Small Business Lending Code of Ethics
Sometimes lessons learned are lessons forgotten. While the subprime crisis seems long ago, even today it still illuminates just how dangerous it can be when loan brokers run wild. If we’re not careful, we may have to learn that lesson all over again.
Interestingly enough, the often-controversial Dodd-Frank rules reined in mortgage brokers, but now we are discussing the unwind of all or part of this law. Many of the brokers who earned their stripes in the run-up to the subprime crisis have resurrected their careers in a new industry: loan brokering to small businesses. Small-business loan brokers are not currently regulated at the Federal Level, nor are the regulated (in most cases) at the State Level. California requires a license, but it is little more than just a fee the State asks for. Aside from fair lending laws, they aren’t subject to federal oversight. Regulated commercial banks have traditionally steered clear of small-business loan brokers, but the explosive growth of largely unregulated online lenders has given them new opportunities to prey on unsuspecting borrowers.
Anyone in the lending business knows that finding creditworthy borrowers can be difficult. Brokers originate as much as seventy percent of all loans at some of the largest online lenders. That is potentially an epic problem, since brokers’ hefty commissions dramatically increase the costs of already-expensive loans. I recently received an email from a New York lender offering up to a staggering 19% fee on loans meeting certain criteria. A business borrowing $100,000 over six months would pay back $135,000, with the broker getting $19,000. The 19% fee is more than the lender would make on the loan, and more than six times what brokers earn on typical Small Business Administration (SBA) loans.
Unsuspecting borrowers rarely know how much they’re paying for their brokers’ services because these fees are not transparent in the term sheet or the loan agreement(s). Since brokers often market themselves as “impartial”, this often fools the borrower into thinking they are getting a good deal. Small business borrowers are not in the strongest negotiating position and can be vulnerable to this type of transaction. Adding salt to the wound, some lenders offer hefty commissions from and/or bonuses to salesmen for steering borrowers toward high-priced loans, even if cheaper options are available. As with the mortgage melt-down, that rapacity can trap borrowers into loans they simply cannot afford.
While the media may have people fooled into thinking that the rise of online upstarts would bring greater transparency to the process, the most abhorrent offenders are often offline loan brokers. Clearly understand this: while there’s no question that the World Wide Web has the potential to make finding a loan as seamless as booking a flight on Expedia, many of the most prominent online brokers engage in usurious tricks, while pretending to carry the torch of “disruptive innovation”.
These actions impugn the reputation of all brokers and undermine the positive role that brokers can play in facilitating loan discovery. After all, finding a business loan on your own can be daunting, consuming three full workdays on average and requiring that borrowers make sense of myriad complicated loan options.
Since brokers wield enormous influence over a borrower’s financing decision, it’s imperative to establish rules of the road that compel all brokers to respect the trust of borrowers. As a first step, lenders and brokers should agree to a broker code of ethics, keeping these principles in mind.
I have personally worked with many fine brokers out there that ensure loan advice is in the borrower’s best interest. That should really be a minimum requirement. After all many brokers sell themselves as “impartial advocates” to begin with. Brokers need to disclose conflicts of interest that could compromise the integrity of any advice offered. Borrowers deserve to know what they are paying for, and this includes the broker’s fee(s) that are “baked” into any loan agreement.
Educating borrowers is a rewarding accomplishment. Brokers that are worth their salt, should consistently engage in this practice. Tools such as loan calculators, amortization tables, and annual percentage rates help borrowers intelligently shop loan products. Disclosure of the pros and cons of each loan product, including the total interest paid, termination fees, etc…are at a minimum basic knowledge for borrowers. Many business owners are just as untrained in the subtle differences of loan options and terms (as consumers).
We all want to think that the good on people will always prevail. Many brokers have a code of ethics they adhere to; however, this wishful thinking is insufficient to rein in the most predatory brokers. Greater regulatory oversight is warranted, but unfortunately that will take time. Until then, direct lenders need to collectively support rules of the road to help borrowers distinguish between brokers who put borrowers’ best interests first and brokers that are simply out for themselves. ____________________________________________________________________________
Mr. Cox is Managing Principal with Pendleton Capital Group, Inc. – a factoring and trade financing company headquartered in Houston, TX. PCG provides professional “best practices” Factoring and Trade Financing and other small business services. His office is in Houston, TX, and he can be reached for additional information or consultation at [email protected] or 713-808-9746. The company’s website can be accessed at www.pendletoncapitalgroup.com