This week, private lending took a rap with the Chinese hard money lending company Ezubao that may well have been the biggest scam in history.
Ezubao was located in China and hard money lenders in China have different rules and set-ups to hard money lenders in California. Knowing the differences can help you feel more safe about looking into hard money opportunities in California.
The story of Ezubao
Thirty-four year old Ding Ning was a high-school dropout who made it big in ratty ways. He launched Ezubao in 2014, and seeded multiple offices across China. Expensive ad spots promoted his venture; the gov.cn government website interviewed him citing his success as an entrepreneur. What Ezuabo essentially did was the same thing that private lending companies do: It promised loans to those who were unable to snag one the traditional way, i.e. through banks or regular Credit Unions.
Millions of people per year look for private lending, or unconventional, loans. In China, scores of thousands did. So Ding Ying became wealthy. According to Shanghaiist.com, he spent “over 1 billion yuan on his beloved, including a charmingly nepotistic monthly salary of 1 million yuan to his brother Ding Dian.” He also gave a business partner gifts that included a 12 million yuan diamond ring and a 130 million yuan villa in Singapore.
Ezubao was an example of all that can go wrong with private lending. Banks offer loans to borrowers based on high credit scores and credible work history. Few are able to hook these loans especially since banks and conventional lending institutions such as credit unions have become ever more particular in how they lend to. Alternative private lenders (or hard money lenders) such as Ezubao promise to look at the borrower’s collateral rather than at their FICO scores. Shadow organizations exist and Ezubao was one of them.
Private investors try to make a profit. One way of doing so is to charge a higher interest rate and lower loan to value scores. This detracts from their popularity but it’s their only way of making money. Ezubao differentiated itself and guaranteed lower interest rates than those of the banks. Of course people flocked to it. Ezuabo seemed fantastic. The problem was that 95 percent of the company’s borrowers were fictitious entities.
At the end of the day, more than 900,000 investors lost $7.6 billion. Some lost their entire life’s savings.
Do we have Ezuabos in California?
Shadow industries like this did at exist at one time. Back in the economically harsh year of 2007 when banks were falling and nontraditional lenders twisted themselves into pretzels with exploitation, things became so bad that the former Pimco economist Paul McCulley coined the term ‘the shadow bankers’ to refer to these disreputable private, non-tariff lenders.
They spanned everything from online loan originators, mortgage-finance companies, money-market mutual funds and hedge funds to good old-fashioned pawn shops and loan sharks. And hard money/ bridge/ personal money lenders, too.
Thankfully, the California federal government and consumer agencies have put regulations in effect that curb scams.
In California, lenders have to be specifically licensed by national and local agencies to practice. Standards include certifications from associations such as the National Mortgage Licensing System (NMLS). Exams are challenging and can take years to pass. Any failure and broker has to retake until he or she is accepted.
In the early 2000s, FDIC created law 6500 on Consumer Protection which restricts balloon loans so that they cannot mature in less than 5 years. In some cases, such loans are even banned. The Government also bans negative amortization (i.e. extreme interest that makes repayment impossible).
Federal laws also stipulate that the lender can ask for no more than two reasonable sized prepayments although the number and amount depends on the structure of the loan. If the lender exceeds this, the borrower can consult state regulations to determine if the request is lawful and reasonable. If not, he may be able to exit his loan contract at no penalty to himself.
Furthermore, federal laws on consumer protection insist that all lenders must conduct some sort of credit check or income verification before issuing a loan. A lender who proceeds without checking the borrower’s financial ability, or, worse still, lends even though the borrower has a low chance of repaying performs, what is called, a “predatory loan”. Consequences are such that the judge can render such a loan unlawful and dismiss it if it occurs.
Six months ago, the California’s Department of Business Oversight set itself to looking at the practices of 14 so-called marketplace lenders. The Office of the Comptroller of the Currency noted the explosion of growth in loans to financial firms that don’t take deposits and warned banks to monitor the concentration risk, adding it will “be a focus of our supervision strategies going forward.”
At the same time, the Basel Committee on Bank Supervision is examining “step-in” risks that could force regulated lenders to come to the rescue of shadow banking firms with which they do business. Even investigations into financing to terrorists may pose a risk, according to Compass Point analysts.
How does this affect California’s commercial hard money lending industry?
The results are positive.
Commercial hard money lenders are forced to tighten their scrupulousness.
So with rising interest rates, increased regulatory scrutiny and fresh competition, there’s a good chance that alternative private commercial money lenders in California may be better than ever.
Does this make all private lending industries in California honest? No.
But you’re protected by your government.
You are less likely to find Ezuabos here.