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Early December 2015, J.P. Morgan announced a strategic partnership with OnDeck Capital, an alternative lending company, to originate, underwrite, and distribute loans that are targeted specifically at small businesses. The news impacted the banking world, as evidenced by a 28% single-day spike in OnDeck share price and has long-term implications for alternative lenders – of which hard money lenders are a core part.
The partnership scared many private lenders into worrying that major banks may be thinking of controlling their realms. JP Morgan’s partnership with OutBack does seem to indicate as much. Banks are already large. Are they going to take over alternative lending, too?
On the one hand…
Banks, such as JP Morgan, do have definite advantages over direct hard money lenders. And they know it. These include the following:
Product Construct. The biggest names in the traditional lending institutions, such as Charles Schwab or Bank of America, are able to afford giving clients long-term loans and lines of credit that sometimes extend to five or more years. In contrast, alternative lenders who fund from their own pockets can only supply loans that at best cap three years. These suit people who are desperate for some sort of money even if ‘short term’. Banks have the advantage in that their loans last longer for cheaper rates. Moreover, some major banks (such as Wells Fargo) have recently rolled out evergreen loans with no maturity date. This makes it harder for direct hard money lenders to compete.
High interest. Pricing hard money lenders charge notoriously high lines of credit – think of somewhere in the 70-80 percent range. Traditional banks, on the other hand, half this. To put that into perspective, consider that one of Bank of America’s basic small business credit cards (MasterCard Cash Rewards) carries an APR range between 11 and 21 percent – not for a term loan or line of credit, but for a credit card! Alternative money lenders may advertise their business by touting their efficiency and impressive speed, but it is the high interest factor that deters potential clients. And once again banks have the upper hand.
Borrower Risk Profile. Banks only accept applicants who they are convinced can repay. Banks consult credit history and FICO score to determine worthiness. Hard money lenders, on the other hand, get their business by taking on the more fiscally risky cases. As a result, and not surprisingly, hard money lenders have a median range of 16% default with forecasters predicting that many more borrowers will default in 2016 as prices stretch still higher. In short, one can say that banks bank the ‘cream of the crop’. Hard money lenders, on the other hand, tend to take the ‘cream of the crap’ (because those borrowers are the ones who usually have no option) and, sometimes, although not always, lose accordingly.
Macro Sensitivity. Just yesterday (December 16, 1015), the Federal Reserve issued its long-expected interest rate hike. The increase is insignificant (from a range of 0% to 0.25% to a range of 0.25% to 0.5%.), but it adds to an already onerous private lending interest rate. The slight increase may add little to the impact of the banks. It adds a lot to the already high interest rate of the private money lender.
Most of all, banks have access to troves of data that private hard money lenders lack. Data banks include the years of experience and libraries of accounts, spending, and risk data. They are therefore able to underwrite credit with more predictive certainty and confidence.
Banks also have diversification and connection to one another. They are one homogenous body with access to shared information. Hard money lenders lack this. They’re theoretically unable to assess a single borrower’s creditworthiness based on metrics captured from a variety of bank-offered products.
On the other hand…
This is not to say that banks are going to dominate the industry of hard money lenders and capture their business. Hard money lenders have succeeded as evidenced from their growth and the industry is becoming more stabilized. Tom SEO of TechCrunch.com predicts that unconventional lenders – hard money lenders among them – will survive and may even thrive. This is because of three things that are happening right now:
- Hard money lenders lowered their loan-to-value (LTV) levels – That is huge. Until a month ago, one of the aspects that most frightened potential borrowers was the low LTV ratio where borrowers received pittance for their property (as low as 50-70%). More recently, competition pushed lenders to stretch it to 80%. Some offer complete percentage rates. This has gone a long way to increasing attractiveness of the hard money lending industry.
- Technology – Technology helps with online Directories sorting lenders according to localities, loan offerings, rates,and prices. Aggregation causes bidding which stimulates lenders to convenient and fast schedules – and, sometimes, to more reqasonable prices. The internet also assists hard money lenders in that it helps them investigate a client’s background. Banks may have access to helpful troves of data. But Google (and other engines) give lenders access to unprecedented resources. These resources improve with time. Private lending individuals use these data resources to guide their transactions.
- Alternative lenders that build full-service solutions will survive. Tom SEO believes that private lenders who offer a ‘a one stop shop’ for all sorts of banking needs will reach the finish line. By offering a range of products and service that are compatible to traditional banks, while at the same time avoiding excessive overhead and maintaining operational efficiency, these private hard money lenders could hew their own niche and displace trial banks for a certain population.
So if you are a direct hard money lender or thinking of becoming one, the future is not entirely grim. Banks, such as JP Morgan, may dominate at the moment, but will never displace you. You offer advantages that they don’t have and people need you.