Selling Subprime Loans to Wall Street Investors, This Time for Small Businesses

Online lender OnDeck has loaned small businesses more than $1 billion since 2007, financed by backers such as Google Ventures and Goldman Sachs. Now, the company is selling bonds backed by its high-cost, low-dollar-amount loans—a move OnDeck says will create new opportunities for Main Street merchants and Wall Street investors.

The $175 million offering is a “landmark in terms of creating a new asset class,” says Noah Breslow, chief executive of New York-based OnDeck. The company, which loaned small businesses $475 million last year, wants to raise money from a broader group of investors. Packaging loans into bonds will ultimately translate to more capital available to Main Street businesses at better interest rates, Breslow says.

If that sounds familiar, that’s because the same process of bundling loans and selling them to investors fed the last decade’s mortgage lending bubble that crippled the global economy when it burst. Small business lending is tiny compared with the U.S. mortgage market, and other types of loans, such as credit card borrowing and auto loans, have long been sold the same way. Packaging bonds funded by unsecured loans to pizza shops and car mechanics is unusual, though.

The deal is also notable for another reason. OnDeck, CAN Capital, Kabbage, and other unregulated small business lenders are generally lending to businesses that banks consider too risky, and they’ve often played coy when asked to describe the details of their lending practices. As part of OnDeck’s bond offering, the company is pulling back the curtain on the prices small businesses pay to borrow from nonbank lenders.

The weighted average annual interest rate for the 5,397 loans being securitized for the bond offering is 54 percent, according to a document (PDF) published online by DBRS, the company rating the bond. That’s almost double the maximum amount credit card lenders are allowed to charge. The document also shows that OnDeck used independent brokers for 47 percent of its loans last year—a practice that diverts borrowing costs to third parties that often have incentives to place business owners in the costliest possible loan.

The loan portfolio being packaged for investors also includes 21 loans with APRs of more than 100 percent, topping out at 134 percent. “I’m shocked and stunned,” says Mark Pinsky, CEO of Opportunity Finance Network, an umbrella group for community-based lenders. “Any smart investor who has any experience at all is going to see that they’re doing something risky.”

About two dozen lenders specializing in small, short-term loans provided small businesses $3 billion in 2013, estimates Marc Glazer, CEO of Business Financial Services, a Coral Springs (Fla.)-based alternative lender. That’s double the volume of loans for $150,000 or less guaranteed (PDF) by the Small Business Administration last year.

Other companies are trying to connect small business borrowers and Wall Street investors. Lending Club, a San Francisco-based peer-to-peer lender that specializes in connecting private investors with borrowers seeking personal loans, started lending to small businesses in March. And Biz2Credit, a New York-based company best known as an online broker that connects small businesses with lenders, is laying plans to securitize small business loans by the end of the year, according to CEO Rohit Arora: “There are a lot of creditworthy businesses that can’t get [bank] loans,” and plenty of investors who “are hungry for yield,” he says.

And despite the high interest rates, not all of OnDeck’s borrowers would be considered risky bets. Forty percent of loans included in the bond offering went to borrowers with FICO scores of 700 or higher, suggesting that even business owners with relatively tidy credit histories are having a hard time getting lower-cost bank loans.

Breslow says that some of the borrowers in OnDeck’s portfolio could probably qualify for less expensive credit but choose OnDeck for its low-hassle application process and relatively small loans. “Our product is becoming more mainstream, and transparency is part of that,” Breslow says.

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