News Column

Are Non-Bank Lenders Reshaping the Financial Landscape?

Jan. 26, 2013

Dan Zehr, Austin American-Statesman

loans, non-bank loans

Jan. 26--Lewis Spellman made a rather bold prediction over lunch last April.

By that spring, a lukewarm recovery had started nudging the U.S. economy upward, and most of the country's banks had regained their balance following the crises that battered the industry in 2008.

Yet despite the optimistic signs, Spellman suggested traditional bank lending was on the front end of what would become a slow, inexorable decline. Non-bank lenders would secure an ever-increasing share of the market for business and consumer loans, the University of Texas finance professor said.

Asked last week if his views had softened -- if the rise of alternative lenders had slowed -- Spellman held firm: "No," he said, "it's ramping up."

Constrained by tighter regulations and still suffering the aftereffects of the financial turmoil, banks have had little choice but to keep lending standards conservative, he said, With that supply of capital declining, more and more consumers and businesses have turned to alternative sources of credit and capital during the downturn.

Few people have as pessimistic an outlook on traditional bank lending as Spellman, particularly folks in the industry itself. They note that underwriting standards at many banks, while still tight, have loosened somewhat over the past year -- and that bank lending, while still lower than pre-recession peaks, has started to grow again.

Since a sharp decline in 2009, lending at federally insured banks has increased each year, albeit at less than 2 percent annually, according to data from the FDIC. Texas banks had a slight dip in 2010 but have picked up since.

"Traditional lending is still alive and well ...," said John Heasley, executive vice president and general counsel of the Texas Bankers Association. "I think there will always be a place for loans from traditional deposit takers and for small and midsize business lenders in a community. I have a hard time seeing what would take its place."

But many bankers and industry proponents conceded that non-bank lending has expanded in recent years -- growth that might continue even if traditional bank lending rebounds to its pre-recession growth rates.

Credit unions have stepped up their lending. In Austin and across the country, many of these cooperatives have posted record lending growth in recent years and are pushing for the ability to do more. Meanwhile, forthcoming crowdfunding rules could open up a new, multibillion-dollar pipeline between small businesses and the investing public at large.

Credit Unions

San Antonio residents have known about Randolph-Brooks Federal Credit Union for decades, but more recently it has made a strong push in the Austin market. It now has eight branches in the Austin metro area, and as of September it was the area's third-largest credit union by membership and lending volume.

In four of the past five years, its lending totals have increased more than 20 percent in and around Austin -- the only exception was 2009, when loan growth was 15 percent.

"We are a fairly old-fashioned, conservative lender from the standpoint that, prior to the recession, we were lending the way we'd always lent, not taking on a more aggressive stance," said Mark Sekula, the credit union's executive vice president and chief lending officer.

The Randolph-Brooks' story is far from exclusive. Credit unions in Texas and across the country saw considerable gains coming out of the financial crisis, in part due to tighter lending standards at banks.

Amplify Federal Credit Union, born in 1967 to serve IBM's employees in Texas, has seen lending soar in recent years. Total loan volume has jumped to $1.1 billion through 28,800 loans, said Kendall Garrison, senior vice president for lending.

A growing portion of that total has come from commercial lending -- loans to businesses for things like equipment or real estate. Amplify started its commercial practice in 2006 on a small scale, Garrison said, and by the end of the year it had $2.4 million of business loans on its books. By the end of 2012, that number had jumped to $52.8 million.

"The big money center banks kind of closed up their lending shops for several years, so it was left to us in credit union land and at the community banks to continue to make commercial loans," Garrison said. "So we ended up continuing to grow in a limited way because we have a cap to how much we can do."

That federal cap limits the total of new loans a credit union can make to 12.25 percent of its total assets. Randolph-Brooks isn't bumping up against the cap, Sekula said. Amplify, on the other hand, expects to hit it about midway through this year, Garrison said.

Because of their growing commercial lending business, credit unions have made the cap a key policy push in Washington. Arguing that banks aren't able to lend as much to small businesses in the current environment, credit unions want to raise the cap to 25 percent.

Bankers counter that the current cap is reasonable given that they are taxed at a corporate level and credit unions are not. (Credit union members pay taxes on their dividends.)

The current Congress has not considered any bills on the cap, and the focus might shift as federal lawmakers consider broader, revenue-generating items -- including potential changes to credit unions' tax status.

"Our view is that bank-like credit unions, the very complex entities, should be subject to tax just like banks and regulated just like banks," said Keith Leggett, vice president and senior economist at the American Bankers Association. "There's no justification from a policy standpoint as to why they're excluded, especially when you look at comparable institutions that were exempt at one time but have lost their tax exemption."

Crowdfunding

They didn't actually serve Kool-Aid at the inaugural Crowdfund Texas conference, held earlier this month at the Omni Austin Hotel. But then, they didn't need to -- most of the speakers had already taken a slug or two from the pitcher.

One sponsor promised that crowdfunding would be nothing short of a game-changer, a radical transformation of the very economy and business world as we know it today.

The passion was energizing, but the attendance of more than 200 curious entrepreneurs, legislators, academics and investors was all the more encouraging, said Jason Best, one of the primary forces behind crowdfunding's inclusion in the Jumpstart Our Business Startups (JOBS) Act, which President Barack Obama signed last year.

"You need all of those constituencies to come to together to make it an effective market," Best said last week. "You need the true believers, the clear-eyed skeptics and the pragmatists to make sure you build a market that operates effectively."

The U.S. Securities and Exchange Commission has yet to issue its initial rules for crowdfunding, despite a Dec. 31 deadline. But the basic outline laid out in the JOBS Act will essentially open up commercial lending to the general public.

Companies, most likely small businesses, will be able to raise up to $1 million in equity or debt capital a year through registered online portals. These issuers can solicit investments through their social networks but can't publicly advertise the terms of the deal.

Public investors can learn about the company and invest via the registered portals. Unaccredited investors, those with less than $1 million in net worth, can invest as much as $2,000 or 5 percent of their income a year, whichever is greater. Investments must be held at least a year.

Already, Best and others have created the framework for a thriving industry, offering due diligence, advisory and other services to businesses and potential investors. Best is a co-founder of Crowdfund Capital Advisors, which he and Sherwood Neiss founded to help build "a functioning ecosystem for crowdfunding to take place."

The effort has had its ups and downs. While current sites have had considerable success -- groups on Kickstarter raised more than $250 million last year, up from $85 million in 2011 -- this current form of crowdfunding isn't technically an investment.

The JOBS Act would allow true investments by the public through online portals, but as such it requires regulatory approval. At the Crowdfund Texas conference the consensus estimate for SEC's initial rules was later this year.

"The rules required for crowdfunding securities offerings have not been adopted by federal regulators and it is unclear when this may occur," said Texas Securities Commissioner John Morgan. "Until these rules are in place, investors should avoid any securities offering representing itself to be 'crowdfunding' authorized under the JOBS Act."

However the finals rules take shape, a new crowdfunding investment industry is on the horizon. An upcoming study by the University of California-Berkeley forecasts about $4 billion of equity investments during crowdfund investing's first few years. While that pales in comparison with the $26 billion that venture capitalists invested in about 3,600 companies during 2012, Best and his colleagues expect that to grow rapidly as the industry formalizes.

"It's a multibillion-dollar opportunity in the near term," he said. "And what we saw at the Texas conference ... was a lot of very serious people there -- entrepreneurs, legislators, venture capitalists, government officials, development executives -- saying, 'This is for real, and I need to pay attention to this.'"

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