Business Finance Misinformation and Confusion

Confusion about commercial loans and working capital financing seems to be increasing despite efforts by the federal government and commercial lenders to suggest that there is ample business loan funding. As a result, the actual availability of business financing for commercial finance programs such as commercial mortgages and business cash advances is unclear to most business owners.

It seems apparent that there have been many reports suggesting that normal commercial finance channels are either frozen or extremely sluggish. In reality there are probably more opportunities for commercial loan needs than suggested by such reports. However, increasing uncertainties in financial and credit markets have produced conflicting and misleading information about the availability of commercial financing. For most business owners, it is probably not clear if business finance funding is realistically available to them or not.

In spite of some admittedly bad news, there continue to be to reliable funding sources for commercial real estate loans, working capital loans and especially for business cash advances. At the same time, the current negative economic conditions will prove to be difficult for most businesses. Commercial borrowers should expect that extra efforts will be required to successfully arrange commercial financing. An especially harsh reality for business financing is that many banks have discontinued all or most of their business lending activities, often with very little advance notice.

One common example of commercial finance misinformation distorting what is actually feasible is that some kinds of commercial financing have been more disrupted than others by recent events. Commercial borrowers might be unnecessarily confused by reports that do not refer to all commercial loan situations but rather primarily apply to a very specialized form of business financing. For example, by most accounts commercial construction loans are in short supply currently. Such specialized business loans are not as easily available as they were just a few months ago, and a more accurate accounting would reflect that the number of commercial lenders currently active in construction financing has shrunk dramatically. At the same time, most commercial real estate loans without new construction have not been as severely impacted as funding requests which do involve construction financing.

Several publications have reported that most new business financing requests are on hold or have simply been rejected due to recent financial market uncertainties, and this is another example of how business finance funding reports might confuse small business owners. While the sources for this information might have been honestly told by one or more lending institutions that they are in fact deferring new commercial loan funding, this does not mean that is the case for the entire country. If the discussion involved automobile sales, it would be comparable to concluding that nobody is selling cars anywhere after learning that several major dealers and two manufacturers announced that they were going out of business due to lack of adequate sales. Just because one or more banks fail or stop making business loans, it does not mean that there are not commercial loans available from other sources.

Commercial borrowers would be wise to maintain a cautious perspective in determining how to refinance or obtain small business loans simply because the banking industry has been involved in financial disruptions of an epic proportion. Many banks are sounding and acting like they have been through the equivalent of a train wreck. In such a natural disaster, it might not be prudent for business owners to seek the advice of banks which effectively caused the train to derail in the first place.

Despite reports about limited availability of business financing, some commercial lending activities such as business cash advance programs are actually as active as they have ever been. In the current commercial funding crisis, small business owners should seek a commercial loans expert for a realistic assessment and candid discussion about working capital loans and business finance programs

The Value of Disruption

‘Great things are not done by impulse, but by a series of small things brought together.’ Vincent Van Gough

Like the old adage that it was not the prospectors but those selling them pickaxes and shovels that prospered in the Goldrush Bitcoin’s value might be seen to lie not so much in its speculative value but in the disruptive innovation it brings.

At Bitcoin’s heart lies the blockchain, an online, decentralised, user-managed ledger that records all transactions. The blockchain allows for secure and anonymous peer to peer transfers and has the potential to circumvent traditional middlemen and deliver savings of time and money for the customer.

Remittances are a platform that the blockchain has the potential to disrupt, the opportunity to return value to the customer being considerable. The World Bank estimated global remittances in 2011 totalled over $500bn, approximately $400bn of this going to developing countries. Remittances from the UK were estimated at $23.1bn making it the third largest source after the US ($120bn) and Canada ($23.3bn). In the same year India was the top recipient, receiving $63.8bn followed by China ($40.48bn), Mexico ($23.59bn), Philippines ($22.97bn) and Nigeria ($20.62bn).

Remittance platforms are a mixture of the formal and informal, ranging from cash transported across borders by friends and family and hawala brokers to banks and money transfer operators (MTO’s). These platforms are by no means fool proof and are often loaded with inefficiency. Bank transfers are not universal in their coverage, Barclays, the last major UK bank providing remittance services to Somalia announced last year its intent to shut down the accounts of those money transfer businesses registered with it due to concerns over money laundering and terrorist financing. This impacted on the $162m sent from the UK to Somalia each year, the majority of which goes to covering basic household expenses such as food, education and medicine. Many African countries also restrict remittances being paid into banks and instead contract with MTO’s to operate on their behalf creating a restricted market which does not benefit the customer.

The cost of remittances via a MTO from the UK varies per destination country, typically 6 – 11% of the total amount going to the provider. In an industry where transactions from host countries total hundreds of millions of pounds per annum the opportunities to improve the welfare of recipients by reducing transaction costs via a disruptive platform are significant.

So, where does the blockchain feature? Digital wallets enabled by the blockchain allow almost instantaneous peer to peer Bitcoin/digital currency transactions at little or no cost. With the recent introduction of wallets with currency conversion functions there suddenly exists the opportunity for secure and anonymous remittances in the currency of ones choosing, all that is required is for the sender and receiver to have a smart phone with a customised digital wallet downloaded. The cost and features of the transaction can be set by the wallet provider, the opportunity existing to shave percentage points of current transaction costs.

An alternate means of transmission is via Bitcoin ATM’s, ATM’s configured to ‘vend’ Bitcoin direct rather than have one purchase it via an exchange, Though small in number they are rapidly gaining traction in the US and Europe, manufacturers such as Lamassu proposing the provision of transmission and currency conversion functionality. Such functionality would allow one to insert or ‘bank’ cash into an ATM in country A and a recipient to securely withdraw the funds in the currency of their choosing in country B.

Concerns around remittances being used for terrorist financing or other criminal activities would require any wallet or ATM provider to register with the relevant financial regulators and their users required to complete Know Your Customer checks before transmissions could take place but this need not be overly onerous for either party with the appropriate guidance and processes built into the operating platform.

The blockchain is a disruptive tool that has the potential to return current charges to those who need them most while allowing a healthy margin for the wallet/ATM provider due to the economies of scale involv

The Disruption of Consumer Finance and the Banking Sector

Due to the disturbed trust relationship between savers and the financial sector, individuals now require and expect to be more in control of their financial resources. In other words, we want to be the master of our own capital and logically so. This change in consumer preferences has deep implications for the financial sector, as individuals will favor highly-specialized service providers which can assure a higher level of transparency and decision power.

The industry is experiencing a major shift in terms of “unbundling” (as defined by Fred Wilson in this video), moving away from the centralization of old. Now, only a few companies are fully part of this movement. But they are, in my view, disrupting the industry. More interestingly, these companies are just the pioneers of the movement-and that’s why the FinTech sector is really “hot” at the moment.

Now, let’s discuss examples of these pioneers I mentioned, as they embody the movement of increased control and transparency in today’s financial climate. I purposely chose to focus on FinTech consumer-driven solution, which provides the largest impact on the banking sector today.

1) Wealth / Investment management

Investment management is a key activity for financial institutions. However, unless you are a top-tier customer with several million entrusted to the firm, it’s essentially impossible to track or control how your money is being managed. Especially after the massive shocks some institutions went through, savers are increasingly worried about their money and prefer to be more in charge of investment decisions.

That’s probably one of the reasons why companies like WealthFront in the U.S., Nutmeg in the UK and Stockpot in AUS are gaining large market consensus. These companies not only lowered the barrier to entry (as you just sign up on their website), but also assure lower transaction & management fees (thanks to a leaner structure) as well as better, real-time transparency and control of the investment strategy. Most importantly, they offer savers these benefits without requiring them to exert any effort in the decision making process. In other words, those institutions lessen the hassle of making a savvy choice by walking you through and facilitating your decisions, leaving you, the user, fully in charge.

2) Lending

There are many individuals and small businesses demanding micro loans. On the one hand, financial institutions face overexposure to market and default risk, and on the other hand, individuals want to maintain full control of the way their capital is being allocated. Taking this into account, it is no surprise that companies like (the now public) LendingClub in the US or Funding Circle in UK are experiencing exponential growth. It may seem like a non-overlapping market for banks, but it will actually start to take its toll on the traditional banking sector sooner rather than later.

3) Online Stock Trading

In other words: making the investment in stock-listed companies available to the masses. This is controversial, but extremely disrupting and in line with the new taste of savers for being the arbitrators of their own money. Even though it’s taking the appearance of online gaming, online investment platforms are addressing the same kind of customers that banks serve and, just like for lending, it will increasingly affect their business. A natural evolution of this movement will be the creation of an online marketplace for privately-held shares, featuring lower liquidity, lower regulatory requirements for the companies and higher intrinsic risk. Some initiatives in the EU as well as the US seem to indicate this eventuality is near.

4) Collection of savings and personal finance

How was the banking sector created in the first place? Simple: collection of capital in return for an interest rate and allocation of the same capital for a higher average interest rate.

Today, there is an entire sector of online-only banks, which are offering lower costs and overall better services to their customers, thanks to a leaner and more flexible structure. This enables them to implement new value-adding features to improve their services. EverBank is already public while Moven, Simple and Green Dot are other valid examples. These banks offer full transparency and prove to adjust their technology to the changing taste of savers.

Commercial Finance – The Mortgage Meltdown

Banks lend money to people and businesses. The money is used for investment purposes and consumer purchases like food, cars and houses. When these investments are productive the money eventually finds its way back to the bank and an overall liquidity of a well functioning economy is created. The money cycles round and round when the economy is functioning effectively.

When the market is disrupted financial markets tend to seize up. The liquidity cycle may slow, freeze up to a degree or stop completely. This is true because banks are highly leveraged. A well capitalized bank is only required to have 6% of their assets in core capital. It is estimated that the residential mortgage meltdown will cause credit losses of about $400 billion dollars. This credit loss is about 2% of all U.S. equities. This hurts the bank’s balance sheets because it impacts their 6% core capital. To compensate, banks have to charge more for loans, pay less for deposits and create higher standards for borrowers which leads to less lending.

Why did this happen? Once upon a time after the great depression of the 1930’s a new national banking system was created. Banks were required to join to meet high standards of safety and soundness. The purpose was to prevent future failures of banks and to prevent another disastrous depression. Savings and Loans (which still exist but call themselves Banks today) were created primarily to lend money to people to buy houses. They took their depositor’s money, lent it to people to buy homes and held these loans in their portfolio. If a homeowner failed to pay and there was a loss, the institution took the loss. The system was simple and the institutions were responsible for the building of millions of homes for over 50 years. This changed drastically with the invention of the secondary market, collateralized debt obligations which are also know as collateralized mortgage obligations.

Our government created the Government National Mortgage Association (commonly known as Ginnie Mae) and the Federal National Mortgage Association (commonly known as Fannie Mae) to purchase mortgages from banks to expand the amount of money available in the banking system to purchase homes. Then Wall Street firms created a way to expand the market exponentially by bundling up home loans in clever ways that allowed originators and Wall Street to make big profits. The big stock market firms were securitizers of mortgage-backed securities and resecuritizers who sliced and diced different parts of the groups of home loans to be bought and sold in the stock market based on prices set by the market and market analysts. Home loans, packaged as securities, are bought and sold like stocks and bonds.

In the quest to do more and more business, the standards to get a loan were lowered to a point where, at least in some cases, if a person wanted to buy a house and could assert they could pay for it they received the loan. Borrowers with weak or poor credit histories were able to get loans. There was little risk to the lender because unlike the earlier days when home loans were held in their portfolios, these loans were sold and if the loans defaulted the investors or purchasers of these loans would take the losses i.e. not the bank making the loan. The result today is tumult in our economy from the mortgage meltdown which has disrupted the overall financial system and affects all lending in a negative way.

Who is responsible for this situation? All loan originators, including banks, are responsible for turning a blind eye to loans that were based on poor credit criteria. Under the label of “subprime” loans there were low documentation loans, no documentation loans and very high loan to value loans- many of which are the foreclosures we read about on a daily basis. Wall Street is responsible for pumping this system into a financial disaster that may grow from the current $400 billion dollar estimate to over a trillion dollars. Realtors, mortgage brokers, home buyers and speculators are responsible for their willingness to pay higher and higher prices for homes on the belief that prices would only go higher and higher. This basically fueled the system for the mortgage meltdown.

Are there any similarities to the saving and loan crisis of the 1980’s? Between 1986 and 1995 Savings and Loans (S&L’s) lost about $153 billion. The institutions were regulated by the Federal Home Loan Bank Board and the Federal Savings and Loan Insurance Corporation. These entities passed laws that required the S&L’s to make fixed rate loans only for their portfolios. The rates that could be charged for these loans were determined by the marketplace. Imagine an institution with $100 million in loans at 6% to 8%. For years the interest rates on deposits were also regulated by the government. The interest rate spread between the two allowed institutions to make a small profit.

In 1980 the U.S. Congress passed the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA). A committee was established in Congress. Over a period of years the committee deregulated the rates S&L’s could pay on savings. Nothing was changed with respect to what could be charged for home loans. Many institutions started to loose huge amounts of money because they had to pay market rates of 10% to 12% for their savings, yet they were stuck with their old 6% to 8% loans. Some executives in the savings and loan business referred to this committee as the damned idiots in Washington.

Many books have been written about these events. There is documented evidence of substantial wrongdoing by S&L executives who were trying to invest funds to save their institutions, sometimes for personal gains. Some were sophisticated criminals. Congress recognized their mistake in 1982 when the Garn-St.Germain Depositary Institutions Act was passed to allow S&Ls to diversify their activities to increase their profits. It also allowed S&L’s to make variable rate loans. It was too little too late. After bankrupt institutions were liquidated by the government, the surviving S&Ls were assessed billions of dollars by the Federal Deposit Insurance Corporation to replenish the fund that insures the depositors of all U.S. banking institutions.
The mortgage meltdown and the savings and loan crises are similar with regard to the presence of greed and criminal activity. They are very different with respect to the fact that the S&L crises originated from a broken government mandated regulatory system and the mortgage meltdown has been caused primarily by a system that went wild with greed.

This has impacted non-bank lenders such as private commercial finance companies that provide hard money real estate loans, purchase order financing and accounts receivable financing. Most of these firms have raised their prices and their origination standards for safety and soundness of operations.

The bottom line: Bank lending can be replaced by other sources such as commercial finance companies to some degree. Hard money, purchase order financing and accounts receivable financing will help some businesses grow during these difficult times. But for the average borrower, businessman, or business owner these are difficult economic times, caused by the mortgage meltdown, which are here to stay for several years.

Great Disruptive Models All Start With Chaos

There is a lot of attention right now on start-ups, supporting young entrepreneurs and the financing that can take the next big idea to glory. There’s also no shortage of mature businesses that still have an awful lot to offer. If there was one thing that was synonymous about the successes in all of these groups, it’s the ability to organize chaos for their customers. The fascinating thing about chaos is that it’s everywhere and usually behind the veil of a “routine” that we’re just used to suffering through. Solving the suffering is also part of the theory behind Revolution Delivery, but the underlying driver is chaos.

Models That Organize Chaos Have Been Around For a Long Time

An investment advisor organizes the chaos around trying to pick and choose investments.
Even something as low tech as consulting, brings in expertise and structure to organize business chaos.

New and Not So New Models That Organize Chaos Are Everywhere

Uber Uber Uber… yeah, yeah, yeah. We all know the story, but a company like Uber organizes the chaos of flagging down a taxi, arguing with the cabby about taking a credit card, and then having to figure out a tip. Lots of chaos.

Amazon has taken the chaos out of shopping.

CRM systems organize all the chaos around keeping track of our customers, and then marketing automation took it a step further and organized all the chaos around prospecting leads, nurturing them and turning them into customers.

Social media takes the chaos out of having to stay in touch with so many people. This of course adds a whole new level of chaos, but that’s a story for another day.

All of these things and people, not only organize chaos, but create bankable value we can feel in our wallet and stress levels.

Disruption isn’t chaos, it’s the solution.

Every new idea that we hear about from entrepreneurs is about disruption. However, it’s important to understand that disruption itself is not the chaos, it is the solution to the chaos.

For instance, take something as simple as banking. Lots and lots of chaos there. A company like ING Direct (now called Tangerine… coincidentally from the same branding company that came up with Blackberry – what will happen to these people when they run out of fruit.) took the chaos out of going to the bank by having an “online only” model. Sure everyone jumped on that disruption bandwagon in some form or another making it less novel over time, but in the end it was the first solution to banking chaos. The customer’s received better savings rates and less fees and the bank itself managed a very light infrastructure. Hence, a very nice disruptive solution to chaos. Endless examples of this, but you see the point. You can’t have a disruptive solution without having some sort of chaos to organize.

If Profitable Disruptive Businesses Had a Formula, Here is What It Would Look Like.

Chaos / Chaos Solution = Level of Control = Excited Customers

The Solution is Control

The reason every entrepreneur is searching for disruption, is that it provides steady waters in a boiling sea of chaos. In short, they give us a modicum of control in something that we never had control over, and many times, never knew how much we wanted it until we had it.

Remember running back to the office to check your email, going to the bank to deposit a check, waiting at home for a phone call and in fact, having to communicate with someone live over the phone instead of just sending a quick SMS? All of those things were situations that were out of your control, meaning, they ended up dictating or altering your behaviour. You were an easy target back then because those situations were heavy on chaos and light on control. Any time control is given back, we will gobble it up like Apple shares on the news Steve Jobs has come back from the dead.

If you want to assure your business is going to survive into the future, you need to keep asking:

Are we solving chaos
Are we giving back control
Are we spending time on solving future chaos

If you are, you’ll survive. If you’re not, you’re just part of the chaos and you should prepare to be disrupted right out of business.

This article was written by Dominic Mazzone, Managing Partner of Smashbox Consulting.