Senate Standing Committee on Banking and Financial Institutions

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The Senate Committee on Banking and Financial Institutions will begin in 60 seconds.

The Senate Committee on Banking and Financial Institutions will come to order, and we have one bill on today's agenda. It is SB728 from Senator Padilla.

As many of you know, this is not our regularly scheduled hearing time or our typical hearing room, but due to next week's spring recess, we are compelled to adjust our normal hearing schedule to allow for this bill to move through the appropriate committees and meet important senate deadlines and because we like the author so much with that.

So, thank you to my fellow committee members for accommodating your schedules. It's nice to see at least two of you here. We have yet enough members to establish a quorum, but we can go ahead and open as a sub-committee. And with that, Senator Padilla, obviously you're here, so you're welcome to present your Bill at your discretion.

Thank you very much, Mr. Chairman and members, and thank you for the accommodation. I'm pleased to present SB728 which would require non loan commercial financing companies to register with the DFPI under California Consumer Financial Protection Law, which is designed to provide oversight of non-loan types of financing.

Small businesses are struggling to access the responsible capital they need to grow, especially in post-COVID recovery. Small business owners are heavily marketed to buy alternative financing products that may not be loans, including merchant cash advances and factoring, which Federal Reserve research referred to specifically as potentially higher cost and less transparent credit products.

California's DFPI has oversight over small business loans. Currently there is no oversight over these non-loan types of commercial financing.

The need for this oversight can be illustrated by MCAs, or merchant cash advances, an increasingly common form of financing where a business receives an upfront sum of money in exchange for a percentage of future credit sales or daily bank deposits.

MCAs can operate with terms that may drive small business owners into further debt cycles because of unmanageable repayment terms. Study of California businesses found average small business using these unregulated loan products as being charged payments of 178% of their net income.

In other words, financing payments cost nearly double what the business owner could often pay, driving businesses from profitability to unprofitability. Worse, Latino small businesses, for example, owners were being charged 44 times what they could afford to pay.

Federal Reserve research finds Black and Latino owned businesses twice as likely to be affected by these, quote, potentially higher costs and less transparent credit products. A report by the Federal Reserve Bank of New York and the Stanford Graduate School of Business also found that Latino business owners are more likely to use factoring and merchant cash advances.

This unregulated market is not small. For example, the volume of merchant cash advanced financing alone was more than six times the volume of SBA loans below the 250,000 mark as of 2019.

Though SB728 can improve access to capital and innovation in small business financing, by establishing a level playing field of competition and transparency for both loan and non-loan commercial financing; we can protect borrowers from predatory lending practices that are harming businesses, families and communities.

Joining me today are Heidi Pickman representing Cameo Network and Louis Caditz-Peck with the Responsible Business Lending Coalition. Excuse me.

Senator, and before we go to lead witnesses, let us establish a quorum. Assistant, please call roll.

[Roll Call].

All right, we have established a quorum. We can go to lead witnesses. Two minutes each. And please feel free to begin.

Chairman Grayson, Vice Chair Niello, and members of the committee, to refresh your memory, I'm Heidi Pickman with Cameo Network, an association of more than 400 business coaching organizations, and community lenders and a proud sponsor of SB728.

California has led the country in responsible small business lending practices, passing five such bills, starting with the Truth in Lending Bill in 2018. SB728 continues that leadership. In these hearings, we've told you stories of small business owners that are paying exorbitant amounts for their financing.

Stories that are appearing in Forbes, Bloomberg and the Wall Street Journal with headlines such as the "Predatory Lending Machine Crushing Small Businesses Across America," "Easy Financing Sources Push Small Businesses Into Bankruptcy," "Brokers Get Big Commissions for Selling Entrepreneurs Costly Loans," "Wall Street Finds New Subprime with 125% Business Loans."

SB728 addresses the misaligned incentives of brokers and the predatory products. A quick scan of the industry magazine, DeBank.com, shows commissions of 14 and 18 points or percentage of the sale with aggressive commissions to brokers who steal small business borrowers to high-cost products. In comparison, commissions on SBA loans range from 1 to 4%.

The bill also bans the following predatory practices. California's 2022 ban on confessions of judgment is being circumvented by similar legal devices used to take money straight from small business bank accounts with no legal recourse. And confidentiality clauses are being used to bully small businesses into keeping silent about their victimization.

And we just heard about another contract provision that if you get that kind of financing, they're not allowed to be a person in a lawsuit against the company for being victimized. Thank you, and I respectfully ask for your I vote on SB728 to ensure small businesses have access to affordable, responsible for financing.

Thank you so much. Next witness.

Thank you, Chair Grayson. Honorable Senators, my name is Louis Caditz-Peck. I'm the Executive Director of the Responsible Business Lending Coalition. We represent over a thousand organizations nationwide, small business groups for profit lenders to small businesses and nonprofits that serve small businesses.

And across all of our for profit and nonprofit members, the group was unanimous in urging your support for this bill. To summarize why, I'll quote for you press coverage about this bill from last year.

Last year, of course, this committee passed forward a version of this bill that was more expansive than what you see here today, with nearly everyone's support. Thank you for that. Here's the kicker. The press coverage wrote, "If this bill becomes law, providers and brokers of merchant cash advances, factoring and lease financing will have to register with DFPI."

That's right, the press wrote: no more flying under the radar. So, what's flying under the radar today? An exploding industry of financing companies and brokers selling what the senator quoted the Federal Reserve research describing as higher cost, less transparent credit products.

And while DFPI has oversight now over our members that are offering small business loans, there's no oversight over competing products, like merchant cash advances, that are not technically loans. And so, this bill closes that loophole by applying the CCFPL, which is the state's regulatory framework for non-loan financing, especially emerging and higher risk financing products like these.

That's one reason why CCFPL is a more appropriate way to do this than alternatives. So why do we need a level playing field of oversight? Right now, small businesses are reeling from chaotic tariffs, at risk of a downturn.

And while they're desperate and struggling, I'm very concerned that these higher cost, less transparent credit products are poised to just tear through our economy over the next couple months, everywhere on Main Street. And without this bill, a business that is victimized may not be able to get help.

As Heidi described, this legislature has passed five laws to address these problems the small businesses face. But without this bill, DFPI is challenged to actually use those laws y'all have worked so hard to pass to protect those small businesses. DFPI doesn't know what companies -

If you can wrap that up.

Thank you, sir - are lending and operating in California because they're flying under the radar. So, thank you for your consideration.

Absolutely. Thank you so much for your testimony. Any witnesses in support and the audience would like to go on record, come forward. Seeing none. Do we have lead opposition that would like to speak, and you can have. - all right. You can have up to two lead opposition where you can come speak two minutes each.

We don't have an official position.

We don't have an official position either.

Okay. You are started now. Two minutes each.

I'll go first. We're both acknowledging that we don't have an official position, but I haven't had an opportunity to speak with the author's office about the concerns we have on behalf of. Carolyn Veal Hunter, on behalf of the Revenue Based Financing Coalition.

First, we support the issue of registration at RBFC, have worked with registration in several states and we also support the banning of the COJs. There's a couple just small elements that we do have concerns with, and that is one is that there's a new definition of small business.

And across the government code, the financial code and the civil code, there are different definitions of what is a small business. And we think that needs to be addressed. This is a good chance to try to address that properly. Additionally, you talk about a California resident. Only in Section 728 talks about this only impacts the California resident.

However, you reference Section 1701 for the Revenue and Tax Code, which a person who is a California resident, even if they don't live in the state, even if they're not current in the state. So, by referencing that, you're pulling people who don't live into the state into that definition of a California resident.

And finally, the third one is just that we are just concerned with respect to, as the DFPI does, their regulations. That is clear that they don't try to take something that we're calling registration in this bill, and it ended up looking more like licensing. And that's kind of the concern we've had in the past.

And so those are our concerns.

Thank you.

We look forward to working with the authors because we think we can work through these. They're not insurmountable.

Good news. Thank you. Next witness.

Mr. Chair and members, Mark Smith, Smith Policy Group, making comments on behalf of the Secured Finance Network. SFNet is the principal trade organization that represents the asset based lending and factoring industries.

Asset based lending and factoring are well established traditional financing products and account for nearly $1.0 trillion of outstanding financing in the United States, underpinning a substantial percentage of our GDP. Many, but not all SFNet member finance providers are licensed pursuant to California financing law.

We have had productive conversations with the author's staff and the committee staff, but we remain concerned that the language of the bill does not reflect the intent that has been described to us. We have yet to sit down with the sponsors, but we are planning to do that.

In short, I wish to highlight four items of concern, in no particular order of priority. We believe that 728 should consider including carve outs and exemptions for more sophisticated transactions and for de minimis lenders; we would suggest thresholds similar to those in Division 9.5 of the Financial Code.

We are highly concerned with language in the bill that prohibits provisions in the financing agreements prior to a borrower's default to attach or garnish money held in a borrower's account.

We would like additional clarity around what the specifics of registration are under the proposed legislation, and we are unsure what is meant by prohibitions restricting loan recipients from disclosing information that the recipient gains from business activities with the lenders.

So, for example, terms or conditions of a product or services offered by the registrant: is this limited only to financial terms, or could this pertain to possible disclosure of a lender's proprietary software as an example?

We thank you for the opportunity to provide these comments in committee today and we look forward to exploring and addressing these concerns in our conversations to follow. Thank you.

Thank you so much for your testimony. Any other members in public that would like to go on record in opposition, please step forward to the microphone. Anyone with concerns, please forward step forward to the microphone. Seeing none. Let's bring it back to committee for questions, comments. Seeing - we have one. Vice Chair.

Thank you, Mr. Chair. So, in a way this seems, excuse me, seems to be kind of a one size fits all approach. The assumption is that all businesses of a million and a quarter revenue per month are fundamentally unsophisticated and I don't know that that's a legitimate assumption.

But the real difference is that we're regulating quite different activity in the consumer, and loans are primarily for consumption type of financing: home car, TV. That's not at all what we're talking about when we're dealing with businesses small or large; they are looking for capital to provide a return on investment.

Those are really quite different financing products and to lump those together in a regulatory regime seems strange, for lack of a better term. But over all this the regulatory authority hasn't said anything. At least near as I could tell, DFBI has not weighed in on this.

So, to pass this bill, we have no idea what they're going to do or what they think about it. And for that reason, I have to conclude that this is a kind of a work in process because those things need to be defined.

First of all, we need to define why it makes sense to regulate the financing of a TV along with the asset-based products as an example. That is a long-established means of acquiring funds. I first learned about that in a basic business class somewhere around 1968, so it's been around a while.

And how those are somehow similar. But most importantly, what the regulatory entity thinks about this and how they're going to pursue it. So, I can't support the bill today. I'm not going to vote no. But I can't give it my aye blessing just yet.

Thank you, Vice Chair, for your comments. Any other questions from members or comments. Seeing none, we will go back to the author. Senator, would you like to close?

I'll keep it simple and brief, and I respect my esteemed colleagues caution here and there. Certainly, for the record, Mr. Chairman and members, we will continue working with all concerned stakeholders and regulatory bodies as we move this bill so that it has the maximum desired impact.

The issue here is access and cost and disparity in who is both in need of these types of financial instruments and lending and who is abused in the process. And that's the goal of the legislation. I think the data is pretty substantial, that it's not an uneven playing field at the moment.

And that's the intent of the bill. So, we're committed to keep working the bill. With that I would respectfully ask for an aye vote.

Thank you so much, Senator. And I appreciate your willingness to continue to work on the bill. Of course, being the first committee, we would expect it to be a work in progress and appreciate your willingness to work with all sides and hear all sides. As do I have - I do have a motion from Senator Richardson.

And with that the motion is do pass and re-refer to Committee on Judiciary. Assistant, please call the roll.

Senate Bill 728: motion is do passed but first refer to the Committee on Judiciary. [Roll Call].

Aye's: 5. No's: 0. With 1 not voting. The bill is out, and this committee is adjourned.