Marketplace lending took root in the shadow of the last financial crisis. Now, the question for consumers, businesses and marketplace lenders (MPLs) alike, is whether the conditions are right for it to thrive in the wake of the coronavirus and what may be the "deepest recession on record."
No doubt, cash-strapped consumers and small businesses will want to turn to nonbank lenders, such as MPLs and other fintech companies, for funding. MPLs may even be able to provide those loans through the recently announced Paycheck Protection Program (PPP) of the "Coronavirus Aid, Relief and Economic Security Act" (CARES Act). But there are hurdles this time around in what is currently an economic, rather than financial, crisis. Investors already seem to recognize this, as publicly traded MPLs continue to trade at or near all-time lows.
The federal response to this economic crisis has been focused on - and rightly so - putting cash in the hands of consumers and businesses. The Federal Reserve has cut interest rates to 0%, lowering the cost for consumer borrowing from traditional banks. The CARES Act, signed into law on March 27, includes a $10 billion expansion of the Economic Injury Disaster Loans Program (EIDL) for small businesses (including flash grants of up to $10,000 that need not be repaid).
Perhaps most significant is the CARES Act's $349 billion PPP program (which is more than twice as large as the last six years of SBA lending combined). Within the framework of the Small Business Administration's (SBA) 7(a) loan program, these PPP loans are only available to businesses that, among other things, employ less than 500 employees. At the same time, all PPP loans have a 1% fixed interest rate, require no collateral or guarantor, and loan payments will also be deferred for six months. Where the loan is used to cover payroll, mortgage interest, rent and utilities, and where small businesses retain their employees and maintain their wages, the PPP loan will be forgiven (with some limitations) for those costs.
Unfortunately, the rollout of the PPP loan process has already been fraught with problems - and many small businesses are struggling to even find lenders to consider their applications. Amazon Web Services has begun working with the SBA to deal with the program's technological issues. It appears MPLs may not be eligible to receive PPP loans, as "[f]irms involved in lending activities," along with other kinds of business, such as casinos, are ineligible businesses under the 7(a) framework.
Likewise, there have also been significant issues with the EIDL program. Many applicants still have not received $10,000 flash grants and the SBA has told business owners that if they were to receive a grant, it would be limited to $1,000 per employee (so businesses with less than ten employees will not receive the full amount); and although the program is supposed to offer loans of up to $2 million, the SBA has told many recent applicants that loans would be capped at just $15,000 per borrower.
It May Be Better To Give than To Receive
Given the administrative issues and concerns that banks may take too long to approve PPP loans, the time would appear right for fintechs, which have cutting edge technology to assess borrower risk, accept online applications, make lending decisions in just minutes, and then wire money to the borrowers in less than 48 hours. The government seems to understand this and the U.S. Treasury Secretary, Steven Mnuchin, has stated that fintechs will now be authorized to make these loans. On April 8, the SBA released an application for nonbank lenders to participate in the PPP, with an FAQ.
But it won't come easy. Although many banks will be practically pre-approved for the program, nonbanks will have to meet certain standards (including under the Bank Secrecy Act) that will require heavy investments of time and money. Moreover, fintech lenders may need to change their systems to allow for SBA servicing and administration. At the same time, lenders can only charge 1% on PPP loans, which may be insufficient economic incentive to undertake the effort. On the positive side, lenders will be able to sell PPP loans into the secondary market, allowing investors to cash in their investments early. Each lender will need to individually weigh the negatives and benefits to participation.
Although a few MPLs have indicated they will be applying to become SBA lenders, we are not aware of any MPLs or fintechs that that have made any PPP loans just yet. Instead, MPLs have been partnering with already SBA-authorized lenders. Several MPLs already have PPP loan applications available to connect small businesses with SBA lenders. Another has partnered with one unnamed SBA bank to deliver PPP loans to small business. Some MPLs have indicated to borrowers that they can reserve their spot to receive a PPP loan from a partner.
State regulators around the country - the primary supervisors of nonbank lenders, such as MPLs, have implored MPLs to take action to help borrowers. The New York State Department of Finance is encouraging licensed lenders to consider all reasonable and prudent steps to assist businesses that have been adversely impacted by COVID-19. Similarly, the Market Place Lending Association has asked that MPLs provide "impacted borrowers with forbearance, loan extensions, and other repayment flexibility that is typically provided to borrowers impacted by natural disasters."
To protect investors, MPLs can take steps to "enhance the resiliency of their portfolios," such as lowering approvals for higher-risk borrowers and increasing income/employment verification requirements. Several had already started preparing for a recession even before the crisis by diversifying funding sources, establishing committed warehouse facilities and generating positive cash flow from operations through lower costs.
To protect borrowers, MPLs can waive late fees, ramp up servicing capabilities and introduce hardship plans (that can be applied for online) to allow eligible borrowers to make interest-only payments for a few months. Some MPLs are already offering existing borrowers up to three months payment relief with fee waivers and suppression of delinquency reporting to bureaus, due date adjustments, multi-month extensions, payment drops and loan settlements.
With these recovery efforts, it may seem like nonbank lenders are being asked to accept inordinate risk. But, as we pointed out in our interview in Structured Credit Investor, given the size and scope of the government's commitment to maintain employment and keep employers afloat until the virus subsides, this might be the best medicine for those with the liquidity to take advantage of it. Once the virus dissipates and impacted borrowers are able to resume working and making payments, MPLs may emerge with a stronger market position and valued portfolio.
Regardless of whether fintech lenders ultimately become lenders in the PPP program (other than through partnership with SBA banks), it may be the case that the better capitalized and larger MPLs will be in a better position to weather the storm and any liquidity crunch. But smaller niche lenders with less exposure to the more severely impacted markets could also be a bright spot in the industry if they follow some of the steps above. Given the judicial finding that the OCC lacks the authority to grant fintechs special purpose charters, which would have authorized fintechs to engage in certain banking activities, the future of the market will be shaped by whether MPLs continue efforts to pursue the lengthy and expensive process of becoming banks via acquisition. Bold steps forward taken in such a time of uncertainty can transform competition on the other side of this crisis.
Adam Levy and Nicole Serratore, attorneys in the Insolvency, Creditors' Rights and Financial Products Group, each contributed to this post.
Originally published April 12, 2020.
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