In early December 2015, JP Morgan announced a strategic partnership with OnDeck Capital, an alternative lending company, to originate, underwrite and distribute loans specifically for small businesses. The news shocked the banking world, as evidenced by a 28% increase in OnDeck’s stock price in a single day and has long-term implications for alternative lenders, of which hard money lenders are a critical part. .
The association spooked many private lenders and made them worry that the major banks might be thinking of controlling their domains. JP Morgan’s association with OutBack seems to indicate this. Banks are already big. Will they take over the alternative loans too?
On the one hand…
Banks, like JP Morgan, have clear advantages over direct hard money lenders. And they know it. These include the following:
Product construction. The biggest names in traditional lending institutions, like Charles Schwab or Bank of America, can afford to extend long-term loans and lines of credit to clients that sometimes extend to five or more years. In contrast, out-of-pocket alternative lenders can only offer loans that are, at best, limited to three years. These suit people who are desperate for some kind of money, even if it is “short term”. Banks have the advantage that their loans last longer at lower rates. Additionally, some major banks (such as Wells Fargo) have recently launched perennial loans with no maturity date. This makes it difficult for direct hard money lenders to compete.
Great interest. 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. To put that in perspective, consider that one of Bank of America’s basic small business credit cards (MasterCard Cash Rewards) has an APR range between 11 and 21 percent, not for a term loan or a line credit, but for a credit card! Alternative money lenders may advertise their business by touting its impressive speed and efficiency, but it is the high interest factor that deters potential customers. And once again the banks have the upper hand.
Borrower’s risk profile. Banks only accept applicants who are convinced they can repay. Banks look at your credit history and FICO score to determine your worth. Hard money lenders, on the other hand, get their business by taking on the riskiest cases from a tax point of view. As a result, and unsurprisingly, hard money lenders have a median default rate of 16% and forecasters predict that many more borrowers will default in 2016 as prices rise further. In short, it can be said that banks deposit the “cream of the crop”. Hard money lenders, on the other hand, tend to take the ‘cream of the shit’ (because those borrowers are the ones who generally don’t have a choice) and sometimes, though not always, lose accordingly.
Macro sensitivity. Just yesterday (December 16, 1015), the Federal Reserve issued its long-awaited rise in interest rates. The increase is negligible (from a range of 0% to 0.25% to a range of 0.25% to 0.5%), but is in addition to an already onerous private loan 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 lender.
It’s more …
Above all, banks have access to a wealth of data that private hard money lenders lack. Databanks include years of experience and libraries of account, expense, and risk data. Therefore, they can write credit with greater predictive certainty and confidence.
Banks are also diversified and connected to each other. They are a homogeneous body with access to shared information. Hard money lenders lack this. In theory, they cannot assess the creditworthiness of a single borrower based on metrics captured from a variety of products offered by banks.
This is not to say that banks will dominate the hard money lenders industry and capture their business. Hard money lenders have been successful as evidenced by their growth and the industry is stabilizing further. TechCrunch.com’s Tom SEO predicts that unconventional lenders, including hard money lenders, will survive and may even prosper. This is due to three things that are happening right now:
- Hard money lenders cut their loan-to-value (LTV) levels – that’s huge. Until a month ago, one of the aspects that most scared potential borrowers was the low LTV ratio where borrowers received misery for their property (as low as 50-70%). More recently, competition pushed lenders to stretch it to 80%. Some offer full percentage rates. This has gone a long way towards increasing the attractiveness of the hard money lending industry.
- Technology: Technology helps online directories rank lenders based on locations, loan offers, rates, and prices. Aggregation triggers bids that encourage lenders to set up convenient and quick hours, and sometimes at more reasonable prices. The Internet also helps hard money lenders in the sense that it helps them do a customer background check. Banks can have access to valuable treasuries of data. But Google (and other engines) give lenders access to unprecedented resources. These resources improve over time. Private lenders use these data resources to guide their transactions.
- Alternative lenders creating full service solutions will survive. Tom SEO believes that private lenders offering a “one stop shop” for all types of banking needs will hit the mark. By offering a range of products and services that are compatible with traditional banks, while at the same time avoiding excessive overheads and maintaining operational efficiency, these private hard money lenders could carve out their own niche and displace trial banks to a certain population.
In shorts …
So if you are a direct hard money lender or are thinking of becoming one, the future is not entirely bleak. Banks, like JP Morgan, may dominate right now, but they will never displace you. You offer advantages that they do not have and people need you.