Regulators Have Small Business Finance in Their Sights

For equipment leasing and finance companies that lease equipment or provide financing to small businesses, the regulatory trends are clear. We don’t know all the changes coming, we don’t know exactly how they’ll be enacted and we don’t know exactly when, but it is clear that the trend is moving toward treating small business finance similar to consumer finance.

For years now, the trends in consumer finance have been toward disclosure, limitations on utilizing certain contract provisions and even requiring lenders to determine whether the customer has the ability to pay.

This trend has been driven by the worst examples of lenders utilizing complicated contracts to unscrupulously take advantage of customers. We all know that these examples are usually the exception rather than the rule, but unfortunately, if these bad stories make it into a media exposé on the practice, they are spun in a way that makes it seem as if every industry participant is treating their customers poorly.

Unfortunately, the small business finance world is no different. The use of automatic renewals is a good example. In many cases, automatic renewals are convenient for the customer and lessor alike. However, one company exercising their automatic renewal clauses to the extent that the customer has paid more in lease payments than the underlying equipment is worth, sometimes many times over, ruins it for everyone. 

Another example is the use of confessions of judgment; in many cases they are a tool that allows work-outs to be completed to the advantage of both the customer and lender. However, some finance companies have exercised their confessions of judgment on perceived technical defaults, even if the customer is making their payments. This has led to negative media coverage, and follow-on legislative efforts at the state and the federal levels to prohibit the usage of these provisions in all commercial transactions.

Small business finance is increasingly being treated like consumer finance.

Many of these issues have started at the state level and then moved slowly to the federal level. In the next few years, absent some sea change, Section 1071 of Dodd-Frank will come into effect. Once that occurs, commercial finance companies will be required to report certain demographic and loan/lease level information to the federal government for every credit applicant. While there hopefully will be broad exemptions, the trend toward disclosure is clear. Additionally, in recent months, there have been moves at the state and federal levels to apply the Truth in Lending Act to small business finance. 

In light of the economic effects of the pandemic disproportionately affecting small business, the appetite by policy makers for information about the level of small business credit issuance will be large. This appetite will be for all small business credit but will be even stronger in the areas of minority-owned and woman-owned businesses, which are also being disproportionately affected by the economic consequences of the pandemic. 

For those of you who were active market participants during the Great Recession in the 2008-2010 timeframe, you’ll recall the amount of media coverage regarding the slow recovery of small business credit markets. Current indications are that, in many ways, this economic downturn’s impact on small business could be worse, albeit more intensely focused on certain market segments. If history is a guide, the trend toward policy makers wanting more information about the recovery in these segments will accelerate.

Equipment finance companies that lend to small businesses are wise to think about how their business processes could be amended to report this information. While it may not be required next week or next month, this is an undeniable trend that our industry will need to adapt to.