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On Deck Capital Compared To Subprime Lender By Short-Seller

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Street Sweeper suggests On Deck Capital’s business model smells a lot like the subprime mortgage lenders that got our economy in trouble

On Deck Capital has only been public for a few months, but already its business model has raised some concerns on Wall Street. Federal filings indicate that the company charges rates that are so steep, the folks at The Street Sweeper accuse it of charging “loan-shark rates.”

What might be wrong with On Deck Capital?

On Deck Capital makes loans to small businesses that have bad credit, charging them very high interest rates in the process, according to Sonya Colberg, a senior investigative reporter for The Street Sweeper. On the surface, it doesn’t sound like what the firm does is anything out of the ordinary, but just how high of rates are these firms allowed to charge?

As it turns out On Deck Capital does not talk much about the annual percentage rates it charges. The firm advertisers APRs between 18% and 36%, but according to Colberg, federal filings show the firm charges annual rates as high as 99% to some desperate borrows.

Why can On Deck get away with this?

The reporter states that laws governing interest rates for commercial loans differ across each state. For example, California’s rates are at 10% or 5% higher than the rate set by the Federal Reserve. In Illinois, however, the highest rate lenders are allowed to charge is 9%.

Apparently regulators have begun to keep a closer high on payday lenders, which are notorious for charging ridiculously high interest rates. As a result, it’s possible On Deck will soon appear on regulatory radar as well.

Remember the subprime mortgage crisis?

Colberg likens On Deck’s business model to the mode used by lenders that caused the subprime mortgage crisis. Although the firm is frequently compared to Lending Club, the two companies have very different business models.

On Deck evaluates each loan application using computers without meeting with business owners. Often the borrower sees their cash within just a day or two. Most of the firm’s loans are handed out using credit lines that come from banks. Then On Deck reportedly sells off its loans in pieces. Additionally, she said the firm lets institutional investors purchase loans.

According to Colberg, On Deck Capital also uses independent brokers to get customers, which in and of itself isn’t bad. The problem though is that, according to Bloomberg Businessweek, some of the brokers had convictions in a variety of financial crimes, including stock scams, gambling, embezzling, insider trading and even dealing ecstasy.

In response to this concern, the CEO of On Deck said they continually audit the independent brokers they use through feedback from customers and frequently cuts off relationships with some of them.

Will On Deck Capital be around much longer?

Colberg suggests that the clock may be ticking for On Deck. Jane Haskin, a certified public accountant and also president and CEO of First Bethany Bank and Trust, told her that a business model that’s based on making loans to people who probably won’t be able to pay it back is not sustainable. She added that if the firm isn’t careful, “they won’t be in business long, even if they’re doubling their money on the money they loan out.”

She reports that the interest rates On Deck charges are sometimes twice or three times the rates charged by credit card companies, and often borrowers can’t pay back the loan. Additionally, the firm automatically withdraws payments from borrowers’ accounts every day.

The firm responded that customers tend to think of their rates as daily rates or a “cents on dollar” payback rate. However, a filing with the Securities and Exchange Commission clearly states that their loans have APRs from 19.99% up to 99%.

On Deck Capita may have a sky-high default rate

Management at On Deck Capital don’t sound like they’re very sure of or are otherwise hiding just how much money the firm loses on its risky loans. In an interview with The Street, On Deck CEO Noah Breslow said they lose about 6 cents for every dollar they lend. However, the firm’s regulatory filing states that the expected rate is 7 cents per dollar, which is similar to Lending Club’s 5% rate of default on loans.

However, Colberg discovered that On Deck lost $26.7 million in loans over the last nine months. The firm’s gross revenue during that same time frame was $107.6 million, which means the firm lost about 24.8%–way more than what management has been saying they expect to lose.

She also points out that the firm has set aside $47 million for “provisions for expected losses,” a requirement for lenders in their regulatory filings. That’s almost triple the amount On Deck needed in the previous year.

All in all, what Colberg uncovered appears to be quite damning for On Deck Capital, but as with all Wall Street stories, there are two sides. Analysts at BTG certainly seem to like the firm’s business model. For a bullish view, you can check out their thesis here and decide which side you’ll take on this stock.

Shares of On Deck Capital slipped as much as 1.09% to $17.20 per share during regular trading hours today.

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