«Chairman Neugebauer, Ranking Member Clay, and Members of the Subcommittee: I am honored to appear before the Subcommittee today on behalf of CAN ...»
Testimony of Parris Sanz
Chief Legal Officer, CAN Capital, Inc.
Before the House Committee on Financial Services, Subcommittee on
Financial Institutions and Consumer Credit
“Examining the Opportunities and Challenges with Financial Technology (“FinTech”):
The Development of Online Marketplace Lending”
July 12, 2016
Chairman Neugebauer, Ranking Member Clay, and Members of the Subcommittee:
I am honored to appear before the Subcommittee today on behalf of CAN Capital and the Electronic Transactions Association (“ETA”) to discuss the critical role online lending can play in expanding access to credit to our nation’s small business owners.
About CAN Capital Founded in 1998 by a woman small business owner who sought to solve the problem of small business access to capital, CAN Capital is the longest tenured and largest alternative small business finance company. CAN Capital currently employs approximately 450 employees and has provided access to over $6 billion of capital to our small business customers in more than 175,000 separate transactions. The Company provides access to as much as $250,000 per business location, although most customers seek $100,000 or less, and the average transaction size is approximately $45,000. The Company has served small businesses in hundreds of different industries, including healthcare, food retail, automotive, construction, spas and beauty, and business equipment and services, among others. For over 18 years, CAN Capital has served the Main Street businesses that account for half of the private sector workforce and two out of every three new jobs created in the last two decades.1 About ETA ETA is the leading trade association for the payments industry, representing over 500 companies that offer electronic transaction processing products and services, including financial institutions, transaction processors, payments networks, and others. ETA members make commerce possible by processing more than $6 trillion in purchases in the U.S. and deploying payments innovations to merchants and consumers. ETA also has members that are engaged in online lending for commercial enterprises, primarily small businesses, either directly or in partnership with other lenders.
1 Joint Small Business Credit Survey Report, 2014, Federal Reserve Banks of New York, Atlanta, Cleveland and Philadelphia (released February
2015) at 4 (“Joint Small Business Credit Survey”); Karen Gordon Mills, Brayden McCarthy, The State of Small Business Lending: Credit Access During the Recovery and How Technology May Change the Game, Harvard Business School Working Paper 15-004 (July 22, 2014) at 24 (“State of Small Business Lending”).
Access to capital is the lifeblood of small businesses and a major determinant of their success or failure. Unlike larger businesses, small businesses do not typically have access to the capital markets and are heavily dependent upon bank financing.2 Even when bank lending to small businesses was at its apex, from 2005 through 2007, more than 50% of small and midsized businesses reported difficulties obtaining sufficient credit.3 Thereafter, the financial crisis virtually shut down almost all bank lending to small businesses. More than eight years later, challenges still exist for many small businesses to obtain the credit they need from traditional small business loans. According to a 2014 Federal Reserve survey “a majority of small firms (under $1 million in annual revenues) and startups (under 5 years in business) were unable to secure any credit in the prior year”.4 That is a huge gap in credit availability that leaves many small businesses struggling, with significant adverse implications for the economy as a whole.
The problem is especially acute for small businesses seeking smaller loan amounts.
Loans of $100,000 or less account for 90% of small business loans.5 According to the same 2014 Fed survey mentioned above, more than half of the small businesses surveyed that applied for credit in 2014 were seeking loans of $100,000 or less.6 Among small business applicants with less than $1 million in annual revenues, more than half of them received less than 50% of the amount for which they applied.7 This lack of access to smaller loans adversely affects the ability of small businesses to pursue growth opportunities or hire new employees.
Traditional lenders have been unable to effectively address the needs of small businesses because of high customer acquisition and underwriting costs, outmoded and cumbersome underwriting methods and overhead costs associated with their brick and mortar branches. As the Department of Treasury noted in its recent request for information (“RFI”) on online and marketplace lending, traditional small business lenders have “high search, transaction and underwriting costs … relative to potential revenue - it costs about the same to underwrite a $5 million dollar loan as a $200,000 loan - and many small business owners report they are unable to access the credit needed to grow their business”.8 Because of the disproportionately high costs of originating small business loans, it can be uneconomical for many banks and other financial institutions to make loans to many small businesses in amounts less than $150,000, $250,000 or even $1 million dollars. As a result, such institutions have not largely focused on the small business lending market and the percentage of bank loans made to small businesses has dropped to record low levels. In 1995, small business loans accounted for 50% of all bank loans. By 2012, this number had declined to 30%.9 Foreseeably, the continuing consolidation in the banking industry may result in even less traditional bank lending to small businesses.
2 Small businesses receive 95% of their financing from banks. 2011 Economic Report of the President, Council of Economic Advisors, The White House.
3 Experian Information Solutions, Quarterly Business Credit Review for Q3 2013, December 10, 2013, citing NFIB Small Business Optimism Survey, Moody’s Analytics, 2013.
4 Joint Small Business Credit Survey at 4.
5 Office of Advocacy, Small Business Lending in the United States 2013, Victoria Williams, U.S. Small Business Administration, 2014.
6 Joint Small Business Credit Survey at 4.
7 Ibid at 14.
8 80 FedReg. 42866, 42867 (July 20, 2015), citing The Future of Finance, Goldman Sachs Equity Research, March 3, 2015.
9 Karen Gordon Mills, Brayden McCarthy, The State of Small Business Lending: Credit Access During the Recovery and How Technology May Change the Game, Harvard Business School Working Paper 15-004 (July 22, 2014) at 24 (“State of Small Business Lending”).
2 Even where a bank’s minimum loan amount may be consistent with the needs of a small business, the prospective borrower would still have to contend with a potentially cumbersome underwriting process that frequently focuses more upon the creditworthiness and collateral of the business owner than factors associated with the performance of the business.
In addition, small business owners want to focus on running their businesses, not searching for funds. On average, a small business owner may spend 30 hours or more applying for credit from a traditional small business loan program and wait weeks or longer for the underwriting process to run its course and the funds to be disbursed, assuming the loan request is approved.10 By and large, small business owners do not have the luxury of devoting this kind of time to a search for funds, especially where their own low personal credit scores or absence of sufficient collateral may make the search futile. For small business owners with the fortitude to work through the traditional lending process, the odds of receiving all the capital needed for their business still are not guaranteed.11 Online Lenders Role in Expanding Access to Credit to Undeserved Small Businesses Fortunately for small businesses, new and innovative technology platforms are expanding access to credit and offering attractive alternatives to traditional loans.12 Online lending platforms, like CAN Capital and other ETA members, provide small businesses with access to smaller loans (typically less than $250,000) and shorter terms13 that are often better suited to their day to day operating needs or short-term use cases. Online lending platforms also allow small businesses to apply for credit online, from any geographic location, in a fraction of the time it takes to apply for credit from a traditional loan program.14 Using sophisticated, datadriven algorithms to screen the creditworthiness of potential small business borrowers, our industry is able to reach funding decisions quickly and efficiently, and provide access to capital to approved borrowers expeditiously and in some cases within 24 hours. 15 Taking advantage of these technology platforms has allowed small businesses to focus more of their time and effort on growing their businesses, hiring workers and positively impacting the economy.16 Our industry’s approach to evaluating risk differs materially from the traditional underwriting process. Instead of focusing on the performance and prospects of potential small business borrowers, traditional loan programs tend to focus on the personal credit histories of the business owners. They require extensive documentation and frequently require specific and/or personal collateral. Their underwriting approach tends to work only for small businesses with an 10 Small Business Credit Survey, Spring 2014, Federal Reserve Bank of New York (“Small Business Credit Survey”). Of the small businesses surveyed, 40% applied for credit in 2013. Among those that applied for credit, they spent, on average, 33 hours applying, submitting 3 applications to 2.7 financial institutions and more than 51% of them were seeking $100,000 or less.
11 Small Business Credit Survey at 13. Out of the 40% of small businesses surveyed that applied for credit in 2013, only 39% received all or most of the capital that their businesses required.
12 In 2014, almost 20 percent of small business applicants sought credit from an online lender. 80 FedReg 42867.
13 80 FedReg. 42867.
14 Joint Small Business Credit Survey at 4,6 (reporting that survey respondents spent an average of 24 hours researching and completing credit applications).
15 In the case of CAN Capital’s platform, business owners can complete a pre-qualification application online or over the phone and receive a noobligation quote within 10 minutes. The approval rate among businesses that submit a pre-qualification application is approximately 50%. For most customers whose complete applications have been approved, funds are sent the same day as approval or the next day.
16 A study conducted by the Analysis Group in 2014 estimated that the first $1 billion in loans made by one of the largest online marketplace small business lenders generated $3.42 billion in economic impact through industry, supply chain and job creation gains and that 22,000 jobs were created as a result of small business owners having capital to grow their businesses.[cite] 3 extensive history of profitability, owners with good personal credit histories, and businesses that do not have an urgent need for capital.
Companies like CAN Capital deploy data-driven algorithms to quickly assess the risk of extending capital to small businesses with the same robustness as traditional lenders.
Underwriting decisions are made based on factors including the financial performance and prospects of the small business itself and look beyond the business owner’s FICO score (i.e., the criterion on which many banks seem to rely in determining eligibility for a small business loan).
Unlike many traditional bank loans, none of the small business financial products we provide require personal collateral (such as a personal residence or automobile); only a pledge of business assets. Accordingly, CAN Capital and other industry peers have built risk and underwriting models based on firmographic variables, including sales and revenue data, cash flow history, and time in business, to approve small businesses whose owners may have personal FICO scores below 650 (arguably the most underserved segment of the small business population). As a result, our platform allows us to safely provide access to capital for many small business applicants that most banks might decline.
While one might think the ease and speed of our industry’s underwriting process coupled with our willingness to cater to underserved small businesses would have a negative effect on loan performance, the data tells a different story. Since 2008, for example, CAN Capital’s average net write-off rate has been less than 7%. During that time, which includes the most recent financial crisis, we provided small businesses with access to nearly $5 billion in funding.
In contrast, small business lending from traditional bank loan programs essentially froze during the same time period, thereby underscoring the resiliency of our business model. 17
Online Small Business Lending Models
Online lenders are a diverse, nimble and innovative group. The many different models for online lending platforms are the products of the creativity and resourcefulness made possible by the use of financial technology to expand access to credit for small businesses, improve the borrower experience, and bring technology-based efficiencies to the market. As policymakers evaluate the various business models in the online small business lending industry, we hope they appreciate that the broad range and diverse nature of various credit products available to small businesses may not fit neatly into the market segmentation categories used in traditional lending.
Lending models vary based on the nature of the borrower – consumer or business – and the mechanisms used to fund the loans, whether through retail investor participation, private market investor participation, balance sheets, bank partners, and/or hybrid combinations. For example, U.S. peer-to-peer lending – which we would define primarily as the matching of retail investors (although institutional investors may play a large role) with individual borrowers through the SEC registration of a security -- developed within the consumer lending space. To date, this model is predominantly deployed on the consumer side and not for small business/commercial loans.
17 Access to capital has been critical to small businesses, which were hit harder during the 2008 financial crisis and have been slower to recover.