back in 90 days. That interest rate that you’re paying is gonna be a lot higher than you can pay it back in a year or if you paid it back based on taking a penny out of every credit card transaction. So, when these lenders come in, they can offer you this wide array of ways in which it’s not gonna cost you anything to your dad and that’s been the challenge. The issue of the annualized cost of capital is to say whether you take that loan for 90 days or for 2 years. You have an annualized cost as if it was for 12 months and more importantly knowing how much it’s gonna cost you. You can shop the next vendor and the next financier and have an apples to apples to compare it to because one vendor may say, “Pay me in 6 months.” Another one will say, “Well, 18 months.” Well, what’s the difference?
[0:34:59]
And so, that annualized cost is a way to have that one standard review. And I did do a chart here to give you a sense of these are the standards required by the bill. And at the bottom of it, it says, “What’s the annualized cost of capital?” You have a way of reviewing that. This chart is based on $150,000 one time over the period of time. And so, each of these steps disclosed and then this is the last one, the bill that’s being debated today. What’s the annualized cost if you paid it over 12 months? This is a 15-month example, but this is what it would be over 12. And you can compare it from person to person or lender to lender.
Gonzalez Fletcher: As long as the product you’re getting is all from— Like I think what I’m struggling with is you’re making an assumption that they’re looking just at this one product, right, this online product and they’re not thinking through like “Well, I have space on this credit card. I have the ability—” You know? And if we’re not using the same percentage, then it’s biased to this because you’re gonna get a lower percentage. That’s what I’m concerned. Does that make sense?
Glazer: Yes. So now—
Gonzalez Fletcher: I feel really ignorant in this space. I have to tell you.
Glazer: No. No. And listen, welcome to the world of small business lending. Okay?
Gonzalez Fletcher: Right.
Glazer: Even us have struggle with it. So, this is an example based on 150,000 one-time loan paid off over— is it— about 3 years. Okay? Now, here’s another example of $150,000. But now, it’s paid off— let’s see here—
Gonzalez Fletcher: A little over a year.
Glazer: Right. A little over a year and it comes from money out of your— See, it says— Let’s see. Okay. This is the 15-month loan one time. This is money out of your cash register over a much longer period of time. And you can see how these charts then work out. Under this one, they’re both $150,000. This is the total cost of all your payments. This is 170. That’s 179. Here’s your financing costs under this example. It’s 20,000. On this example, it’s 29,000. Here’s how much you paid everyday. If what’s most sensitive to your dad was how much he had to put out everyday, this one is $370. That one is $163. And so, you work down this chart and then you say, “Well, what if I had to pay this over 1 year?” The apples and apples, this is a 10% cost and that one is a 6% cost, but you can get a sense of the complexity of these. Just two different examples. A flat loan versus something that you’re gonna pay off everyday out of your cash register. And this is the dilemma that they all face. How do you create the apples to apples with these different products? And this shows you that you can have different products with different loan amounts and different directions, but the one thing that you can compare the apples to is the annualized cost of capital in both charts. They’re never gonna give you an APR and an ACC. They’re gonna just show you the— whatever the law requires is what they’re gonna provide. And this is a way for you to cross comparison shop that doesn’t exist today.
Gonzalez Fletcher: Okay. So, I’m sorry. So, I get how you can compare these two. And I applaud what you’re trying to do. I think this is good. My concern is how do you compare this to my business credit card or something that’s giving me just an APR?
Glazer: That’s a consumer loan and that is a—
Gonzalez Fletcher: But small businesses use credit in a variety of way. I mean, I guess you can say loan, but I mean especially small businesses use a variety— I’m just worried about that like are we— This makes very good for what you are trying to do, but that’s not the only way people borrow money to—
Glazer: Right. And the challenges that the credit card APR— it’s based on how much you pay and when. In other words, that’s just an estimate, but it’s a changing estimate every month. If you decide to only pay so much in the principal, that’s gonna change that number. And so, that’s the dilemma of even looking at that financial instrument of if I put this on my credit card versus take out a business loan. It’s a very challenging thing for anyone to understand because— And that’s why I go back to the simplicity, is the annual cost, not an APR that fluctuates. And obviously, some in the industry say we love it and some say they hate it and wanted a change in the bill. And that will always remain that dilemma. Buyer beware, lender beware. We’re just trying to give that small business owner one additional tool and that’s not how much is the money gonna cost me or how much do I pay everyday. What would this cost if I had it for 12 months?
Gonzalez Fletcher: Why wouldn’t you have both?
Glazer: Well, we do. The bill does require that all these elements be provided.
Gonzalez Fletcher: No. APR and ACC. Why wouldn’t you have both?
[0:39:59]
Glazer: Well, first, we had the concern on APR about the legal jeopardy of that number fluctuating and how can you have it be a fair estimate.
Gonzalez Fletcher: How do they do it on credit cards? I get a credit card or I’m applying for a credit card and it tells me this is the APR and that’s [0:40:13][Inaudible]
Glazer: There is about a stack of federal regulation this high that went into that high plus more that have gone into the whole determination of APR. And when you say it’s been around a long time, it’s been hotly debated on the federal level. And so, you have this body of information that’s now there that guides companies in how they do it and how they calculate it.
Gonzalez Fletcher: So, these companies could do that.
Glazer: They could do that today. Most of them don’t. I’m happy to hear one that does provide it. But again, it’s the Wild West, so—
Gonzalez Fletcher: So, why wouldn’t we want both? I mean, there’s a function to do it and then it could better cross compare between different products. I meant more disclosure, not less.
Glazer: Yes.
Gonzalez Fletcher: I’m not like setting you— I have no idea. I’m totally confused on trying to do the right thing in this bill, so—
Glazer: Yeah. Well, look, I’m open minded. For me, the fundamental issue is how do we provide an appropriate level disclosure to give that small business person a fighting chance in the lending market. I hadn’t thought about whether providing both and whether that would be helpful or less helpful. I’m open minded to it. I’ve been trying to simplify this because there’s been a lot of efforts to complicate it and that’s why I hadn’t gone in that direction, but I’m still open minded about whether that would be more helpful or less.
Gonzalez Fletcher: Well, I would say for a lot of small businesses and I think that small business is my community where you have a lot of non-English speakers, a lot of non-native speakers being able to actually look at two completely different products. One that’s maybe not supposed to be used for small business loans. But as a credit card versus this to line up the letters regardless of how you get to that number and what it means, but line up the letters and try to get to some comparison would be helpful rather than assuming the level of knowledge I think that even if it was in their home language, probably— I mean, it’s beyond me and I consider myself slightly educated, but definitely with folks who are new to this country and who are trying to figure this all out I’m a little concerned. That’s all.
Glazer: Yeah. Thank you.
Limon: Thank you. Assembly Member Steinorth.
Steinorth: First, I just like to say I think this is very clever. I’ve been in business for over 20 years and my business is helping local and small businesses grow. I’ve been doing that successfully. I’ve probably helped over 10,000 businesses be successful and the single greatest reason for their failure is under capitalization. Period. That’s it. And so, short term versus longer term access to capital, I believe that your way of— I’m really trying to add the transparency to the short term access to capital so people have a clear understanding of what it’s going to cost their business. It’s gonna be very useful for their success.
Glazer: Thank you.
Steinorth: So, I’ll be voting yes on this bill. Thank you.
Glazer: Thank you. I appreciate it.
Limon: Thank you. Senator, you and I have had multiple conversations about this and I think the analysis does express some concern with the ability to enforce particularly because enforcement is also a way to ensure that your objective is met. It’s not just an enforcement mechanism, but it’s also about the objective. But we’ve also had conversations about the direction of the bill and knowing how important it is for any, you know, consumer to have the information they need to make the best decisions. What I’m hearing is that at this point APR— You’re lucky if you have it. Some do. Some don’t. It’s not a standardization. And so, as I listen to colleagues bring concerns forward about how do you compare all of your options, not just your online lending, but all of your options, I also understand that currently that can’t exist because if they— Right now today, if they were to try to go to an online loan or a cash advance and also compare credit cards, they don’t have the mechanism to look at it apples to apples. I appreciate that this is at least for the moment a temporary solution. It has a 4-year sunset so that we can understand. I still continue to have concerns about how the objective is going to be met, how we know that whether it’s ACC or something else is going to be met, and how we’re ensuring that over the next 4 years potentially all the consumers or customers of this product see the same thing. I’m not sure. But there are certain themes that you have brought forward, themes that I have been very sensitive to this year in the world of banking and finance. And those include the importance for transparency, for disclosure, and for people to understand the true cost of a loan.
[0:45:08]
I understand how hard it is for these things or these elements to be in place with a lot of products. And for those reasons, I’m going to give you an aye vote in good faith that we can try to get there, but I will note that there are still some concerns and I’m happy to be part of any kind of conversation to make sure that the objective you’re trying to get to is one that is able to be met. And I know how hard this work is. And with that, if there are no other comments, I think we will have you close and then we’ll take a vote. Thank you.
Glazer: Thank you, Madam Chair and members, for this thoughtful, thorough conversation that we’ve had today. I appreciate it. I wanna underscore again how hard we have worked (my staff, your staff, and others) to try to narrow the differences, take out leasing, take out some of the receivables issues that we can’t really fit into this box so that we could provide something that’s simple, and easy, and understandable, and transparent. I think we’ve gone a long ways here. I know there’s more work still to be done and I’m happy to look— I look forward to that work that we can do together. We do need to protect our small business people. And it is a Wild West of financing out there. And I think this bill does get us closer to that space and I appreciate your consideration. Thank you.
Limon: Thank you. Please call the roll.
Speaker: Limon.
Limon: Aye.
Speaker: Limon aye. Chen:
Chen: Aye.
Speaker: Chen aye. Acosta.
Acosta: Aye.
Speaker: Acosta aye. Burke. Gloria. Gabriel.
Gabriel: Aye.
Speaker: Gabriel aye. Gonzalez Fletcher. Gonzalez Fletcher not voting. Grayson.
Grayson: Aye.
Speaker: Grayson aye. Steinorth.
Steinorth: Aye.
Speaker: Steinorth aye. Stone. Weber.
Weber: Aye.
Speaker: Weber aye.
Limon: All right. The motion is do pass and that is out 7-0. We will leave the roll open for additional add-ons.
Glazer: Thank you very much.
Limon: Thank you.
Glazer: Thank you all.
[0:47:24] End of Audio
The Madden Decision, Three Years Later
February 18, 2018
At first, reversing the 2015 Madden v. Midland Funding court decision, which continues to vex the country’s financial system and which is having a negative impact on the financial technology industry, seemed like a fairly reasonable expectation.
The controversial ruling by the Second Circuit Court of Appeals in New York, which also covers the states of Connecticut and Vermont, had humble roots. Saliha Madden, a New Yorker, had contracted for a credit card offered by Bank of America that charged a 27% interest rate, which was both allowable under Delaware law and in force in her home state.
But when Madden defaulted on her payments and the debt was eventually transferred to Midland Funding, one of the country’s largest purchasers of unpaid debts, she sued on behalf of herself and others. Madden’s claim under the Fair Debt Collection Practices Act was that the debt was illegal for two reasons: the 27% interest rate was in violation of New York State’s 16% civil usury rate and 25% criminal usury rate; and Midland, a debt-collection agency, did not have the same rights as a bank to override New York’s state usury laws.
In 2013, Madden lost at the district court level but, two years later, she won on appeal. Extension of the National Bank Act’s usury-rate preemption to third party debt-buyers like Midland, the Second Circuit Court ruled, would be an “overly broad” interpretation of the statute.
For the banking industry, the Madden decision – which after all involved the Bank of America — meant that they would be constrained from selling off their debt to non-bank second parties in just three states. But for the financial technology industry, says Todd Baker, a senior fellow Harvard’s Kennedy School of Government and a principal at Broadmoor Consulting, it was especially troubling.
“The ability to ‘export’ interest rates is critical to the current securitization market and to the practice that some banks have embraced as lenders of record for fintechs that want to operate in all 50 states,” Baker told AltFinanceDaily in an e-mail interview.
A 2016 study by a trio of law professors at Columbia, Stanford and Fordham found other consequences of Madden. They determined that “hundreds of loans (were) issued to borrowers with FICO scores below 640 in Connecticut and New York in the first half of 2015, but no such loans after July 2015.” In another finding, they reported: “Not only did lenders make smaller loans in these states post-Madden, but they also declined to issue loans to the higher-risk borrowers most likely to borrow above usury rates.”
With only three states observing the “Madden Rule,” the general assumption in business, financial and legal circles was that the Supreme Court would likely overturn Madden and harmonize the law. Brightening prospects for a Madden reversal by the Supremes: not only were all segments of the powerful financial industry behind that effort but the Obama Administration’s Solicitor General supported the anti-Madden petitioners (but complicating matters, the SG recommended against the High Court’s hearing the case until it was fully resolved in lower courts).
Despite all the heavyweight backing, however, the High Court announced in June, 2016, that it would decline to hear Madden.
That decision was especially disheartening for members of the financial technology community. “The Supreme Court has upheld the doctrine of ‘valid when made’ for a long time,” a glum Scott Stewart, chief executive of the Innovative Lending Platform Association – a Washington, D.C.-based trade group representing small-business lenders including Kabbbage, OnDeck, and CAN Capital — told AltFinanceDaily.
Even so, the setback was not regarded as fatal. Congress appeared poised to ride to the lending industry’s rescue. Indeed, there was rare bipartisan support on Capitol Hill for the Protecting Consumers’ Access to Credit Act of 2017 — better known as the “Madden fix.”
Introduced in the House by Patrick McHenry, a North Carolina Republican, and in the Senate by Mark Warner, Democrat of Virginia, the proposed legislation would add the following language to the National Bank Act. “A loan that is valid when made as to its maximum rate of interest…shall remain valid with respect to such rate regardless of whether the loan is subsequently sold, assigned, or otherwise transferred to a third party, and may be enforced by such third party notwithstanding any State law to the contrary.”
Just before Thanksgiving, the House Financial Services Committee approved the Madden fix by 42-17, with nine Democrats joining the Republican majority, including some members of the Congressional Black Caucus. Notes ILPA’s Stewart: “We were seeing broad-based support.”
But the optimism has been short-lived. The Madden fix was not included in a package of financial legislation recently approved by the Senate Banking Committee, headed by Sen. Mike Crapo, Republican of Idaho. Moreover, observes Stewart: “Senator Warner appears to have gotten cold feet.”
What happened? Last fall, a coast-to-coast alliance of 202 consumer groups and community organizations came out squarely against the McHenry-Warner bill. Denouncing the bill in a strongly worded public letter, the groups — ranging from grassroots councils like the West Virginia Citizen Action Group and the Indiana Institute for Working Families to Washington fixtures like Consumer Action and Consumer Federation of America – declared: “Reversing the Second Circuit’s decision, as this bill seeks to do, would make it easier for payday lenders, debt buyers, online lenders, fintech companies, and other companies to use ‘rent-a-bank’ arrangements to charge high rates on loans.”
The letter also charged that, if enacted, the McHenry-Warner bill “could open the floodgates to a wide range of predatory actors to make loans at 300% annual interest or higher.” And the group’s letter asserted that “the bill is a massive attack on state consumer protection laws.”
Lauren Saunders, an attorney with the National Consumer Law Center in Washington, a signatory to the letter and spokesperson for the alliance, told AltFinanceDaily that “our main concern is that interest-rate caps are the No. 1 protection against predatory lending and, for the most part, they only exist at the state level.”
But in their study on Madden, the Stanford-Columbia-Fordham legal scholars report that the strength of state usury laws has largely been sapped since the 1970s. “Despite their pervasiveness,” write law professors Colleen Honigsberg, Robert J. Jackson, Jr., and Richard Squire, “usury laws have very little effect on modern American lending markets. The reason is that federal law preempts state usury limits, rendering these caps inoperable for most loans.”
While the battle over the Madden fix has all the earmarks of a classic consumers-versus-industry kerfuffle, the fintechs and their allies are making the argument that they are being unfairly lumped in with payday lenders. “Online lending, generally at interest rates below 36%, is a far cry from predatory lending at rates in the hundreds of percent that use observable rent-a-charter techniques and that result in debt-traps for borrowers,” insists Cornelius Hurley, a Boston University law professor and executive director of the Online Lending Policy Institute. Because of fintechs, he adds: “A lot of people who wouldn’t otherwise qualify in the existing system are getting credit.”
A 2016 Philadelphia Federal Reserve Bank study reports that traditional sources of funding for small businesses are gradually exiting that market. In 1997, small banks under $1 billion in assets –which are “the traditional go-to source of small business credit,” Fed researchers note — had 14 percent of their assets in small business loans. By 2016, that figure had dipped to about 11 percent.
The Joint Small Business Credit Survey Report conducted by the Federal Reserve in 2015 determined that the inability to gain access to credit “has been an important obstacle for smaller, younger, less profitable, and minority-owned businesses.” It looked at credit applications from very small businesses that depend on contractors — not employees – and discovered that only 29 percent of applicants received the full amount of their requested loan while 30 percent received only partial funding. The borrowers who “were not fully funded through the traditional channel have increasingly turned to online alternative lenders,” the Fed study reported.
The ILPA’s Stewart gives this example: A woman who owns a two-person hair-braiding shop in St. Louis and wants to borrow $20,000 to expand but has “a terrible credit score of 640 because she’s had cancer in the family,” will find the odds stacked against when seeking a loan from a traditional financial institution.
But a fintech lender like Kabbage or CAN Capital will not only make the loan, but often deliver the money in just a few days, compared with the weeks or even months of delivery time taken by a typical bank. “She’ll pay 40% APR or $2,100 (in interest) over six months,” Steward explains. “She’s saying, ‘I’ll make that bet on myself’ and add two additional chairs, which will give her $40,000-$50,000 or more in new revenues.”
In yet another analysis by the Philadelphia Fed published in 2017, researchers concluded that one prominent financial technology platform “played a role in filling the credit gap” for consumer loans. In examining data supplied by Lending Club, the researchers reported that, save for the first few years of its existence, the fintech’s “activities have been mainly in the areas in which there has been a decline in bank branches….More than 75 percent of newly originated loans in 2014 and 2015 were in the areas where bank branches declined in the local market.”
Meanwhile, there is palpable fear in the fintech world that, without a Madden fix, their business model is vulnerable. Those worries were exacerbated last year when the attorney general of Colorado cited Madden in alleging violations of Colorado’s Uniform Consumer Credit Code in separate complaints against Marlette Funding LLC and Avant of Colorado LLC. According to an analysis by Pepper Hamilton, a Philadelphia-headquartered law firm, “the respective complaints filed against Marlette and Avant allege facts that are clearly distinguishable from the facts considered by the Second Circuit in Madden.
“Yet those differences did not prevent the Colorado attorney general from citing Madden for the broad-based proposition that a non-bank that receives the assignment of a loan from a bank can never rely on federal preemption of state usury laws ‘because banks cannot validly assign such rights to non-banks.’”
Should the Federal court accept the reasoning of Madden, Pepper Hamilton’s analysis declares, such a ruling “could have severe adverse consequences for the marketplace and the online lending industry and for the banking industry generally….”
Online Small Business Lending Provides Benefits to Small Business Owners, Finds New Survey
October 23, 2017
Washington, D.C., October, 23, 2017 – Four leading trade associations – Electronic Transactions Association, Innovative Lending Platform Association, the Marketplace Lending Association, and the Small Business Finance Association – commissioned a comprehensive survey of U.S. small business owners from Edelman Intelligence. The survey conducted by Edelman Intelligence found that a large majority (70%) of small business owners believe there are more credit options today when compared to five years ago, and 97% of those feel that the growing number of financing options is a good thing.
Small businesses owners need quick and streamlined access to credit to grow their businesses and the American economy. Online small business lenders are financial firms that provide credit to small business owners through automated, technology-enabled platforms. They regularly work with traditional lenders to deliver loans. By leveraging the ubiquity, speed and convenience of the Internet, online small business lenders use sophisticated software platforms to provide American small business owners with fast, easy and affordable credit.
Key findings of the study include:
- An overwhelming majority of small business owners reported more lending options available now than five years ago. 70 percent of small- and medium-sized business owners say there are more lending options now, and 97 percent of those believe that the increase in options is a positive thing for their businesses.
- Most small business owners reported using online small business lenders to help them expand their locations, make necessary hiring and equipment purchases, and help manage cash flow.
- Of the small business owners considering taking out a loan in the next 12 months, close to 40 percent say they will consider borrowing from an online lender.
- Online small business lenders have high levels of satisfaction and scored high marks for ease of use and business growth enablement. According to the study, 98 percent of small business owners who have used online lenders say they are likely to take out another loan with an online lender.
- For many small business owners, online small business lending platforms are a popular alternative to asking friends and family for a loan.
Media inquiries should be directed to:
ETA PRESS CONTACT:
Laura Hubbard, lhubbard@electran.org
ILPA PRESS CONTACT:
Jim Larkin, jlarkin@ondeck.com
203-526-7457
MLA PRESS CONTACT:
Nat Hoopes, nat.hoopes@marketplacelendingassociation.org
SBFA PRESS CONTACT:
Steve Denis, sdenis@sbfassociation.org
Breakout Capital Expands Senior Leadership Team
August 6, 2017Breakout Capital – a leading small business lender – announces the hires of Robert Fleischmann as Senior Vice President, Strategic Partnerships and Tom McCammon as Senior Vice President, Business Operations. These key additions position the small business lender for continued growth.
McLean, VA, August 7, 2017 – Breakout Capital announced today the appointments of Robert Fleischmann as Senior Vice President, Strategic Partnerships and Tom McCammon as Senior Vice President, Business Operations. Both Mr. Fleischmann and Mr. McCammon bring a wealth of knowledge and small business lending experience that can accelerate Breakout Capital’s rapid growth.
“Breakout Capital’s growing employee base shares the same passion and commitment to advancing the Company’s mission to provide transparent working capital solutions, educate small businesses, and promote industry-wide best practices. We are thrilled with the additions of Robert and Tom to the leadership team,” said Founder & CEO, Carl Fairbank.
“Breakout Capital impressed me with its outstanding commitment to educating and advocating on behalf of small businesses,” said Fleischmann. “The innovative loan products combined with the impressive team of professionals make me extremely excited about the opportunity.”
Mr. Fleischmann will lead Breakout Capital’s efforts to expand and diversify its channels through strategic partnerships. Prior to joining Breakout Capital, Mr. Fleischmann was Director of Strategic Partnerships at RapidAdvance where he worked with a diverse group of partners, including banks and commercial finance companies, to help meet the financing needs of their business clients.
Mr. McCammon joins Breakout Capital with direct industry experience as he was formerly Director of Portfolio Management and Credit Operations at OnDeck. Prior to OnDeck and his recent move to the Breakout team, Mr. McCammon was involved in two de novo banks and was a consultant to the FDIC during the financial crisis. He will be a central figure in continuing to build Breakout Capital’s stature as both a credit-and customer-centric enterprise.
“Having worked in both retail banking and fintech, I was drawn to Breakout Capital as they have successfully combined strong credit and ethics fundamentals from traditional banking while still efficiently delivering capital to small businesses,” said Mr. McCammon.
Breakout Capital has quickly established a reputation as one of the most trusted and respected lenders in the market with a focus on product innovation, transparency, responsible lending and a partnership-based approach that extends beyond providing capital. Additionally, Breakout Capital is a Principal Member of the Innovative Lending Platform Association (ILPA), the leading trade organization representing a diverse group of online lending and service companies serving small businesses.
About Breakout Capital
Breakout Capital, headquartered in McLean, VA., is a technology-enabled direct lender which has provided a wide range of working capital solutions to small businesses across the country. In addition to becoming one of the fastest growing companies in the market, Breakout Capital is a leading advocate for small business. Its CEO, Carl Fairbank, is a Board Member of the Innovative Lending Platform Association. Breakout Capital has produced a highly regarded “educational series” through its blog, Breakout Bites, that helps small businesses better understand the technology-enabled lending market and how to avoid the hidden fees and debt traps that are prevalent in the industry. With a laser focus on educating small businesses, advocating for industry-wide best practices, and providing diverse, transparent working capital solutions, Breakout Capital is changing the financial landscape for millions of small businesses in need of funding. For more information, visit http://www.breakoutfinance.com.
