Online lenders operating in California such as LendingClub Corp. and OnDeck Capital Inc. would be required to ditch the annual percentage rate (APR) in favor of a new metric when disclosing small-business loan costs if a bill before California’s Assembly becomes law.
The bill (S.B. 1235), which has already passed the state Senate, would require nonbank small-business lenders to estimate the “annualized cost of capital” (ACC) to disclose financing costs. The untested metric selected by the bill’s sponsor, Sen. Steve Glazer (D), would replace the APR often used in disclosures for all types of commercial financing products issued by nonbank lenders, from term loans to lines of credit to merchant cash advances.
With nearly 4 million small businesses, California represents a large market for fintech lenders. Five of the largest online lenders funded approximately $1.6 billion to 21,832 California small businesses from 2015 to 2017, according to a May report commissioned by two fintech trade groups.
Many fintech trade groups said they support the bill’s transparency goals but oppose the ACC metric, saying it’s more likely to confuse borrowers who might think they’re comparing it to APR.
“ACC is entirely untested in the marketplace — no federal or state agency has adopted it, and there are no studies to evaluate whether ACC yields accurate results across different financing products, or how it compares to other annualized rates,” Scott Stewart, CEO of the Innovative Lending Platform Association, told Bloomberg Law by email.
Small-business owners are increasingly turning to fintech lenders to meet their financing needs, but struggle to understand the costs and fees associated with different credit, the Federal Reserve Board said in a 2018 report.
Commercial loans aren’t subject to the same disclosure rules as consumer loans, though many lenders voluntarily use interest rates and APR to help small-business borrowers estimate the cost of financing.
That’s one reason the new metric has many marketplace lenders worried.
“It would be reckless to use California’s small-businesses population as guinea pigs to test this new metric,” Stewart said. ILPA members include Kabbage, OnDeck, and Lendio, some of the largest small-business online lenders in the U.S.
Others are concerned ACC could misrepresent loan costs. Using ACC “consistently produces a lower number than APR and traditional interest rates,” the Marketplace Lenders Association, whose members include Affirm, LendingClub, Prosper, and SoFi, said in an opposition letter.
“ACC will give higher-cost financing the inaccurate appearance of being less expensive than credit cards, bank loans, or loans from more transparent nonbanks. This will effectively steer small businesses towards more expensive financing,” the MLA said.
The ACC will be easier than APR for small businesses to calculate and understand, Glazer’s chief of staff, Daniel Weintraub, told Bloomberg Law. “ACC is just an annualized interest rate, one of the oldest metrics in the finance world. You add up all the costs, expressed as a percentage of a loan amount,” he said.
“It’s true that the two metrics, depending on the structure of the financing, can provide different numbers, but they’re not meant to be compared,” he said.
Though the bill would sunset the ACC disclosure requirement after four years, Glazer’s office hopes it will catch on in other states that look to California for policy models, Weintraub said.
Merchant Cash Advance Split
The Small Business Finance Association, which represents small business lenders including merchant cash advance providers, supports the ACC metric specifically. “We feel it’s a better representation of a cost to a business,” and APR can distort the price of short-term products, Steve Denis, the SBFC’s executive director, told Bloomberg Law.
But others said the SBFA’s members have the most to gain by using the metric by making their rates appear lower than others. “The ACC metric was concocted by the Merchant Cash Advance (MCA) lobby as an end-around effort to avoid using the financial standard Annualized Percentage Rate (APR) metric, used by virtually every bank lender, online lender and credit card issuer in the United States,” the ILPA’s Stewart said.
A different merchant cash advance group opposes the metric. “Because this disclosure is not consistently used in any business finance transactions, it will confuse small business owners and increase the risk of litigation,” the Commercial Finance Coalition said in an opposition letter.
“Any set of disclosures will require flexibility to ensure that information given to business owners is not misleading or even deceptive. The Legislature should consider what terms business owners would actually find helpful,” the CFC said.
Further Revisions Ahead?
The bill passed the California Senate on May 31, but must pass the full Assembly. It would have to pass the Senate again to account for previous changes to reach Gov. Jerry Brown’s desk.
The Assembly Banking and Finance Committee approved the bill June 26 by a 9-0 vote, but with “questions about how the new metric” would work, acting committee Chairwoman Monique Limon told Bloomberg Law.
The committee members wanted to advance the bill to show support for Glazer’s intent to promote lending transparency, she said. “I think some people thought more information is better than none,” Limon said.
The bill could still change as it proceeds, though its sponsor has the last word on the text. Glazer would still consider changes “that broaden the coalition in favor of the bill” and preserve its goals, Weintraub said.
“We’re all watching what the author decides to do,” Limon said.