In this week’s Alternative Commercial Finance Update, we’ll look at the impact of potential interest rate decreases, the growth of alternative lending in traditional bank spaces, and fraud in alternative finance.
Interest rates, inflation, and job growth news in September
The Federal Reserve will almost certainly cut interest rates at its meeting concluding on September 18, 2024, although the amount of this decrease remains uncertain. We can expect some signals earlier in the month. First, the Bureau of Labor Statistics will release an unemployment report this Friday with data from August. Recent reports have generated controversy for accidentally releasing data to some financial firms before a public release and overestimating job growth. Second, the Consumer Price Index for August will be released on September 11. July’s report, released in August, showed a 2.9% annualized inflation rate, compared to the Federal Reserve’s target of 2%.
Impact on alternative lending and fintech
A decrease in interest rates will result in lower borrowing costs for alternative lenders and potentially lower rates and more available funds for their own borrowers. As recent interest rates have remained “higher for longer” to combat stubbornly high inflation, stock prices for a number of fintechs and alternative lenders fell, and some have become more restrictive with their offerings to borrowers. If interest rates begin to drop in September, these lending sources may become more permissive with customers and terms of their credit offerings. Of course, borrowers who have turned to alternative lending amid higher rates and more restrictive offerings from traditional bank lenders may have more options with those sources as well. Investors may also look for opportunities in alternative lending in the low-interest rate environment when the nearly-guaranteed growth in excess of 5% from treasury bills and I bonds, CD’s, and money market funds over the past few years disappears.
Fraud in alternative lending
If interest rates do drop and generate more business in the alternative lending space, we advise exercising caution and conducting due diligence when reviewing these opportunities. Jason Zweig, columnist of the Intelligent Investor at the Wall Street Journal, recently observed that alternative lending sources may appear with promises of the growth possible in the high-interest rate environment. One nonbank example he cites recently offered term deposits with growth of 10 percentage points above market rates and full insurance coverage far exceeding FDIC limits. Upon receiving questions from the WSJ, the lender began taking its websites with these offers offline. This is not the first accusation of fraud in the current alternative lending space.
White Rock Insurance sued China Construction Bank Corp, a large commercial lender in China, in New York state court last week. White Rock accused CCB of providing fake letters of credit to bankrupt Israeli fintech startup Vesttoo and defrauding the international insurance market. Vesttoo had promised to connect insurance companies with capital market investors for reinsurance coverage that would be backed by the letters of credit. According to White Rock’s claim, a banker at CCB collaborated with Vesttoo to defraud insurers, investors, and auditors about the authenticity of the letters of credit used to generate business for the fintech, resulting in this $140MM claim.
The Consumer Financial Protection Bureau (CFPB) recently fined NewDay Financial LLC, a nonbank lender, $2.25MM for purportedly deceiving active-duty troops and veterans in its offerings of cash-out refinancing of home mortgages. According to the CFPB, NewDay failed to disclose taxes and insurance payments in its monthly payment calculations. The CFPB, along with the Veterans Affairs administration, has expressed concern about loan churning, in which lenders pressure veterans to unnecessarily refinance their homes purchased through VA loans. Under this practice, veterans who had obtained a cash-out refinance loan would receive offers to refinance again with a lower rate but additional fees, resulting in higher overall costs.
This trend should concern both businesses and consumers looking to interact with alternative lending sources and fintechs. For the average consumer, this market is no longer limited to buying meme stocks on Robinhood. The case of NewDay above highlights how nonbank lenders are now operating in the home mortgage space. This expansion is not limited to the U.S. market. In Ireland, fintech Revolut will begin offering home mortgages and attempt to compete with traditional banks.
This month will likely bring new opportunities in the alternative lending space as a result of lower interest rates—but be cautious about those who are offering deals too good to be true.
News and views
Last week, we hosted a webinar on small business finance companies’ compliance with Dodd-Frank Section 1071 data collection and reporting rules. We have previously discussed ongoing litigation of CFPB rules adopted under this Act. Lenders making small business loans should continue to prepare for the new small data collection rule, especially in light of a ruling by Judge Randy Crane of the U.S. District Court in the Southern District of Texas last week. Judge Crane granted the CFPB’s motion for summary judgment in a case brought by banking industry groups including the American Bankers Association and Texas Bankers Association.
Have you considered whether there are viable alternatives or improvements to credit scores and credit risk decision making? We have shared updates in the past from Alex Johnson at Fintech Takes on regulation of financial services companies’ use of AI and ideal small business lenders. Alex published an article last week on the history of credit risk decisions and modern credit scores and potential developments with artificial intelligence (AI). Alex discusses using AI to develop models for lenders to predict a customer’s risk of defaulting on a loan, then assessing the model against the FICO score as a baseline. Fintech companies in particular can capitalize on this tool by generating their own data continuously rather than relying on historical, external data. Specifically, they can create low-risk products that generate signals of default, allow consumers to share financial data with third parties in open banking, and use embedded lending. As Alex cautions, lenders should be cautious of violating fair lending laws in the development and use of these tools.
News you can bank on
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