How Much Is Too Much to Pay for a Small Business Loan?

That was a big question at a conference on small business lending on Thursday at the Federal Reserve Bank of New York, where executives from high-cost alternative lenders mingled with bankers and regulators.

Bob Coleman, who edits the Coleman Report, a trade publication for small business lenders, put it to an executive from OnDeck, an online lender that charges annualized interest rates as high as 134 percent.

A bit of background: Lenders such as OnDeck offer short-term loans for small dollar amounts, generally less than $100,000 for fewer than 12 months, with quick approvals. That’s a kind of capital banks don’t usually offer. Earlier this month, when OnDeck sold bonds backed by its subprime business loans to Wall Street investors, the company revealed that the weighted average APR on the loans it sold investors was 54 percent.

Is that a reasonable rate to charge small business owners? Coleman asked.

“We think it is,” said Andrea Gellert, the OnDeck executive. “APRs somewhat distort the true economic costs and the cost-return relationship on the loan.” To make that point, Gellert posited a hypothetical business owner who has a limited amount of time to buy discounted inventory. “If I buy that inventory for a dollar and sell that inventory for $2 in a six-month period, that’s a 200 percent return. So my 54 percent cost makes absolute sense. I will make that tradeoff every single time.”

Alternative lenders like OnDeck are becoming increasingly popular. They topped $3 billion in loans last year, according to one recent estimate, double the amount of loans for less than $150,000 guaranteed by the Small Business Administration.

At the moment, alternative loans are largely unregulated. For the banking regulators that hosted the Fed conference, there’s a follow-up question worth considering: If APR isn’t the right way to evaluate short-term business loans, what is?

The industry suggests looking at something called net promoter score, a measure of customer satisfaction that Gellert cited at the New York Fed. Two of her fellow panelists, Lending Club Chief Executive Renaud Laplanche, and Darrell Esch, a vice president at PayPal’s small business lending program—also lauded the metric.

Executives at alternative lenders also argue that high renewal rates show the loans are serving borrowers. CAN Capital CEO Dan DeMeo, whose company competes with OnDeck, has said that 75 percent of his company’s customers come back for additional loans, indicating a high-level of satisfaction.

Neither of those measures reveals anything about the cost of the loans, though, so they don’t replace APRs, which allow borrowers to evaluate various offers of credit side by side.

In the consumer lending world, short-term loans with high interest rates have drawn fire from regulators and advocates as predatory debt traps. The Center for Financial Services Innovation, a nonprofit focused on consumer finance, suggests best practices for small dollar personal loans: Lenders should  practice transparent marketing and help borrowers build credit.

But businesses are supposed to be more sophisticated than consumers, and small business loans aren’t governed by the same laws. Some fear regulators will stifle new credit products that could benefit small businesses, even if that credit comes at a high price. On another panel at the Fed conference, William Dennis, a senior research fellow at the National Federation of Independent Business, said he had a message for the Consumer Financial Protection Bureau: “Don’t screw this up.” (It’s worth noting that the NFIB marketed a credit card to its members last fall that lacked key borrower protections required by law for consumers.)

The cost of nonbank business loans needs to come down, whether through market competition or with the help of regulators, says Rohit Arora, CEO of Biz2Credit, a company that serves as an online middleman for small business loans. “Alternative lenders do a great job on customer service, but the pricing sucks,” he says.

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