Feds target predatory lenders to small business, but Pennsylvania remains a haven for the industry - TribLIVE

Feds target predatory lenders to small business, but Pennsylvania remains a haven for the industry - TribLIVE


Feds target predatory lenders to small business, but Pennsylvania remains a haven for the industry - TribLIVE

Posted: 28 Sep 2020 12:00 AM PDT

Last summer, Philadelphia lawyer Shane Heskin told Congress that Pennsylvania has robust laws to prevent consumers from being gouged on loans — but none protecting business owners.

"Consumers have laws protecting them from usurious interest rates," he said. "But for small businesses, those protection laws don't apply at all."

Heskin defends business owners in court who get quick money from what he argues are deeply predatory "merchant cash advance" lenders. Although he and other industry critics have yet to gain traction among legislators in Harrisburg, warnings hit home when federal regulators brought a sweeping lawsuit against Par Funding, a Philadelphia lender of more than $600 million to small businesses nationwide.

The lawsuit described Par Funding as an "opportunistic" lender that charged merchants punishingly high interest — 50%, on average, but often astronomically more — to borrow cash. When debtors fell behind, the U.S. Securities and Exchange Commission alleged earlier this year, Par sued them by the hundreds, all the while hiding the massive number of loan defaults from investors who had put up the money that Par lent.

Par and others in the MCA industry, as it is known, thrived on two legal strategies.

One is a matter of semantics: The firms insist they aren't making loans, but rather advancing money from profits on future sales. This frees MCAs from usury laws placing a ceiling on interest.

While Pennsylvania has no cap on business loans, other states do, including New Jersey, New York, Texas and California.

The other legal weapon, even more powerful, is what's called a "confession of judgment." Lenders such as Par include a clause in loan paperwork that requires borrowers, in effect, to "confess" up front that they won't fight collection steps to garnishee their income.

Heskin detailed the abuses during a U.S. House hearing last year, titled "Crushed by Confessions of Judgment: The Small Business Story." In an interview, he summed up, "I've seen interest rates as high as 2,000% on short-term loans, paid off with other loans."

Once a borrower misses payments, "they start taking money out of your account" based on those confessions of judgment. Heskin said Par and other MCAs take wages, siphon money from bank accounts, and even threaten to foreclose on borrowers' homes.

New York and New Jersey banned confessions of judgment in the last two years, joining a handful of other states, but no Pennsylvania legislator has proposed a ban.

Attorneys general in New York and New Jersey, the SEC, and the Federal Trade Commission have begun to crack down on cash-advance abuses, yet Pennsylvania Attorney General Josh Shapiro has yet to speak out on the issue.

In August, the FTC sued Yellowstone Capital, a New Jersey firm that was a pioneer in this controversial financing niche, accusing it of hitting up borrowers with hidden fees and overcharging them in collections. In June, the FTC and New York's attorney general, Letitia James, together sued two other lenders, leveling similar accusations.

In the New York state suit, James alleged that one firm's principal told a borrower: "I know where you live. I know where your mother lives. I will take your daughters from you. … You have no idea what I'm going to do.'"

Par Funding, in particular, has been dogged by allegations that it is a modern take on loansharking.

In a lawsuit against it, a Miami borrower alleges that a debt collector repeatedly threatened and cursed employees and at one point threatened to break the legs of the firm's owner. The federal suit says another collector, Renata "Gino" Gioe, showed up in the office in 2018 to say: "I need to resolve this problem now that I am here in Miami. This man needs to pay or I will use the old-style New York Italian way."

(The suit was dismissed last month on technical grounds, unrelated to the allegations involving Gioe).

Last month, the FBI arrested Gioe, a felon and bodybuilder, and charged him with threatening a New Jersey debtor. In 2018, a Bloomberg Businessweek investigative series on merchant cash advances had identified Gioe as a collector for Par who merchants said had made threats.

Par Funding's co-founder, Joseph LaForte, denied allegations of threats. He is a twice-convicted felon awaiting trial on charges of illegal possession of guns.

After the federal and state lawsuits were filed in New York, FTC commissioner Rohit Chopra issued a pointed statement, saying the agency had to make sure lenders were "serving small businesses, not exploiting them."

Although some firms tout flexible payback terms, Chopra said this "may be a sham, since many of these products require fixed daily payments, and lenders can file 'confessions of judgment' upon any slowdown in payments, with no notice or due process for borrowers."

Merchant cash advance firms became popular about two decades ago. Supporters say such retail and e-commerce giants as Amazon, Paypal and Shopify were among the first to become billion-dollar lenders of cash to small businesses, tying the loans to future sales.

Grant Phillips, a Long Beach, N.Y., lawyer who also defends debtors against the cash advance lenders, said the 2008 fiscal crisis generated big growth in merchant cash advance firms as conventional banks retrenched.

"This can be a viable alternative to conventional funding," Phillips said. "It's very much an American invention, and it's legal."

"Small businesses couldn't get loans after the Great Financial Crisis, and merchant cash advance lenders plugged that hole," Phillips said. "I can charge daily interest in excess of usury law, because technically I'm purchasing future sales. It's not a loan."

At the same time, Phillips said: "There's no regulation, no interest cap. It opens the door to greed."

Sean Murray, editor of deBanked.com, a trade publication that covers the merchant cash advance firms, said Amazon, PayPal and Shopify, as well as newcomers Kabbage and QuickBooks Capital, have operated with little controversy. By Murray's estimate, the industry lent $8 billion to small businesses five years ago. By last year, he said, the amount had more than tripled.

"There are good people in this industry," Murray said. "And there are many small businesses that can't get a loan from a bank."

More than a half-century ago, the Pennsylvania Supreme Court, in Cutler Corp. v. Latshaw, called the confession-of-judgment clause a necessary evil.

It is, the court wrote in 1954, ?perhaps the most powerful and drastic document known to civil law" and "equivalent to a warrior of old entering a combat by discarding his shield and breaking his sword." But the clause was legal, the court said, as long as borrowers' "helplessness and impoverishment was voluntarily accepted and consciously assumed."

Nonetheless, the FTC banned confessions of judgment against consumers nationally in 1985. A growing number of states forbid them for either consumers or businesses. New York and New Jersey recently joined about seven other states in imposing total bans to protect businesses, too.

New York did so last August after Bloomberg Businessweek, in its 2018 investigative project, reported that the state had become a national magnet for merchant cash lawsuits against borrowers, and the filing ground for 25,000 suits. What lured lenders was a legal system overwhelmingly tilted in their favor: New York let them immediately tap into defendants' bank accounts and seize assets even before the borrowers had learned they had been sued.

New York in August 2019 banned confession of judgment suits against out-of-state defendants.

Par Funding, for one, suddenly began bringing hundreds more lawsuits in Philadelphia Common Pleas Court. Records show the firm filed 777 lawsuit there in 2019, nearly six times the number of the previous year.

"These clauses confer immense power and substantially limit due process," said lawyer Benjamin Picker, with the McCausland Keen firm in Chester County, Pa., who also testified before Congress regarding merchant cash loans.

Once lenders are armed with a confession of judgment, he said, they can "skip the entire litigation process and proceed directly to obtaining a judgment against the other party without any opportunity to be heard by the court."

As yet, lawsuits against Par Funding and other merchant cash advance lenders have not stirred any action in Harrisburg.

State Sen. Thomas Killion, R-Delaware, is the only GOP legislator from the Philadelphia region serving on the banking committee in the Republican-controlled upper chamber.

"We've been looking at payday lending abuses, but not lending on the commercial side," Killion said in an interview. "I've been following the story and it's something we need to look at."

In Washington, the legislative fervor is somewhat stronger. An unlikely pair — Republican Sen. Marco Rubio of Florida and Democrat Sen. Sherrod Brown of Ohio — last year jointly introduced a bill to extend to businesses the FTC ban on consumer confessions of judgment. Their proposal has not made it out of committee.

In the U.S. House, U.S. Rep Nydia Velazquez, a Democrat from Brooklyn, has pushed a similar bill. Her measure was voted out of committee along partisan lines and awaits a vote by the full chamber. Republican opponents in the House said a ban on confessions of judgment would choke off a key source of loans and could "ultimately drive up the cost of credit for the smallest businesses."

Locally, U.S. Rep Madeleine Dean, a Democrat who represents Montgomery County, Pa., is pursuing predatory lending issues in the Capitol, notably the Fair Debt Collection Practices for Servicemembers Act. It would prohibit debt collectors from making certain threats against military personnel, such as an assertion that they would lose rank if they didn't pay up.

"We have a gap in our federal laws." Dean said. "And we should follow New York's lead on getting rid of confessions of judgment."

Categories: Business | News | Pennsylvania

New data shows small businesses in communities of color had unequal access to federal COVID-19 relief - Brookings Institution

Posted: 17 Sep 2020 12:00 AM PDT

Congress's major COVID-19 relief program for small businesses, the Paycheck Protection Program (PPP), has so far distributed 5 million loans across the country. That distribution, however, has not been equal. Newly released data offers a comprehensive snapshot of how access to PPP loans varied considerably based on neighborhood demographics, with small businesses in majority-white neighborhoods receiving PPP loans more quickly than small businesses in majority-Black and majority-Latino or Hispanic neighborhoods.

A 'Herculean' response with a painful execution

The equation for the COVID-19-induced small business crisis has been troubling but simple. Starting in March, millions of small businesses stopped generating revenue, but still had payroll and other fixed costs (utilities, rent, debt payments, etc.). These businesses needed new sources of immediate liquidity, and Congress designed the PPP to cover their labor costs for 10 weeks. The goal was to avoid a historic wave of small business closures that could tear apart the fabric of the economy.

With this urgency, Congress built on the principles of the Small Business Administration's existing 7(a) loan guarantee program to distribute loans through certified lenders (banks, credit unions, CDFIs, and, eventually, financial technology companies and non-bank lenders). SBA removed the majority of the 7(a) program's rules—requiring no fees, no credit scores, and no collateral from applicants. This enabled the financial system to move a historic amount of capital in a very short period.

Implementation challenges were immediate. At a Brookings event in April, then KeyBank CEO Beth Mooney characterized the PPP as a "Herculean" public-private response whose "execution was very painful." She reported that KeyBank, the nation's ninth-largest SBA lender, typically does about 600 SBA 7(a) loans annually, or about 50 per month. But in the first half of April alone, they issued 37,000 loans. Mooney acknowledged that KeyBank's initial outreach was to its existing customers, which means that unbanked or underbanked small businesses were not included in that first push.

The PPP also revealed capital access challenges for some small businesses due to broader shifts in the small business lending market. Over the past couple decades, large banks have been less likely to operate in the small-loan space due to low profit margins, and small banks that traditionally served local small businesses have declined due to a wave of bank consolidations since the financial crisis.

This has a disparate impact at the neighborhood level. According to the Institute for Local Self-Reliance, since 2006, communities of color have lost more small community banks than other communities. Online lenders have stepped up to fill the gap with internet-based technologies that allow for more efficient loan processing and lower transaction costs, albeit with higher interest rates. But those online lenders were not made eligible to issue PPP loans until April 14, two days before the first round of PPP funds was depleted. At the same time, independent contractors and self-employed individuals (business owners who do not have employees) were not eligible for PPP loans until April 10.

Understanding these shifts in the small business lending landscape is critical to understanding what happened next.

Neighborhoods of color with the most cash-constrained small businesses received PPP loans last

The PPP initially relied on traditional banks to deliver loans, which favored existing customers at large banks and disfavored microbusinesses (businesses with fewer than 10 employees), non-employer businesses, and Black- and Latino- or Hispanic-owned businesses (which all tend to be unbanked or underbanked). This disparate access has been hard to measure directly because PPP loan-level data provided by the Treasury Department does not consistently report the race and ethnicity of the loan recipient. However, the database does provide the ZIP code, loan approval date, and lender for over 5 million borrowers, creating an comprehensive picture of small business capital access at the neighborhood scale.

While we do not have data on business owners themselves, neighborhood racial composition can be a useful angle to investigate the PPP's reach, as previous research finds that the racial and ethnic composition of a neighborhood is related to small businesses' liquidity and profitability. Prior to the COVID-19 pandemic, the JPMorgan Chase Institute found that businesses in communities of color were the most cash-constrained but the least likely to have existing relationships with large banks.

Our analysis of Treasury's data shows how this precondition systematically delayed access to PPP loans in majority-minority neighborhoods. On average, it took 31 days for small businesses with paid employees in majority-Black ZIP codes to receive PPP loans—seven days longer than those in majority-white communities (Chart 1). For non-employer businesses, the loan delay between majority-Black and majority-white neighborhoods grew to nearly three weeks. This delay is particularly acute because, according to the JPMorgan Chase Institute, in at least 90% of all majority-Black and majority-Latino or Hispanic neighborhoods, a majority of small businesses have cash buffers of less than three weeks, compared to only 35% of majority-white neighborhoods.

Beyond the preexisting disparate access to banking, a matched-pair test conducted in April found that Black business owners were more likely to be denied PPP loans compared to white business owners with similar application profiles due to outright lending discrimination.

Fig1

Online lenders served large shares of sole proprietors in communities of color

With less access to large banks, many unbanked or underbanked non-employer businesses turned to other types of financial institutions (Chart 2). In majority-Black neighborhoods, for instance, financial technology companies ("fintechs") and online lending companies issued nearly 80% of loans for non-employer small businesses. This is consistent with the Federal Reserve's 2020 Small Business Credit Survey conclusion that online lenders were the main source of credit for Black-owned small businesses, while other small businesses mainly drew financing from large banks. Importantly, fintechs and many other online lending companies were not allowed to distribute PPP loans until April 14, after the first round of funding was almost depleted—further contributing to the delay in capital access for many small businesses.

Notably, the relationship between lending source and neighborhood demographics takes on a different pattern for small businesses with paid employees. Large and medium-sized banks accounted for about half of loans in majority-white, majority-Black, and majority-Latino or Hispanic neighborhoods, and over 60% of loans in majority-Asian American neighborhoods. Small banks and credit unions played a larger role in majority-white neighborhoods, accounting for more than 40% of loans. Community development financial institutions (CDFIs), meanwhile, accounted for about 6% of loans for small employer businesses in majority-Black neighborhoods, the highest among all demographic groups.

Fig 2

How the PPP came to ground in Washington, D.C.

The national trends related to capital access come into sharper relief at the local level. In Washington, D.C., for example, PPP loan receipt dates follow a clear racial and spatial pattern. Small businesses in majority-Black neighborhoods, including those south and east of the Anacostia River, waited 37 days for their PPP assistance on average—10 days longer than small businesses in majority-white neighborhoods (Chart 3A). Small businesses in majority-Black neighborhoods were also more likely to apply for their loans from fintechs or online lenders (Chart 3B), with the top three PPP lenders being Bank of America (13%), Kabbage (9%), and Celtic Bank (8%). Kabbage is an online lender, and Celtic Bank is the actual lender behind fintechs such as Square and OnDeck.

Even beyond their delayed eligibility to issue PPP loans, the distinction between traditional banks and fintechs is important. At one level, it provides a useful look at what type of lenders serve different communities. In this time of crisis, new research evaluating the PPP suggests that fintechs filled gaps not met by traditional lenders, and thus actually expanded access to PPP loans for very small businesses that were unbanked or underbanked. Because the PPP's repayment and loan forgiveness terms are the same for banks and online lenders, this was helpful for those businesses.

But there are downsides to an overreliance on fintechs. The Federal Reserve found that online lenders have less favorable interest rate and repayment terms compared to traditional banks. And many online lenders remain largely unregulated, leaving borrowers without sufficient consumer protection.

Fig3

We must commit to evening the entrepreneurial playing field

With nearly 70% of businesses expecting that it will take at least four months for their operations to return to normal, Congress returns this week with an urgent need to issue a third round of PPP relief. With established rules and regulations from the federal government as well as preexisting relationships between lenders and borrowers, the hope would be that round three of the PPP would work more smoothly and inclusively than rounds one and two. To respond to some of the challenges discussed in this analysis, the SBA has launched new products such as the Community Advantage Recovery Loan, which targets small businesses in underserved communities with capital and technical assistance.

The longer-term work of equalizing access to business ownership—and the capital it requires—will require both policy change and new norms within corporate America. If this summer is any indication, those shifts are underway. In wake of nationwide protests for racial justice, corporate investment in CDFI funds, procurement reform, and social responsibility initiatives that support minority-owned businesses totaled more than $1 billion. Democratic presidential candidate Joe Biden has a plan to help support entrepreneurs of color, including changing federal procurement policies, and mayors are pledging greater transparency on procurement as well. Meanwhile, entrepreneurship ecosystem builders like our colleague Rodney Sampson are proposing tens of billions of dollars in new, more racially inclusive federal investments in digital skills, entrepreneurship, and capital investment.

There is a clear rationale behind these efforts. The racial wealth gap in the U.S. is large and persistent, and it stands to reason that enhanced resources and policy changes that close entrepreneurship gaps could help close wealth gaps in communities of color. But to be effective, these new efforts must also understand how the small business lending market has shifted and will continue to shift, especially the neighborhood-level dynamics that this analysis outlines. Providing targeted help to small businesses in underserved communities would create not only a more prosperous economy, but a more just one as well.

Method notes:

We first match the lenders in the SBA Paycheck Protection Program Loan Level Data to FFIEC call reports, certified CDFIs lists, and SBA-participating fintech companies, using the lender names provided. We define large banks as those with at least $50 billion in assets; small banks are those with less than $10 billion in assets; medium banks are those in between. Using this method, we were able to identify 91% of the lenders in the database. For the remaining 9% unmatched institutions, we treat lenders as non-bank lending companies if the name contains "llc," "ltd.," or "inc." rather than "bank." Note that some fintech loans are issued by a partner bank, and are listed as "banks" in the PPP data. For example, PayPal loans are issued by WebBank, so loans applied through PayPal list "WebBank" as the actual lender. For the purpose of this analysis, we identified the major fintech bank partners (Cross River Bank, Celtic Bank, and WebBank) and categorized them as fintechs.

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