|05/20/2020||Upstart announces new credit API|
|02/14/2020||US Senators want answers from Upstart|
|02/08/2020||Upstart refutes discrimination accusations|
|04/08/2019||Upstart raises $50M|
|03/27/2018||Upstart seeks $100M|
Upstart, the online personal lender that uses non-traditional data like a college education, job history, and residency to evaluate borrowers, is moving forward with an IPO.
The company revealed its financial statements in an S-1 filed on Thursday. In 2019, Upstart generated $164.2M in revenue and had a net loss of $5M. For 2020 through Sept 30th, revenue was at $146.7M with a net income of $4.5M.
The company said that in 2020, 98% of its revenue was generated from platform, referral and servicing fees that it receives from its bank partners. Their bank partners “include Cross River Bank, Customers Bank, FinWise Bank, First Federal Bank of Kansas City, First National Bank of Omaha, KEMBA Financial Credit Union, TCF Bank, Apple Bank for Savings and Ridgewood Savings Bank.”
Upstart borrowers tend to have limited or no credit history, which is where its AI-driven models with 1,600 variables come into play.
“Our bank partners have generally increasingly retained loans for their own customer base and balance sheet,” the company wrote in its S-1. “In the third quarter of 2020, approximately 22% of Upstart-powered loans were retained by the originating bank, while about 76% of Upstart-powered loans were purchased by institutional investors through our loan funding programs.”
Upstart was valued at $750M during its 2019 Series D.
In 2017, deBanked referred to Upstart as the Tesla of alternative lending.
“You hear so much about how Tesla cars will drive themselves, how Google or Amazon home assistants talk to you to as if you’re human,” said Dave Girouard, Upstart co-founder, in an interview back then. “In lending we are the first company to apply these types of technologies to lending.”
Girouard’s co-founder Paul Gu, who serves as SVP of Product and Data Science, was only 21 when Upstart launched in 2012. He’s now 29.
Anna M. Counselman, the third co-founder, is SVP of People and Operations.
Upstart is planning to raise $100M from its IPO.
Upstart, an AI lending platform, welcomed longtime industry advocate Nat Hoopes to the team this week, to lead as Head of Government Policy and Regulatory affairs. Hoopes previously served as the Marketplace Lending Association executive director (MLA), where he grew the trade group and advocated on behalf of its members.
“My hope is to bring the energy that I did in growing the organization [MLA] and also just in tackling a lot of different workstreams to Upstart,” Hoopes said. “But also, deepen their ties with the DC policy community.”
Hoopes is excited to join the Upstart team and advocate for the company to state and federal legislators. Hoopes intends to address the development of two main issues as he enters his new office: facilitating better credit reporting with the help of AI, and using better credit to bring financing options to disenfranchised minority communities.
Upstart uses non-traditional data like a college education, job history, and residency to evaluate borrowers for personal loans. The company recently introduced an AI-powered Credit Decision API to deliver instant credit decisions. Upstart added auto loans to the platform in June, so the new API works with personal, student, and auto loans.
Hoopes said he and Upstart shared a similar motivation: to provide credit to people and improve financial futures, especially to people unfairly blocked from receiving credit.
“I think because of the structural inequality that we have in our society, a lot of minority groups get really left behind and stuck in a low credit score environment,” Hoopes said. “By using more data, and using it in new ways with artificial intelligence we can really level the playing field.”
Hoopes said that he has already seen Federal regulators in the FDIC and the OCC, and the CFPB working on using AI learning in credit underwriting. He said the Fed is planning out how to help banks adopt more of these models to approve more people.
“I think that’s a key initiative,” Hoopes said. “A key area where I’ll be working for Upstart: Engaging with regulators on how to help banks get more comfortable in serving more customers,”
While advocating for banks to use the credit capabilities of partners like Upstart, Hoopes said he would be devoted to ensuring decisions are made with equality and inclusion in mind. Hoopes will stay on as a member of the MLA board, and working in concert with his responsibilities advocating at Upstart.
“At MLA, I helped develop the diversity and inclusion strategies for our part of the fintech industry,” Hoopes said. “I’ll remain active on those issues at Upstart both collectively with other members of the industry as a member of the MLA.”
Hoopes referred to the Diversity and Inclusion strategy released by MLA last month. Board members signed off on the paper, written with the help of the National Urban Leauge. League president and CEO Marc Morial and Representative Gregory Meeks (D-NY) to create a vision of an inclusive fintech industry.
Hoopes addressed what he said was the failure of the American credit scoring system. For instance, according to Upstart’s study in 2019, 80% of Americans have never defaulted, yet only half have a prime credit score. It’s a problem he says disproportionately affects minority borrowers.
According to a Federal Reserve study, more than three times as many Black consumers (53%) and nearly two times as many Hispanic consumers (30%) as White consumers (16%) are in the lowest percentiles of credit scores.
Hoopes said Upstart does not collect racial data from applicants but cites a CFPB test that found Upstart’s platform increased access to credit across race and ethnicity by 23-29% while decreasing annual interest rates by 15%-17%.
The rise of fintech has already rocked the banking and traditional lending industry and now it’s disrupting FICO, the traditional credit scoring method that’s been in place since the mid-1900s.
FICO, which is the credit scoring system created by Fair Isaac Corp, is getting a makeover. The UltraFICO Score, which is scheduled to launch in early 2019, will pull from a consumer’s checking, savings and money-market accounts and add the data to their credit profile. It creates a broader credit picture, one that is designed to lead to more lending approvals than the static formula provides, as long as a consumer manages their cash well. Reports suggest the FICO score could jump by 20 points or more for millions of borrowers.
Meanwhile, fintech startup Upstart has been in the consumer lending business for the past five years. Upstart takes a two-pronged approaching, using more variables and more machine-learning algorithms than the traditional credit-scoring method.
“Using a variety of machine learning algorithms lets you pick up new insights from data,” said Upstart Co-Founder Paul Gu.
The company’s approach has influenced banks that frequently approach Upstart, a couple of which have become partners that are using a fully branded version of Upstart.com.
It’s not surprising considering Upstart is experiencing a lower loss rate versus its banking competitors. Upstart’s Gu explained the average lender issuing a personal loan to someone with a FICO score in the 660 range will typically experience a loss rate of 14%. Upstart’s loss rate is half that.
“That same 660-type borrower in our portfolio has an annual loss rate of 7%. That’s a pretty staggering difference and translates into benefits for our borrowers,” Gu told deBanked, adding that if the company can cut the loss rate, they can, in turn, lower the interest rate. Certainly, non-fintech lenders are paying attention.
“I don’t want to claim credit for anything FICO is thinking about. But I do think we are showing the industry at large that there is a huge amount of opportunity out there, and that you can go after it with technology that is available today. The potential benefits for consumers and your business are enormous,” Gu said.
Upstart’s early focus was on younger consumers with no real credit history but with an education history, which Gu said has yielded great success for the company. Since then they’ve expanded to pursue other groups of people who have similarly been “lost in the cracks” of the traditional credit scoring system, including certain occupations.
Gu explained that while lenders typically examine a potential borrower’s income level and their debt-to-income ratio, there’s more to it than that. Upstart most recently has created a way to include data based a potential borrower’s occupation, which he points out is tricky to quantify.
“Occupations are combinations of words that are hard to group in a useful way for the purposes of data analysis,” said Gu. Nonetheless, Upstart and its team of nearly a dozen data scientists have poured research into employers and occupations to create a classification system and determine how to turn words into numbers to use in their machine learning model.
“It’s not shocking that some professions are more highly correlated with repayment than others. Nurses, for example, are very reliable in paying back their loans,” Gu explained.
Upstart, which has issued consumer loans to fewer than 300,000 borrowers, has made it their mission to constantly improve upon their models to find cracks. “Our best estimate suggests we’ve solved only 8% of the total opportunity so far,” he said.
It’s early days for FICO’s new credit scoring system, but according to reports lenders have already begun to show an interest. Experian has reportedly partnered with fintech startup Finicity to publish the broader credit profile to banks. But the increased competition doesn’t seem to bother Upstart.
“I think there are starting to be efforts made by other players in the space to do some of the things we’re doing. Some of the lower hanging fruit we were uncompeted for earlier might have a little bit of competition. That said, the thing people don’t realize is how much room for improvement is still left,” Gu said.
As for FICO, their new feature is a side-product to the traditional credit-scoring system, not a replacement, which could impact the pace of adoption and innovation. “This kind of technology investment should take 95% of their attention, not 5%,” said Gu.
Online lender Upstart considers more than 10,000 variables such as an applicant’s education, academic performance, and employment background, according to their website, a proprietary system they say is used to detect “future prime” borrowers. But according to a recent Kroll Rating Agency report, their borrower base looks prime even by traditional standards in that their average borrower is 28 years old, earns $95,000 a year and has a FICO score of 690. Upstart lends money (through Cross River Bank) to individuals for a variety of purposes including student loan refinancing and debt consolidation.
In the Kroll report, Upstart asserts its belief that its use of additional data points will outperform traditional credit models, but concedes that their system has not been tested through economic cycles.
Upstart has raised $88.35 million in equity to-date. The Kroll Report was prepared in anticipation of a $163 million securitization transaction that is expected to close this month. They expect to be making $100 million of loans per month by the end of the year.
It’s been three years since we launched the Upstart lending platform, and today we’re pleased to announce we’ve raised $32.5M to take our business to the next level. The funding round was lead by Rakuten, a global leader in internet services and global innovation headquartered in Japan, and by a large US based asset manager. Existing investors Third Point Ventures, Khosla Ventures, and First Round Capital also participated. We’re particularly excited to have Oskar Mielczarek de la Miel, Oskar Miel, Managing Partner of the Rakuten FinTech Fund join Upstart’s Board of Directors.
With more than 50,000 loans originated, Upstart has the highest consumer ratings in the industry, has Net Promoter Scores (NPS) in excess of 80, and has delivered industry-leading returns to loan investors.
Leaders in Technology and Data Science for Lending
Upstart was the first platform to leverage modern data science and technology to power credit decisions, automate verification, and deliver a superior borrower experience. In 2014, we were first to launch next-day funding. In the last year, we virtually eliminated loan stacking on the Upstart platform, a central cause of credit issues in online lending. Today, more than 20% of our loans are fully automated, helping us attract the best quality borrowers with a superior experience.
As a result of our efforts, we’ve seen unparalleled credit performance, with 2016 cohorts our strongest yet. Upstart loans are funded in four distinct ways: 1) whole loan sales to institutions, 2) retention by Upstart’s originating bank partner, 3) sales to Upstart itself, and 4) via individuals in our fractional market. Furthermore, we expect our first loan securitization transaction within a few months.
2017 and Beyond!
We’ve focused considerable effort on our credit quality and loan economics, and the results speak for themselves. We aim to originate more than $1B in loans in 2017, and expect to reach cash flow profitability this year.
But that’s not all. We’re also thrilled to announce that Sanjay Datta has joined Upstart as CFO. Sanjay was formerly VP of Global Advertising Finance at Google, having spent a decade to help build and internationally expand Google’s $80B core economic engine.
Those that know my history at Google will understand why I’m excited to tell you about “Powered by Upstart”, a Software-as-a Service offering derived from Upstart’s top-rated consumer lending platform. From rate requests through servicing and collections, this new service brings modern technology and data science to the entire lending lifecycle.
Anna, Paul, and I founded Upstart to bring the best of Google to consumer lending. Upstart was the first platform to leverage modern data science and technology to power credit decisions, automate verification, and deliver a superior borrower experience. In 2014, we were first to launch next-day funding. As of today, more than 20% of our loans are fully automated and we expect this percentage to increase significantly through 2017. With more than 50,000 Upstart loans originated, we have the highest consumer ratings in the industry and have delivered industry-leading returns to loan investors. With Net Promoter Scores (NPS) in excess of 80, we’re excited about the impact we’re having.
FinTech is disrupting all areas of financial services. As a leading tech platform in marketplace lending, Upstart aims to partner with financial institutions rather than compete with them. Given the pace of change in lending, technology partnerships will be critical in the years to come, and Upstart aims to be a partner the industry can rely on.
But “Powered by Upstart” is not just software – it’s a turnkey solution that provides all necessary document review, verification phone calls, fraud analysis, and (optionally) customer service, loan servicing and collections.
Software-as-a-Service in lending
SaaS has grown exponentially in the last decade because of its obvious virtues: rather than buying, installing, configuring, hosting, and supporting software yourself, the software is delivered over the cloud. It’s more reliable and always up to date. Delivering cloud software can be challenging in any industry. Usability, reliability, and performance are the minimum to play, and effective change management is critical to success. As the team that delivered Google’s SaaS platform before it was called “cloud”, we understand these challenges.
Of course, the regulatory environment in lending raises the bar even higher. We’ve long demonstrated our commitment to trustful and compliant lending, and we’re likewise committed to delivering robust and compliant lending software.
Fintech IPOs are back. Affirm, a fintech company whose platform offers “a point-of-sale payment solution for consumers, merchant commerce solutions, and a consumer-focused app,” is the latest company to file for an IPO.
Affirm’s S-1 was filed earlier today, revealing that they intend to raise $100 million. The company generated $509M in net revenue during its fiscal year ending June 30 and a net loss of $112 million.
|Fintech||Date Filed||Date Public||Amount Raised|
Unrelated to fintech, but still “tech” are pending IPOs for DoorDash and Airbnb.
Members of the Marketplace Lending Association are taking steps to alleviate financial pressure facing borrowers during the recent crisis.
“This includes providing impacted borrowers with forbearance, loan extensions, and other repayment flexibility that is typically provided to borrowers impacted by natural disasters. During the time of payment forbearance, marketplace lenders are also electing not to report borrowers as ‘late on payment’ to the credit bureaus,” a letter to senior members of Congress signed by Exec Director Nathaniel Hoopes states. “Members are also waiving any late fees for borrowers in forbearance due to the COVID-19 pandemic, posting helplines on company homepages, and communicating options via company servicing portals.”
Members of the MLA include:
- Funding Circle
- Marlette Funding
- College Ave Student Loans
- Arcadia Funds, LLC
- Citadel SPV
- Colchis Capital
- Community Investment Management
- cross river
- Fintech Credit Innovations Inc.
- Laurel road
- SouthEast bank
- Victory Park Capital
For Rochelle Gorey, the chief executive and co-founder of SpringFour, a “social impact” fintech company, mingling with industry movers and shakers at this year’s LendIt Fintech Conference was just what the doctor ordered. “I went mainly for the networking opportunities,” Gorey told deBanked.
SpringFour, which is headquartered in Chicago, works with banks and financial institutions in the 50 states to get distressed borrowers back on track with their debt payments. It does this by digitally linking debtors with governmental and nonprofit agencies that promote “financial wellness.
The indebted parties—more than a million of whom had referrals that were arranged by Gorey’s tech-savvy company last year—constitute not only household consumers but also commercial borrowers. “Small businesses face the same issues of cash flow as consumers, and their business and personal income are often combined,” she says. “If their financial situation is precarious, it’s super-hard to get credit, a line of credit, or a business loan.”
Although Gorey felt “overwhelmed” at first by the throng of 4,000 conference-goers at Moscone Center West in San Francisco—roughly the same number as attended last year, conference organizers assert— her trepidation was short-lived. It wasn’t too long before she was in circulation and having chance encounters and serendipitous interactions, she says, with “all the right people at the workshops and at the tables in the Expo Hall.”
Armed, moreover, with a “networking app” on her mobile phone, Gorey was able to arrange targeted meetings, scoring roughly a dozen, 15-minute tete-a-tetes during the two-day breakout sessions. These included audiences with community bankers, financial technology companies, and “small-dollar” lenders. “And it went both ways,” she says. “I had people reaching out to me”—just about everyone, it seemed, appeared receptive to “finding ways to boost their customers’ financial health.”
Gorey’s success at networking was precisely the experience that the event’s planners had envisioned, says Peter Renton, chairman and co-founder of the LendIt Fintech Conference. Organizers took pains to make schmoozing one of the key features of this year’s gathering. Not only did LendIt provide attendees with a bespoke networking app, but planners scheduled extra time for meet-ups. “We had around 10,000 meetings set up by the app,” Renton says, “about double the number of last year.”
deBanked did not attend the LendIt USA conference on the West Coast this year. But the publication sought out more than a half-dozen attendees—including several financial technology executives, a leading venture capitalist, a regulatory law expert, and the conference’s top administrators—to gather their impressions. While informal and manifestly unscientific, their responses nonetheless yielded up several salient themes.
The popularity—and effectiveness—of networking was a key takeaway. Most seized the opportunity to rub elbows with influential industry players, learn about the hottest startups, compare notes, and catch up on the state of the industry. Most importantly, the event presented a golden opportunity to make the introductions and connections that could generate dealmaking.
“My goal this year was to strike more partnerships with lenders and fintech companies,” says Levi King, chief executive and co-founder at Utah-based Nav, an online, credit-data aggregator and financial matchmaker for small businesses. “We had great meetings with Fiserv, Amazon, Clover Network (a division of First Data), and MasterCard,” he reports, rattling off the names of prominent financial services companies and fintech platforms.
James Garvey, co-founder and chief executive at Self Lender, an Austin-based fintech that builds creditworthiness for “thin file” consumers who have little or no credit history, said his goal at the conference was both to serve on a panel and “meet as many people as I could.”
Self Lender is in its growth stage following a $10 million, series B round of financing in late 2018 from Altos Ventures and Silverton Partners. Garvey reports having meetings with Bank of America and venture capitalist FTV Capital “over coffee” as well as F-Prime Capital, another venture capitalist. “It’s just about building a relationship,” he said of making connections, “so that at some point, if I’m raising money or want to partner, I can make a deal.”
There was a concerted effort to recognize women, as evidenced by a packed “Women in Fintech” (WIF) luncheon that drew roughly 250 persons, 95% of whom were women. (“Many men are big supporters of women in fintech and we didn’t want to exclude them,” Renton says). The luncheon was preceded by a novel event—a 30-minute, ladies-only “speed-networking” session—which attracted 160 participants, reports Joy Schwartz, president of LendIt Fintech and manager of the women’s programs.
At the luncheon, SpringFour’s Gorey says, “it was empowering just to see lot of women who are senior leaders working in financial services, banks and fintechs.” The keynote speech by Valerie Kay, chief capital officer at Lending Club, was another highlight. “She (Kay) talked about taking risks and going to a fintech startup after 23 years at Morgan Stanley,” Gorey reports, adding: “It was inspiring.”
The women’s luncheon also marked the launch of LendIt’s Women In Fintech mentor program, and presentation of a “Fintech Woman of the Year” award. The recipient was Luvleen Sidhu, president, co-founder and chief strategy officer at BankMobile, a digital division of Customers Bank, based near Philadelphia, which employs 250 persons and boasts two million checking account customers.
I am honored to be the 2019 Fintech Women of the Year and thrilled that @BankMobile won Most Innovative Bank. It’s very exciting to be recognized by @LendIt Fintech with this prestigious award and I congratulate the finalists in all the categories. https://t.co/qjADuKEMrB pic.twitter.com/hFJVFw1fLS
— Luvleen Sidhu (@LuvleenSidhu) April 11, 2019
BankMobile, which also won LendIt’s “Most Innovative Bank” award, has an alliance with Upstart to do consumer lending and a partnership with telecommunications company T-Mobile. Known as T-Mobile Money, the latter service provides T-Mobile customers with access to checking accounts with no minimum balance, no monthly or overdraft fees, and access to 55,000 automated teller machines, also with no fees. (At its website, T-Mobile Money describes itself as a bank and uses the slogan: “Not another bank, a better one.”)
The impressive salute to women notwithstanding, their ranks remained fairly thin: just 733 attendees identified themselves as “female” on their registration forms, LendIt’s Schwartz says, a little more than 18% of total participants. Seventy-five of the 350 total speakers and panelists—or 21%—were female. (Schwartz also reports that another 157 registrants selected “prefer not to say” as their sexual orientation, while 22 checked the box describing themselves as “non-conforming.”)
In LendIt’s defense, deBanked, who caters to a similar audience, regularly reviews its readership demographics using several tools. They have consistently indicated that women make up 18% – 23% of the total, in line with what LendIt experienced at its most recent event.
By all accounts, many panels were informative, jampacked and attendees were engaged. King, who moderated a panel on regulatory changes in small business lending, which dealt with such topics as California’s commercial “truth-in-lending” law and controversial “confessions of judgment” laws, says: “They didn’t have to lock the door but the room was pretty full and people seemed to be paying attention. I didn’t see people studying their cellphones.”
The Expo Hall was teeming with budding fintech entrepreneurs, financial services companies and multiple vendors hawking their wares. But as numerous fintechs were angling to forge lucrative symbiotic relationships with banks, some participants—even those who were hailing the conference for its networking and deal-making opportunities—lamented the heavy presence of the establishment.
The banks’ ubiquitousness especially vexed Matthew Burton, a partner at QED Investors, an Arlington, (Va.)-based, venture capital firm and a veteran fintech entrepreneur. Before signing on with QED last year, Burton had been the co-founder of Orchard Platform, an online technology and analytics vendor for fintech and financial services companies which was purchased by fintech lender Kabbage.
Not only did bankers seem to playing a more prominent role at the LendIt conference, Burton notes, but “big four” accounting firm Deloitte had signed on as a major sponsor. “The energy level seemed a bit lower than in past years,” Burton told deBanked. “It’s not like people were depressed but it wasn’t bubbling with excitement. A couple of years ago we thought all these new fintechs would replace the banks,” he explains. “Now the discussion is over how to partner and collaborate with banks. It’s not as exciting as when everyone thought banks were dinosaurs.
“I couldn’t really tell if there were more bankers attending this year,” Burton adds, “but it sure felt like it.”
King, the Nav executive, told deBanked: “It was a little bit subdued. I don’t know if it was nervousness about the economy or politics, but the subject of risk came up more often in side conversations with venture-backed businesses and banks and alternative fintech lenders. One large bank we deal with,” he adds, “told me it’s spending most of its time working on risk.”
Cornelius Hurley, a Boston University law professor and executive director of the Online Lending Policy Institute who participated in a standing-room-only session on state and federal fintech regulation, declares: “I’ve been to three of their conferences, including one in New York, and I would say that this one did not have as much pizzazz. It may be that the industry is maturing.”
For his part—when asked whether there was a palpable absence of passion this year—LendIt’s Renton told deBanked: “I would say that it felt more businesslike. Fintech has had a lot of hype and we have had conferences that were ridiculously over-hyped in 2015 and 2016. And in 2017 (the mood) was much more somber. This one felt optimistic and businesslike.”
There were 750 bankers in attendance, almost one in five participants. “The number of bankers was not up significantly” over last year, Renton says, “but the seniority of the bankers was higher. We worked very hard to get senior bankers to attend this year.”
Renton was bullish on the closer ties developing between nonbank online lenders and banks. That was reflected as well in the several panels exploring ways to develop partnerships between the two sides. He noted that a session called “How Banks are Matching Fintechs on Speed of Funding and User Experience” drew a heavy crowd. “It brought more bankers than we’ve ever had before,” Renton says.
Moderated by Brock Blake, founder and chief executive at the fintech Lendio, the panel was composed of three bankers: Ben Oltman, the Philadelphia-area head of digital lending and partnerships at Citizens Bank; Gina Taylor Cotter, a senior vice-president at American Express (the highest-ranking woman at the company); and Thomas Ferro, a senior marketing manager at Bank of America. “The banks came to LendIt not just to learn but to decide whom they’re going to partner with,” Renton says. “Fintechs need banks and banks need fintechs. That is the narrative you hear on both sides.”
(Asked whether any banks sponsored this year’s conference, Renton replied: “They are not sponsoring yet in any number but we are working on that.”)
OnDeck, a top-tier fintech lender to small-businesses in the U.S., which has been making forays abroad to Australian and Canadian markets, is an enthusiastic champion of the fintech-bank union. So much so that it claimed LendIt’s “Most Promising Partnership” award for the cooperative relationship it struck with Pittsburgh-based PNC Bank, which uses OnDeck’s platform to make small business loans. (Among the partnerships that OnDeck-PNC beat out: Gorey’s SpringFour, which was named a finalist in the competition for its association with BMO Harris Bank.)
“We were the first fintech lender to strike a true platform relationship with a bank,” Jim Larkin, head of corporate communications at OnDeck says, noting that the PNC deal follows on the New York-based fintech’s similar, innovative arrangement with J.P. Morgan Chase. “Others may do referrals,” he explains. “What we do is actually provide the underlying platform to accelerate a bank’s online lending capabilities. We deliver the software and expertise to construct the right type of online lending engine.”
Meanwhile, there was avid interest about the stock performance of publicly traded fintechs—for example, Square and GreenSky—both of which had seen their share prices tumble and then recover.
Burton noted that, among venture-backed firms, the most excitement seemed to be coming from Latin America. “Everyone was very bullish on a Mexican company, Credijusto, an alternative small business lender that was written up the in the Wall Street Journal,” he says. “It’s not going public yet but it had a large debt-and-equity raise of $100 million from Goldman Sachs. And SoftBank Group announced a $5 billion Latin American tech fund.
“There was a lot of talk,” he adds, “about how money was flowing into Mexico and Brazil.”
OnDeck, the reigning king of small business lending among U.S. financial technology companies, is sharpening its business strategies. Among its new initiatives: the company is launching an equipment-finance product this year, targeting loans of $5,000 to $100,000 with two-to-five year maturities secured by “essential-use equipment.”
In touting the program to Wall Street analysts in February, OnDeck’s chief executive, Noah Breslow, declared that the $35 billion, equipment-finance market is “cumbersome” and he pronounced the sector “ripe for disruption.”
While those performance expectations may prove true – the first results of OnDeck’s product launch won’t be seen until 2020 – Breslow’s message seemed to conflict with OnDeck’s image as a public company. Rather than casting itself as a disruptor these days, OnDeck emphasizes the ways that its business is melding with mainstream commerce and finance.
Consider that the New York-based company, which saw its year-over-year revenues rise 14% to $398.4 million in 2018, is collaborating with Visa and Ingo Money to launch an “Instant Funding” line-of-credit that funnels cash “in seconds” to business customers via their debit cards. With the acquisition of Evolocity Financial Group, it is also expanding its commercial lending business in Canada, a move that follows its foray into Australia where, the company reports, loan-origination grew by 80% in 2018.
Perhaps most significant was the 2018 deal that OnDeck inked with PNC Bank, the sixth-largest financial institution in the U.S. with $370.5 billion in assets. Under the agreement, the Pittsburgh-based bank will utilize OnDeck’s digital platform for its small business lending programs. Coming on top of a similar arrangement with megabank J.P. Morgan Chase, the country’s largest with $2.2 trillion in assets, the PNC deal “suggests a further validation of OnDeck’s underlying technology and innovation,” asserts Wall Street analyst Eric Wasserstrom, who follows specialty finance for investment bank UBS.
“It also reflects the fact that doing a partnership is a better business model for the big banks than building out their own platforms,” he says. “Both banks (PNC and J.P. Morgan) have chosen the middle ground: instead of building out their own technology or buying a fintech company, they’ll rent.
“J.P. Morgan has a loan portfolio of $1 trillion,” Wasserstrom explains. “It can’t earn any money making loans of $15,000 or $20,000. Even if it charged 1,000 percent interest for those loans,” he went on, “do you know how much that will influence their balance sheet? How many dollars do think they are going to earn? A giant zero!”
Similarly, Wasserstrom says, spending the tens of millions of dollars required to develop the state-of-the art technology and expertise that would enable a behemoth like J.P. Morgan or a super-regional like PNC to match a fintech’s capability “would still not be a big needle-mover. You’d never earn that money back. But by partnering with a fintech like OnDeck,” he adds, “banks like J.P Morgan and PNC get incremental dollars they wouldn’t otherwise have.”
The alliance between OnDeck and old-line financial institutions is one more sign, if one more sign were needed, that commercial fintech lenders are increasingly blending into the established financial ecosystem.
Not so long ago companies like OnDeck, Kabbage, PayPal, Square, Fundation, Lending Club, and Credibly were viewed by traditional commercial banks and Wall Street as upstart arrivistes. Some may still bear the reputation as disruptors as they continue using their technological prowess to carve out niche funding areas that banks often neglect or disdain.
Yet many fintechs are forming alliances with the same financial institutions they once challenged, helping revitalize them with new product offerings. Other financial technology companies have bulked up in size and are becoming indistinguishable from any major corporation.
Big Fintechs are securitizing their loans with global investment banks, accessing capital from mainline financial institutions like J.P. Morgan, Goldman Sachs and Wells Fargo, and finding additional ways — including becoming publicly listed on the stock exchanges – to tap into the equity and debt markets.
One example of the maturation process: through mid-2018, Atlanta-based Kabbage has securitized $1.5 billion in two bond issuances, 30% of its $5 billion in small business loan originations since 2008.
In addition, fintechs have been raising their industry’s profile with legislators and regulators in both state and federal government, as well as with customers and the public through such trade associations as the Internet Lending Platform Association and the U.S. Chamber of Commerce. Both individually and through the trade groups, these companies are building goodwill by supporting truth-in-lending laws in California and elsewhere, promoting best practices and codes of conduct, and engaging in corporate philanthropy.
Rather than challenging the established order, S&P Global Market Intelligence recently noted in a 2018 report, this cohort of Big Fintech is increasingly burrowing into it. This can especially be seen in the alliances between fintech commercial lenders and banks.
“Bank channel lenders arguably have the best of both worlds,” Nimayi Dixit, a research analyst at S&P Global Market Intelligence wrote approvingly in a 2018 report. “They can export credit risk to bank partners while avoiding the liquidity risks of most marketplace lending platforms. Instead of disrupting banks, bank channel lenders help (existing banks) compete with other digital lenders by providing a similar customer experience.”
It’s a trend that will only accelerate. “We expect more digital lenders to incorporate this funding model into their businesses via white-label or branded services to banking institutions,” the S&P report adds.
Forming partnerships with banks and diversifying into new product areas is not a luxury but a necessity for Fundation, says Sam Graziano, chief executive at the Reston (Va.)-based platform. “You can’t be a one-trick pony,” he says, promising more product launches this year.
Fundation has been steadily making a name for itself by collaborating with independent and regional banks that utilize its platform to make small business loans under $150,000. In January, the company announced formation of a partnership with Bank of California in which the West Coast bank will use Fundation’s platform to offer a digital line of credit for small businesses on its website.
Fundation lists as many as 20 banks as partners, including most prominently a pair of tech-savvy financial institutions — Citizens Bank in Providence, R.I. and Provident Bank in Iselin, N.J. — which have been featured in the trade press for their enthusiastic embrace of Fundation.
John Kamin, executive vice president at $9.8 billion Provident reports that the bank’s “competency” is making commercial loans in the “millions of dollars” and that it had generally shunned making loans as meager as $150,000, never mind smaller ones. But using Fundation’s platform, which automates and streamlines the loan-approval process, the bank can lend cheaply and quickly to entrepreneurs. “We’re able to do it in a matter of days, not weeks,” he marvels.
Not only can a prospective commercial borrower upload tax returns, bank statements and other paperwork, Kamin says, “but with the advanced technology that’s built in, customers can provide a link to their bank account and we can look at cash flows and do other innovative things so you don’t have to wait around for the mail.”
Provident reserves the right to be selective about which loans it wants to maintain on its books. “We can take the cream of the crop” and leave the remainder with Fundation, the banker explains. “We have the ability to turn that dial.”
The partnership offers additional side benefits. “A lot of folks who have signed up (for loans) are non-customers and now we have the ability to market to them,” he says. “After we get a small business to take out a loan, we hope that we can get deposits and even personal accounts. It gives us someone else to market to.”
As a digital lender, Provident can now contend mano a mano with another well-known competitor: J.P. Morgan Chase. “This is the perfect model for us,” says Kamin, “it gives us scale. You can’t build a program like this from scratch. Now we can compete with the big guys. We can compete with J.P. Morgan.”
For Fundation, which booked a half-billion dollars in small business loans last year, doing business with heavily regulated banks puts its stamp on the company. It means, for example, that Fundation must take pains to conform to the industry’s rigid norms governing compliance and information security. But that also builds trust and can result in client referrals for loans that don’t fit a bank’s profile. “For a bank to outsource operations to us,” Graziano says, “we have to operate like a bank.”
Bankrolled with a $100 million line of credit from Goldman Sachs, Fundation’s interest rate charges are not as steep as many competitors’. “The average cost of our loans is in the mid-to-high teens and that’s one reason why banks are willing to work with us,” Graziano says. “Our loans,” he adds, “are attractively structured with low fees and coupon rates that are not too dramatically different from where banks are. We also don’t take as much risk as many in the (alternative funding) industry.”
Despite its establishment ties, Graziano says, Fundation will not become a public company anytime soon. “Going public is not in our near-term plans,” he told deBanked. Doing business as a public company “provides liquidity to shareholders and the ability to use stock as an acquisition tool and for employees’ compensation,” he concedes. “But you’re subject to the relentlessly short-term focus of the market and you’re in the public eye, which can hurt long-term value creation.”
Graziano reports, however, that Fundation will be securitizing portions of its loan portfolio by yearend 2020.
PayPal Working Capital, a division of PayPal Holdings based in San Jose, and Square Inc. of San Francisco, are two Big Fintechs that branched into commercial lending from the payments side of fintech. PayPal began making small business loans in 2013 while Square got into the game in 2014. In just the last half-decade, both companies have leveraged their technological expertise, massive data collections, data-mining skills, and catbird-seat positions in the marketplace to burst on the scene as powerhouse small business lenders.
With somewhat similar business models, the pair have also surfaced as head-to-head competitors, their stock prices and rivalry drawing regular commentary from investors, analysts and journalists. Both have direct access to millions of potential customers. Both have the ability to use “machine learning” to reckon the creditworthiness of business borrowers. Both use algorithms to decide the size and terms of a loan.
Loan approval — or denials — are largely based on a customer’s sales and payments history. Money can appear, sometimes almost magically in minutes, in a borrower’s bank account, debit card or e-wallet. PayPal and Square Capital also deduct repayments directly from a borrower’s credit or debit card sales in “financing structures similar to merchant cash advances,” notes S&P.
At its website, here is how PayPal explains its loan-making process. “The lender reviews your PayPal account history to determine your loan amount. If approved, your maximum loan amount can be up to 35% of the sales your business processed through PayPal in the past 12 months, and no more than $125,000 for your first two loans. After you’ve completed your first two loans, the maximum loan amount increases to $200,000.”
PayPal, which reports having 267 million global accounts, was adroitly positioned when it commenced making small business loans in 2013. But what has really given the Big Fintech a boost, notes Levi King, chief executive and co-founder at Utah-based Nav — an online, credit-data aggregator and financial matchmaker for small businesses – was PayPal’s 2017 acquisition of Swift Financial. The deal not only added 20,000 new business borrowers to its 120,000, reported TechCrunch, but provided PayPal with more sophisticated tools to evaluate borrowers and refine the size and terms of its loans.
“PayPal had already been incredibly successful using transactional data obtained through PayPal accounts,” King told deBanked, “but they were limited by not having a broad view of risk.” It was upon the acquisition of Swift, however, that PayPal gained access to a “bigger financial envelope including personal credit, business credit, and checking account information,” King says, adding: “The additional data makes it way easier for PayPal to assess risk and offer not just bigger loans, but multiple types of loans with various payback terms.”
While PayPal used the Swift acquisition to spur growth and build market share, its rival Square — which is best known for its point-of-sale terminals, its smartphone “Cash App,” and its Square Card — has employed a different strategy.
OF A FREIGHT TRAIN
By selling off loans to third-party institutional investors, who snap them up on what Square calls a “forward-flow basis,” the Big Fintech barged into small business lending with the subtlety of a freight train. In just four years, Square originated 650,000 loans worth $4.0 billion, a stunning rise from the modest base of $13.6 million in 2014.
Square’s third-party funding model, moreover, demonstrates the benefits afforded from being deeply immersed in the financial ecosystem. Off-loading the loans “significantly increases the speed with which we can scale services and allows us to mitigate our balance sheet and liquidity risk,” the company reported in its most recent 10K filing.
Square does not publicly disclose the entire roster of its third-party investors. But Kim Sampson, a media relations manager at Square, told deBanked that the Canada Pension Plan Investment Board — “a global investment manager with more than CA$300 billion in assets under management and a focus on sustained, long term returns” – is one important loan-purchaser.
Square also offers loans on its “partnership platform” to businesses for whom it does not process payments. And late last year the company introduced an updated version of an old-fashioned department store loan. Known as “Square Installments,” the program allows a merchant to offer customers a monthly payment plan for big-ticket purchases costing between $250 and $10,000.
Which model is superior? PayPal’s — which retains small business loans on its balance sheet — or Square’s third-party investor program? “The short answer,” says UBS analyst Wasserstrom, “is that PayPal retains small business loans on its balance sheet, and therefore benefits from the interest income, but takes the associated credit and funding risk.”
Meanwhile, as PayPal and Square stake out territory in the marketplace, their rivalry poses a formidable challenge to other competitors.
Both are well capitalized and risk-averse. PayPal, which reported $4.23 billion in revenues in 2018, a 13% increase over the previous year, reports sitting on $3.8 billion in retained earnings. Square, whose 2018 revenues were up 51 percent to $3.3 billion, reported that — despite losses — it held cash and liquid investments of $1.638 billion at the end of December.
King, the Nav executive, observes that Able, Dealstruck, and Bond Street – three once-promising and innovative fintechs that focused on small business lending – were derailed when they could not overcome the double-whammy of high acquisition costs and pricey capital.
“None of them were able to scale up fast enough in the marketplace,” notes King. “The process of institutionalization is pushing out smaller players.”
Artificial intelligence such as machine learning has the potential to dramatically shift the alternative lending and funding landscape. But humans still have a lot to learn about this budding field.
Across the industry, firms are at different points in terms of machine learning adoption. Some firms have begun to implement machine learning within underwriting in an attempt to curb fraud, get more complex insights into risk, make sounder funding decisions and achieve lower loss rates. Others are still in the R&D and planning stage, quietly laying the groundwork for future implementation across multiple areas of their business, including fraud prevention, underwriting, lead generation and collections.
“It’s entirely critical to the success of our business,” says Paul Gu, co-founder and head of product at Upstart, a consumer lending platform that uses machine learning extensively in its operations. “Done right, it completely changes the possibilities in terms of how accurate underwriting and verification are,” he says.
While there’s no absolute right way to implement machine learning within a lender’s or funder’s business, there are many data-related, regulatory and business-specific factors to consider. Because things can go very wrong from a business or regulatory perspective—or both—if machine learning is not implemented properly, firms need to be especially careful. Here are a few pointers that can help lead to a successful machine learning implementation:
Using machine learning, funders can predict better the likelihood of default versus a rule-based model that looks at factors such as the size of the business, the size of the loan and how old the business is, for example, says Eden Amirav, co-founder and chief executive of Lending Express, a firm that relies heavily on AI to match borrowers and funders.
Machine learning takes hundreds and hundreds of parameters into account which you would never look at with a rule-based model and searches for connections. “You can find much more complex insights using these multiple data points. It’s not something a person can do,” Amirav says.
He contends that machine learning will optimize the number of small businesses that will have access to funding because it allows funders to be more precise in their risk analyses. This will open doors for some merchants who were previously turned down based on less precise models, he predicts. To help in this effort, Lending Express recently launched a new dashboard that uses AI-driven technology to help convert business loan candidates that have been previously turned down into viable applicants. The new LendingScore™ algorithm gives businesses detailed information about how they can improve different funding factors to help them unlock new funding opportunities, Amirav says.
Lenders and funders always have to be thinking about what’s next when it comes to artificial intelligence, even if they aren’t quite ready to implement it. While using machine learning for underwriting is currently the primary focus for many firms, there are many other possible use cases for the alternative lenders and funders, according to industry participants.
Lead generation and renewals are two areas that are ripe for machine learning technology, according to Paul Sitruk, chief risk officer and chief technology officer at 6th Avenue Capital, a small business funder. He predicts that it is only a matter of time before firms are using machine learning in these areas and others. “It can be applied to several areas within our existing processes,” he says.
Collection is another area where machine learning could make the process more efficient for firms. Machines can work out, based on real-life patterns, which types of customers might benefit from call reminders and which will be a waste of time for lenders, says Sandeep Bhandari, chief strategy and chief risk officer at Affirm, which uses advanced analytics to make credit decisions.
“There are different business problems that can be solved through machine learning. Lenders sometimes get too fixated on just the approve/decline problem,” he says.
“Most underwriters don’t have enough data to effectively incorporate AI, deep learning, or machine learning tools,” says Taariq Lewis, chief executive of Aquila, a small business funder. He notes that effective research comes from the use of very large datasets that won’t fit in an excel spreadsheet for testing various hypotheses.
Problems, however, can occur when there’s too much complexity in the models and the results become too hard to understand in actionable business terms. For example, firms may use models that analyze seasonal lender performance without understanding the input assumptions, like weather impact, on certain geographies. This may lead to final results that do not make sense or are unexpected, he says.
“There’s a lot of noise in the data. There are spurious correlations. They make meaningful conclusions hard to get and hard to use,” he says.
The more precise firms can be with the data, the more predictive a machine learning model can be, says Bhandari of Affirm. So, for example, instead of looking at credit utilization ratios generally, the model might be more predictive if it includes the utilization rate over recent months in conjunction with debt balance. It’s critical to include as targeted and complete data as possible. “That’s where some of our competitive advantages come in,” Bhandari says.
Underwriters also have to pay particularly close attention that overfitting doesn’t occur. This happens when machines can perfectly predict data in your data set, but they don’t necessarily reflect real world patterns, says Gu of Upstart.
Keeping close tabs on the computer-driven models over time is also important. The model isn’t going to perform the same all along because the competitive environment changes, as do consumer preferences and behaviors. “You have to monitor what’s going well and what’s not going well all the time,” Bhandari says.
Certainly, as AI is integrated into financial services, state and federal regulators that oversee financial services are taking more of an interest. As such, firms dabbling with new technology have to be very careful that any models they are using don’t run afoul of federal Fair Lending Laws or state regulations.
“If you don’t address it early and you have a model that’s treating customers unfairly or differently, it could result in serious consequences,” says Tim Wieher, chief compliance officer and general counsel of CAN Capital, which is in the early stages of determining how to use AI within its business.
“AI will be transformative for the financial services industry,” he predicts, but says that doing it right takes significant advance planning. For instance, Wieher says it’s very important for firms to involve legal and compliance teams early in the process to review potential models, understand how the technology will impact the lending or funding process and identify the challenges and mitigate the risk.
To be sure, regulation around AI is still a very gray area since the technology is so new and it’s constantly evolving. Banking regulators in particular have been looking closely at the issues pertaining to AI such as its possible applications, short-comings, challenges and supervision. Because the waters are so untested, there can be validity in asking for regulatory and compliance advice before moving ahead full steam, some industry watchers say.
Upstart, for example, which uses AI extensively to price credit and automate the borrowing process, wanted buy-in from the Consumer Financial Protection Bureau to help ease the concern of its backers as well as to satisfy its own concerns about the legality of its efforts. So the firm submitted a no-action request to CFPB. The CFPB responded by issuing a no-action letter to Upstart in September 2017, allowing the company to use its model. In return, Upstart shares certain information with the CFPB regarding the loan applications it receives, how it decides which loans to approve, and how it will mitigate risk to consumers, as well as information on how its model expands access to credit for traditionally underserved populations.
The No-Action Letter is in force for three years and Upstart can seek to renew it if it chooses.
Theoretically firms could have a computer underwriting model constantly updating itself without having a human oversee what the model is doing—but it’s a bad idea, industry participants say. “I believe there are companies doing that, and it’s a risky thing to do,” says Scott M. Pearson, a partner with the law firm Ballard Spahr LLP in Los Angeles.
During review of the models—and before implementing them—people should carefully review the models and the output to make sure there’s nothing that causes intrinsic bias, says Kathryn Petralia, co-founder and president of Kabbage, which is one of the front-runners in using machine learning models to understand and predict business performance.
“If you’re not watching the machine, you don’t know how the machine is complying with regulatory requirements,” she says.
Kabbage has teams of data scientists regularly developing models that the company then reviews internally before deploying. The company is also in frequent contact with regulators about its processes. Petralia says it’s very important that firms be able to explain to regulators how their models work. “Machines aren’t very good at explaining things,” she quips.
As a best practice, Pearson of Ballard Spahr says lenders and funders shouldn’t use any machine learning model until it’s been signed off on by compliance. “That strikes a pretty good balance between getting the benefits of AI and making sure it doesn’t create a compliance problem for you,” he says.
While AI has many benefits, industry participants say alternative lenders and funders need to be mindful of how it can be applied practically and effectively within their particular business model.
Craig Focardi, senior analyst with consulting firm Celent in San Francisco, contends that the classic FICO score continues to be the gold standard for credit decisions in the U.S. He warns firms not to get overly distracted trying to find the next best thing.
“Many fintech lenders have immature risk management and operations functions. They’re better off improving those than dabbling in alternative scoring,” he says, noting that data modeling is an entirely separate core competency.
Indeed, Lewis of Aquila cautions underwriters not to view AI as a silver bullet. “AI is just one tool out of many in the lenders’ toolbox, and our industry should use it and respect its limitations,” he says.
On a business trip to China last summer, Matt Burton had plenty of money in his wallet but it was practically useless.
Case in point: He had a lengthy standoff with a Shanghai taxi driver who insisted on a mobile-phone payment. “I spent 20 minutes arguing with the cabbie,” says Burton, one of the founding partners at Orchard Platform, a leading provider of technology and software to the alternative lending industry. “You’d think that — out of all of the professions — a taxi driver would accept cash.”
The New Yorker finally convinced the cab driver to take the payment in renminbi, China’s paper currency. The incident, meanwhile, is illustrative of how deeply and widely mobile payments have penetrated the huge Chinese market. “No one in China carries wallets anymore,” Burton reports. “Everyone pays with their smart-phones. Even the elderly women selling vegetables on the side of the road accept mobile payments,” he adds. “Cash has become a hassle.”
Welcome to China’s financial technology revolution. Almost overnight, China’s population graduated from calculating with the 16th-century abacus to showcasing what is arguably the world’s most sophisticated system of mobile payments. Thanks to financial technology, China is fast becoming a cashless economy. China is just one place outside the U.S. where financial technology is catching on in a big way. As Americans remain, for the most part, wedded to suburban drive-in banks, walk-up automated teller machines, and plastic credit and debit cards, the rest of the world is rapidly embracing digital solutions. And nowhere is that happening more dramatically than in China.
According to the most recent figures released by China’s Internet Network Information Center, the country had 724 million mobile phone users at the end of June 2017. China’s Ministry of Industry and Information Technology reports, moreover, that consumers paying for everything from food and clothing to utility bills to movie tickets and – you guessed it, cab fare — engaged in 239 billion mobile payment transactions in 2017, a surge of 146 percent over the previous year.
Mobile payments have become a $16 trillion industry in China, the ministry adds, accounting for about half of all such transactions in the world.
And there’s ample room to grow. The World Bank discloses that there are now 772 million Internet users in China, more than double the entire population of the U.S. Yet that leaves 50% of China’s population – mostly in the countryside and rural areas – who are not yet plugged in to the Internet.
Two Chinese mobile-payment platforms dominate the industry. Ant Financial is the 800-pound-gorilla, its Alipay program boasting 520 million global users on its website. It’s an affiliate of publicly traded Alibaba Group Holding, an online merchandiser known as the “Amazon of China” which was founded by entrepreneur Jack Ma, reputedly the richest man in China.
Alipay not only has bragging rights to roughly 60 percent of China’s digital and online payments market but, in 2013, it overtook PayPal as the global leader in third-party payments. With deep roots in e-commerce, Alipay is the go-to payments option for online shoppers, who are steadily migrating from laptops to mobile devices.
WeChat Pay is the upstart in the duopolistic rivalry. Launched in 2013, nearly a decade later than its rival, it’s a unit of conglomerate Tencent Holdings, a social network and messaging platform often compared to Facebook. As WeChat continues to add subscribers, its Tenpay app has been growing accordingly, eroding Alipay’s market share as new users gravitate to the e-payments program. While WeChat records fewer payments than Alipay, Forbes magazine reports that it claims more users.
Whatever WeChat’s virtues, Ant Financial continues to chew up the scenery. It recently topped the charts as the world’s “most innovative” fintech in 2017, as reckoned by a research team formed by accounting giant KPMG and H2 Ventures. China scored a hat trick, moreover, as two additional homegrown fintechs — online property-and-casualty insurer ZhongAn and credit-provider Qudian Inc. — took second and third place, respectively, in KPMG/H2’s rankings. For good measure, China also claimed five of the top ten spots on the “most innovative” list, edging out the U.S., which had four.
Financial analysts recently surveyed by the Financial Times reckon Ant Financial’s market valuation at $150 billion, catapulting the company into the rarified status of not just a “unicorn,” but a “super-unicorn.” (Named after the rarely seen mythical one-horned horse, “unicorns” are start-ups valued at $1 billion). So robust is Ant Financial’s market valuation that the global investment community is salivating over its impending initial public offering.
(Ant’s progenitor, Alibaba, holds bragging rights as the largest IPO ever, according to the Financial Industry Regulatory Authority. It raised $21.8 billion in 2014; its NYSE-listed stock was trading at $194.36 in mid-May, essentially in the same league as Apple and Facebook, trading at $188.80 and 187.08, respectively, on Nasdaq.)
“Four of the largest fintech unicorns in the world are coming out of Asia,” notes Dorel Blitz, the Tel Aviv-based head of fintech at KPMG. “The companies are getting bigger and stronger,” he adds, “and you’re beginning to see more direct investment in public fintech companies as well.”
Adds Orchard’s Burton: “I think it shows you how massive the opportunities are outside the U.S.”
Ant Financial and WeChat are also serving as a world-class demonstration project on how fintechs can turn a tidy profit while opening up financial services to large populations who lack access to basic financial services, thereby providing entry to the middle class. The two platforms have provided “financial inclusion for tens of millions, if not hundreds of millions of people” who previously were on the periphery of the banking and financial system, says Kai Schmitz, a fintech lender at International Finance Corporation that lends to private businesses in the developing world.
Once people are making electronic payments on their mobile devices, Schmitz notes, it creates a “pathway” to a whole panoply of financial services, including personal and business loans, savings, insurance, and investments.
“You can create a user profile so that a large part of the population that could not be reached (by traditional financial institutions) are now making payments and can be followed on the data track,” he says.
The World Bank reports that two billion adults and 200 million businesses in the developing world are currently unable to access even basic financial services. Through IFC, the World Bank has invested $370 million in fintech companies operating throughout Asia, the Middle East, Africa and Latin America. The fintechs, an IFC communications manager told deBanked, offer “a range of products and services — from e-wallets, virtual banks, lending, and online payments to retail payment points and exchanges.” IFC, she adds, also invests in fintech funds.
Anju Patwardhan is the U.S.-based managing director at CreditEase Fintech Investment Fund, a $1 billion Chinese venture capital firm that invests in fintechs delivering financial services to “unbanked” and “underbanked” populations. “They are living in Africa, Bangladesh, China and elsewhere on less than two dollars a day and have no access to financial services,” she says.
“But there are also a very large number of people who may be technically included in the financial system but still don’t have access to a full range of financial services at reasonable prices,” she adds. “If someone is borrowing from a moneylender or pawnbroker, it doesn’t count (as financial inclusion). In that case, the number of people is very much more than two billion.”
Once phone towers are built and a payments infrastructure is in place, fintechs promising more sophisticated financial services can operate similarly to the settlers who followed pioneers in the U.S.’s westward expansion. That’s been the story in Kenya and other African countries where M-Pesa (“pesa” is Swahili for money) and other mobile-phone payments systems set up shop a decade ago.
Branch International, based in San Francisco but doing business exclusively in emerging and frontier markets for only three years, is one of the settlers. It boasts that it now has the “No. 1 finance app in Africa.” In March, Branch raised $70 million in a second-stage round of debt and equity financing from a group of venture capitalists led by Trinity Partners that included Patwardhan’s CreditEase and the IFC. Patwardhan will serve as an advisor to Branch’s board.
Branch’s principal business is making loans and micro-loans ranging from as little as $2 to $1,000 in Nigeria, Kenya, and Tanzania. Despite its name, Branch touts itself as a “branchless bank”, all of the credit transactions taking place on mobile devices, says Matt Flannery, Branch’s chief executive and founder. Its average loan amount is $25.
Many of Branch’s customers are individuals and businesses who often had trouble obtaining credit from established financial institutions or were ineligible for loans. But, according to Branch’s website, it’s possible for a prospective borrower to obtain a loan in just a matter of minutes. “Branch eliminates the challenges of getting a loan by using the data on your phone to create a credit score,” the website says. Branch promises privacy, fees that are “fair and transparent,” and terms that “allow for easy repayment” with no “late fees or rollover fees”. “As you pay back on time,” the website also says, “our fees decrease, and you unlock larger loans with more flexible terms.”
The platform, CEO Flannery says, has lent out $100 million dollars to roughly that same number of people. “The formal financial system in African countries is generally composed of old-fashioned banks that are risk-averse and fairly slow to make lending decisions,” he says. “People really appreciate us,” Flannery adds. “I’d say we’re like Uber and they’re the horse-and-buggy.”
The company is growing by 20 percent month-over-month and expects to disburse more than $250 million in 2018. Asked to describe Branch’s typical borrower, Flannery says: “We have some rural users (of Branch’s finance app). But in general we’re serving the commercial middle-class — shopkeepers and entrepreneurs – in urban capitals.” Want to know precisely who Branch’s customers are? “Just go to downtown Lagos (the capital of Nigeria and the largest city on the African continent) and you’ll see all different kinds of businesses and single-owner merchants on street corners,” Flannery says.
Jeff Stewart, the founder and chairman of Lenddo (which recently merged with competitor EFL) asserts that his firm’s machine learning technology and risk modeling techniques, which are being deployed in emerging countries from Costa Rica to The Philippines, have the capacity to assess the “creditworthiness of everyone on the planet.” In the absence of credit history in much of the developing world, he explains, this can done by constructing a risk profile combining both “psychometrics” and a “digital footprint.”
Psychometrics is a behavioral assessment tool based on a prospective borrower’s “Big Five” personality traits: openness to experience, conscientiousness, extraversion, agreeableness, and neuroticism (OCEAN for short). “What we’ve been able to show,” Stewart asserts, “is that certain personality types have a positive and negative correlation with repayment. It’s not 100 percent accurate. But you can predict the statistical recovery ratio on repayment. You can say that, for a person with a high score, something like 88 out of 1,000 people (with his or her profile) would not repay.”
The digital footprint, which is the second “critical component,” Stewart says, analyzes a prospective borrower’s reliability by reconnoitering their smartphone usage. “We’ll look at everything on your phone,” he says, “How you use the phone. Whom you interact with. When you use your phone. There are thousands of features that generate a digital footprint. Everything from meeting someone at a sports bar to the apps on your phone to things like e-mailed receipts that show your financial activity.”
Such methods help build credit for those lacking credit history while rehabilitating those whose credit history is blemished. And all that’s needed is a smartphone. “We’ve turned the smartphone into a credit bureau,” Stewart says.
The acquisition of smartphones is taking place at a blistering pace, Stewart notes, now that cell phone costs are “at the bottom of the cost pyramid” in many countries. For example, a “low-end Android” now fetches as little as $25 in Africa. “One credible study I’ve seen shows that every 10% percent rise in access to smartphones translates into a 1/2 percent rise in a country’s gross domestic product,” Stewart says.
While the private sector is driving the trend to financial inclusion in China and Africa, India’s government-driven model “is setting a new global standard in using financial technologies to support financial inclusion,” declares Patwardhan of CreditEase, who also lectures at Stanford. “The country has become a giant testing ground for financial inclusion and innovation,” she argues in a recent academic paper, “and may become a role model for other emerging economies.”
India’s state-run effort includes a $1.3 billion digital identity program known as Aadhaar. Under Aadhaar (which means “foundation”), the state issues residents a 12-digit identity number that’s based on their biometric data –such as fingerprints and iris scans — and personal information. The ID number covers more than 1.19 billion residents. In just the first two years after Aadhaar’s 2009 debut, Patwardhan says, more than 250 million Indians were able to open bank accounts.
Jo Ann Barefoot, chief executive at Barefoot Innovation Group in Washington, D.C. and a senior fellow emerita at Harvard’s Kennedy School of Government, agrees. She notes that Aadhaar opened up access to both fintech services and bank accounts to women who were long treated as second-class citizens by the social and economic system. “India’s digital ID program means that wives and daughters have identity now,” she says.
“In the past,” she adds, “only (male) heads of households would have family identity documents and a government card — which would be the equivalent of having a Social Security number in the U.S. But the wife wouldn’t have her own card. So this is a massive door-opener to fintech growth. And it’s also opening up (all areas of) finance to millions and millions of people.”
India’s “digitalization” program, moreover, has entailed development of a national payments network called “unified payments interface,” or UPI. The combination of UPI and Aadhaar as well as other digital initiatives have resulted in “a surge of online lending platforms,” says Patwardhan, citing Capital Float, NeoGrowth, Faircent, LendingKart, Quiklo, IndiaLends, CreditExchange, and Onemi.
The homegrown fintechs, however, will be up against tremendous external pressure as India, with 1.3 billion people and poised to overtake China in population growth, is generating enormous interest from global fintechs. Among outside platforms piling into the country are China’s Ant Financial and WeChat. The former took a $1 billion stake in Paytm, an Indian mobile payments and e-commerce company. Similarly, competitor WeChat’s parent, Tencent, has invested in Hike, a mobile wallet valued at $1.4 billion last June, according to CNBC, exciting investor interest as a unicorn.
U.S. companies are getting into the act too. Google launched digital payments app Tez last September, which “is taking advantage of India’s infrastructure and has already gotten 30 million downloads,” Patwardhan says. In February, Facebook rolled out a peer-to-peer payments feature on WhatsApp. Even Branch’s Flannery has announced that his “branchless bank” plans to earmark part of its $70 million war chest to offer $2-to-$1000 loans on the subcontinent.
Having banned high-denomination paper bills as a way to rein in corruption and aiming at a cashless economy, India has been innovating in ways that “have gone the Chinese one better,” marvels Patwardhan. “Their payment systems going through the UPI network are interoperable,” she notes, for example. “You don’t have to be on the same app or with the same bank. India is now on the cutting edge.”
A story in the Wall Street Journal last week reported that SoFi borrowers are missing their loan payments at an unexpectedly high rate. The emerging trend is part of the reason the company is said to have missed its internal fourth quarter earnings projections. According to a letter SoFi penned to investors that the WSJ obtained, the company had to mark down the “value of certain personal loan assets due to lower-than-expected credit performance.”
$202.3 million of SoFi’s $9 billion in consumer loans since inception had gone into default as of November 30th, 2017, deBanked learned through a report. Consumer loans had been made to a total of more than 266,000 individual borrowers.
A recent ratings agency chart shows the default rates of SoFi Managed Portfolio consumer loans have been increasing since 2015 and that defaults are starting to occur even earlier in the repayment cycle. The April 2015 vintage, for example, showed a default rate near 0.0% by the twelfth month. The April 2017 vintage, by contrast, had already exceeded a default rate of .5% in month eight.
Last March, Bloomberg reported that the company’s personal loan losses at that time were high enough to breach bond triggers that the loans were backed by.
The consumer loan space has become very crowded as of late, with SoFi not only competing against online upstarts like Lending Club and Prosper, but also against banking stalwarts like Goldman Sachs and Discover.
A House financial services subcommittee hearing this past Tuesday put fintech and online lending back in the spotlight. The most notable witness that testified was Nat Hoopes, Executive Director of the Marketplace Lending Association (MLA). The MLA represents companies like Lending Club, Prosper, Funding Circle, Avant, Marlette Funding, Affirm, CommonBond, Upstart, PeerStreet, and StreetShares.
Hoopes testified that “this industry is effectively serving the broad American ‘middle class’ that remains our engine for economic growth and prosperity.” He also cited data from dv01. “More than one million unsecured marketplace personal loans were issued last year – with an average loan balance of approximately $14,000 and a term of greater than 4 years – far from being a small dollar, short term loan,” he said. “[Marketplace Lending Platforms] offering consumer loans do so at an average of 14.7% APR and 100% of the loans are below the 36% APR threshold.”
Prof. Adam J. Levitin, a Georgetown University Law Professor, played the role of fintech skeptic and called for state and federal regulation to address what he believed were lingering issues.
“What is new about fintechs is that they are nonbank financial companies with ready ability to acquire consumers because of the Internet,” Levitin testified. “This means that despite the regular use of buzzwords like ‘transformative’ and ‘disruptive’ in discussions about fintechs, there really isn’t anything particularly transformative or disruptive about them.
You can watch a recording of the full hearing below:
Click the links to view the testimonies of the following witnesses
- Mr. Nathaniel Hoopes, Executive Director, Marketplace Lending Association (TTF)
- Mr. Brian Knight, Director, Program on Financial Regulation and Senior Research Fellow, Mercatus Center, George Mason University (TTF)
- Mr. Brian Peters, Executive Director, Financial Innovation Now (TTF)
- Mr. Andrew Smith, Partner, Covington and Burling, LLP (TTF)
- Prof. Adam J. Levitin, Professor of Law, Georgetown University Law Center (TTF)
Online technology, which paved new paths for consumer and small business lending, is making similar inroads with the commercial real estate industry.
Over the last few years, several online marketplaces have been established to try and match commercial real estate borrowers with lenders quickly and efficiently using technology. In the past, commercial real estate lending depended heavily on having local connections, but online platforms are blurring these lines—making geographical borders less relevant and opening doors for new types of lenders to establish themselves.
While banks remain the largest source of commercial real estate mortgage financing, non–bank players—including credit unions, private capital lenders, accredited and non–accredited investors, hedge funds, insurance companies and lending arms of brokerage firms—have become more formidable opponents in recent years. Online platforms offer even more opportunity for these alternative players to gain a competitive edge.
At present, most of these commercial real estate marketplaces are purely intermediaries—they’re matching borrowers and investors, not actually doing the lending. Certainly, it’s an easier business model to develop than a direct lending one, but things could change over time, as borrowers become more comfortable with the online model and develop confidence that these platforms can perform, industry participants say.
“You have to be viewed as credible with a certainty of funding for borrowers to come to you. You can’t just put up a flag and say ‘Hey we’re making loans’ because borrowers won’t trust you and they won’t have the confidence that the loan is going to close,” says Evan Gentry, founder and chief executive of Money360, one of the few online direct lenders in this space. “However, once you develop a reputation of strong performance, the tide turns very quickly and that confidence is established,” he says.
For now, however, many of the marketplaces say they are content to remain intermediaries and offer business opportunities to lenders instead of competing with them. The sheer size of the market— commercial/multifamily debt outstanding rose to $3.01 trillion at the end of the first quarter, according to data from the Mortgage Bankers Association—and the fact that is an enormously diverse industry with no plain vanilla product makes it more likely that several platforms can co–exist without completely cannibalizing each other’s business, observers say.
Each of the online marketplaces has a different business and pricing model. Some marketplaces focus on small loans, while some have larger minimums; some focus on just debt; some focus on a mixture of equity and debt. Some sites cater to institutional lenders and accredited investors to help fund loans. Other sites invite non–accredited investors who meet certain criteria to participate in loans, opening doors to a segment of the population which previously had minimal access to commercial real estate deals. While the sites differ in their approach, the upshot is clear: banks—while still formidable competitors in commercial real estate lending—are no longer the only game in town for funding these deals.
The struggle for lenders is how to work most effectively with these marketplaces. “If you can acquire customers through only your own channels, then of course you’re going to do that,” says David Snitkof, chief analytics officer at Orchard Platform, which provides data, technology and software to the online lending industry. Otherwise, these marketplaces present a viable opportunity to expand distribution, he says.
GROWTH OPPORTUNITIES ABOUND
The surge of new companies acting as marketplaces between borrowers and lenders of all kinds comes as the commercial real estate industry is finally coming up to speed with respect to technology. The commercial real estate business has been static for decades in terms of how loans are processed and originated, according to industry participants.
“The use of technology is going to be an enormous disrupting force in that space,” says Mitch Ginsberg, co–founder and chief executive of CommLoan, one of the newer marketplaces for commercial real estate lending. Commercial real estate lending is “probably one of the last industries that hasn’t been touched by technology, and it’s ripe for massive disruption,” he says.
CommLoan of Scottsdale, Ariz., was founded in 2014, but the marketplace has only been fully operational since 2016. The platform targets borrowers seeking $1 million to $25 million of capital for all types of commercial real estate loans. It works with more than 440 lenders—including banks, credit unions, commercial mortgage companies, private money lenders and Wall Street firms. Altogether, CommLoan says it has processed more than $680 million in commercial transactions.
Online marketplaces can help make the commercial real estate industry more efficient and transparent, says Yulia Yaani, co-founder and chief executive of RealAtom of Arlington, Va., another new online commercial real estate marketplace. “People are tired of paying huge fees as a result of the market being so opaque,” she says.
RealAtom began operating in 2016 and targets borrowers who are seeking commercial real estate loans from $1 million to $70 million. The lenders on the platform include banks, alternative lenders, insurance companies, pension funds, hedge funds and hard money lenders. The company processed $468 million in commercial loans in its first 11 months of operating, according to Yaani.
Another benefit of online marketplaces is that they “create a liquid, national marketplace where lenders all across the U.S. can bid on a borrower’s business,” says Ely Razin, chief executive of commercial real estate data company CrediFi, which operates the upstart CredifX marketplace. Historically people who own commercial real estate have only been able to get financing through a local relationship with a bank or broker. “For borrowers, this means more certainty of obtaining a loan and optimized capital not limited by the relationship with the local lender,” he says.
CredifX started operating earlier this year to match commercial real estate borrowers, brokers and lenders including banks, finance companies, mortgage companies, hard money and bridge lenders. The platform is for loans of $1 million to $20 million across all major property types in the commercial space. It matches borrowers with appropriate lenders using the information that parent company CrediFi collects and analyzes. The company declined to disclose how much it has processed in commercial transactions.
To be sure, it’s hard to say how the marketplace model will evolve over time and which players will withstand the test of time. Certainly a similar model has faced challenges on the consumer and small business lending side.
“I think the pure marketplace will become more rare as time goes on,” says Peter Renton, founder of Lend Academy, an educational resource for the P2P lending industry. “There are examples of successful companies with a pure marketplace, but they are rare and difficult to scale. The only well-established company that seems completely wedded to the pure marketplace is Funding Circle; pretty much all other companies have switched to a hybrid model of some sort,” he says.
Commercial vs Residential
While much of the recent growth has been within commercial real estate, there are also some marketplaces that cater to residential borrowers or offer a mix of commercial and residential opportunities.
Magilla Loans, for instance, started out in 2016 as a solely commercial marketplace, but expanded outside this silo because customers were asking for residential and other types of loans, says Dean Sioukas, the company’s founder. The company now connects borrowers with lenders for a whole host of loan types—commercial, residential and others like franchise loans and equipment loans. Lenders on the platform include roughly 130 banks, mortgage loan originators, accredited investors, credit unions and online non-depository institutions. The average loan size is $1.4M for business loans and $500K for home loans. Nearly $4 billion in loans has been channeled through the platform since January 2016; of that 70 percent is tied to commercial real estate, according to the company.
While there are marketplaces that focus on residential mortgage lending, some industry participants say that side of the business isn’t as appealing to new online entrants in part because the cost to acquire customers is really high and there are more challenges to working on a national scale.
“It may not be that commercial is more attractive. It may just be easier. Going directly to borrowers in the residential space has proven harder than many companies expected,” says Brett Crosby, co-founder and chief operating officer of PeerStreet, a marketplace for accredited investors to invest in high-quality private real estate backed loans. Experience seems to suggest that for residential mortgage origination, “it’s much better to have a good ground game and know your local market,” he says.
To be sure, as the online market for real estate matures, it’s not so surprising that companies would shift business models to find their own sweet spot. RealtyMogul.com is one example of a company that has morphed over time. The online platform began operating in 2013 in both the residential and commercial space, but has since moved away from the residential business. Accredited investors, non-accredited investors and institutions can use the platform to find equity or debt-based commercial real estate investment opportunities, and borrowers can apply for private hard money loans, bridge loans and permanent loans.
Money360 is another example of a company that has shifted gears. It started out as a pure marketplace, but changed its business model to become a lending platform in 2014. Now the online direct lender in Ladera Ranch, Calif., provides small-to mid-balance commercial real estate loans ranging from $1 million to $20 million. It’s one of the only companies targeting the commercial real estate space in this way and has closed nearly $500 million in total loans since 2014.
Gentry, the company’s founder, says he would expect to see more industrywide changes as the online commercial real estate business continues to evolve. The key to success, he says, is executing well and “knowing when to pivot when you realize something’s not working just right.”
Ultimately, Gentry predicts more online lenders will target the commercial real estate space. He says technology-based alternative lenders have an advantage because they can operate more quickly and efficiently while still being very competitive from a pricing perspective.
“You put all those things together (speed, efficiency and competitive pricing) and that’s what borrowers are looking for,” Gentry says.
Alternative lending fever has spilled over into the auto sector, evidenced by the financing arm of automaker Ford’s decision to move beyond FICO and deeper into machine learning for credit decisions. Ford is moving toward alternative lending strategies in an attempt to capture a wider swath of borrowers, including those with “limited credit histories,” and bolster auto sales.
Ford’s decision comes on the heels of a study with fintech play ZestFinance, the results of which favor a machine-learning based approach to credit decisions.
Ford’s decision comes on the heels of a study between Ford Credit and fintech play ZestFinance, the results of which favor a machine-learning based approach to credit decisions.
“There is absolutely no change in Ford Credit’s risk appetite. Ford Credit is maintaining the consistent and prudent standards it has applied for years. This enhanced ability to look at data will help us more appropriately place applicants along the full spectrum of the risk scale. The result will be some that some people may appear on that scale who did not before, and some applications that are approved today might not be approved in the future. The risk appetite remains the same,” Ford Credit spokesperson Margaret Mellott told deBanked.
Until now, there has been no aspect of machine learning in Ford Credit’s underwriting process.
“The study showed improved predictive power, which holds promise for more approvals … and even stronger business performance, including lower credit losses,” according to Joy Falotico, Ford Credit chairman and CEO, in a press release.
Ford is targeting consumers with a lack of credit history, especially the millennial generation.
While Ford embraces tech-driven underwriting, this style is already knit into the fabric of the MCA and online lending communities.
To name a few, Upstart takes a machine learning approach. FundKite developed algorithmic-based underwriting. UpLyft’s underwriting process has an automated component to it.
Alex Shvarts, CTO and director of business development at FundKite, a balance-sheet based funder, said the company has been writing algorithms since the early days. Now the tech- and algorithm-driven funder wants to expand into small business lending in Q1 2018.
“We’re building our technology to the point that by Q1 next year, we will get into automated loan products. Our technology will be able to underwrite loan products within seconds. We have a lot of data we put together, which allows us to price deals and make offers relatively quickly,” he said.
By a lot of data, Shvarts is referring to hundreds of data points that are used to measure merchant performance. FundKite, which has a default rate of far less than 10 percent, takes the data, reworks and combines it, leading to a fast result.
“Besides the data points we look at the merchant from a collections point of view. If this person or business runs into trouble, could they go out of business or would they be okay?” he said.
That’s where the human element to the underwriting process comes in.
While FundKite relies on algorithm-driven underwriting, the funder is not running an online app yet. There is still a need for human participation surrounding data input, information that is then verified by machines.
“The human element is entering the information correctly, and the machine spits out predetermined pricing based on the business data points and industry,” said Shvarts, adding that FundKite views that information in the context of micro-trends in the industry as well as the overall market environment.
“We know that during certain seasons some merchants perform worse than others. The numbers say the merchant should get this, but we dig a little deeper and say no, this merchant can’t handle this much of an advance and repayment along those lines. The final touches are done by humans. Our technology is advanced so that we are able to get to that point a lot faster and more accurately,” Shvarts said.
Michael Massa, CEO and founder of Uplyft Capital, points to a hybrid approach in the company’s credit underwriting, referring to the automated scoring portion of Uplyft’s underwriting model as a second opinion. “We believe there must be a hybrid of human and automated technology,” said Massa.
Uplyft relies on a proprietary scoring model. The model includes an automated function that attaches a unique rating to the small business based on certain features in the prospective borrower’s profile, such as a home-based versus business location and the number of years the company has been in business, to name a couple.
“It’s only as second opinion for our underwriters, really,” he said, adding that cash flow and affordability are major drivers of the credit decision. “In most cases we price at max affordability for the client while protecting them from overleveraging their accounts, allowing us to provide real help and establish merchant loyalty.”
Second opinion or not the automated function is part of what makes Uplyft a fintech play, setting the funder apart from the banks. “They’re like the payphone and we’re the iPhone. They’re yellow cab and we’re Uber,” said Massa, adding better yet, “we’re Lyft.”
Uplyft is in the process of developing a trio of portals designed for merchants, sales partners and investors to be released shortly. “We are API-ing that now into our CRM,” said Massa.
Merchants can access the portal to apply for funding while sales partners use it to submit files and view a status. Investors can track their participation via the portal. The new portals will be available on the website and through a mobile app that Uplyft is in the final stages of developing.
Uplyft also recently inked an exclusive partnership with an undisclosed software company allowing merchants to link their bank account to the application, capturing six months of actual PDF bank statements in the process.
“It can help us with the initial credit decision and when we’re conducting final verifications. We get the actual bank statement. It’s a legitimate bank statement, not a rendition,” said Massa.
Fintech & Auto Finance
As for the auto industry, don’t be surprised to hear about further collaboration between the automakers and the fintech market. “Financial technology is key … as fintech can contribute to an even more seamless and better personalized vehicle financing experience for the consumer,” according to the Ford press release.
On Halloween, 2014, a largely unknown, Boston-based financial institution, First Trade Union Bank, embraced high-technology, went paperless, and officially adopted a new name: Radius Bank.
In reinventing itself, Radius did more than dump its dowdy moniker. It shuttered five of its six branches, re-staffed its operations with a tech-savvy team, instituted “anytime/anywhere” banking services, and offered customers free access to cash via a nationwide ATM network. And it teamed up with a fistful of financial technology companies to offer an impressive array of online lending and investment products.
Today, the bank’s management boasts that, using their personal mobile phones, some 2,700 people per week are opening up checking accounts, funneling $3 million in consumer deposits into the bank’s virtual vault. That’s a stark contrast from a decade ago when the financial institution was being rocked by the financial crisis and “we couldn’t get anybody to walk into our branches,” says Radius’s chief executive, Mike Butler.
“We tried to leave that old bank behind,” he says. “We’re a virtual retail bank now, an efficiently run organization that offers high levels of customer service and Amazon-like solutions.”
Radius Bank is not alone. At a moment when there is much discussion — and hand-wringing — over the future of seemingly outmoded, highly regulated community banks, a coterie of small but nimble banks is exploiting technology and punching above its weight. Almost overnight, this cohort is combining the skill and hard-won experience of veteran bankers with the lightning-fast, extraordinary power afforded by the Internet and technological advances. As a result, these small and modest-sized institutions are redefining how banking is done.
In addition to Radius Bank, independent banks winning recognition for their bold, innovative – and profitable — exploitation of technology, include: Live Oak Bank in Wilmington, N.C., which adroitly parlays technology to become the No. 2 lender to business and agricultural borrowers backed by the U.S. Small Business Administration; Darien Rowayton Bank in Darien, Conn., which is making a name for itself with coast-to-coast, online refinancing of student loans; and Cross River Bank in Fort Lee, N.J., which does back-end work for a passel of fintech marketplace lenders.
Interestingly, there’s not much overlap. Each of the banks goes its own way. But what all the banks have in common is that each has struck out on its own, each hitting upon a technological formula for success, each experiencing superior growth.
“These are companies that understand the value of a bank charter,” says Charles Wendel, president of Financial Institutions Consulting in Miami. “They have to work under the watchful eyes of state and federal regulators. But their cost of funds is low and they can offer more attractive rates. Because they’re less likely (than nonbank fintechs) to disappear, run out of money, or get sold,” the bank expert adds, “they also have the image of stability with customers.”
These modest-sized banks are emerging as not only pacesetters for the banking industry. Along with making common cause with the fintechs — which had promised to disrupt the banking industry – they’re even beating the fintechs at their own game.
“Classically, community banks have looked to technology partners to provide technological innovation,” says Cary Whaley, first vice-president for payment and technology policy at the Independent Community Bankers of America, a Washington, D.C.-based trade group representing a broad swath of the country’s 5,800 Main Street banks. “They still do. You’re seeing more partnerships. But now you also see community banks building innovative products and services outside of that relationship. You see forward-thinking banks developing their own technology to support big ideas like marketplace lending, distributed ledger technology, and emerging payments technology.”
With its extraordinary skill at exploiting technology, Live Oak Bank – which trades on the Nasdaq and is the only public company encountered in the cohort — has become a Wall Street darling. “While several banks have adopted an online-only model, and nearly all banks are shifting more and more delivery through online channels, Live Oak was built from the ground up as a technology-based bank,” Aaron Deer, a San Francisco-based research analyst at Sandler O’Neill Partners, wrote in a recent investment note.
Driving the success of Live Oak, which operates out of a single branch in the North Carolina seacoast town and has only been in business for a decade, is the explosive growth in its SBA lending, the bank’s “core strategy,” Deer notes. Last year, Live Oak lent out $709.5 million in SBA loans in increments of up to $5 million, the federal agency reports, making it the country’s No. 2 SBA lender. It trailed only megabank Wells Fargo Bank, the third largest bank in the U.S. with $1.5 trillion in assets, which made $838.93 million in SBA-backed loans last year.
As its SBA lending has taken off, Live Oak, which qualifies as a “preferred lender” with the federal agency, boasts assets that have nearly tripled to $1.4 billion in 2016, up from $567 million two years earlier. Those are flabbergastingly fantastic growth numbers. But just as incongruously — by nipping at the heels of Wells Fargo — Live Oak has been challenging a bank more than a thousand times its asset size for dominance in SBA lending.
And, interestingly, the bank is able to book those outsized amounts of SBA loans while lending to only 15 industries out of 1,100 approved by the government agency, slightly more than 1% of the universe. That’s up from 13 industries in 2015, and Live Oak is adding two to four additional industries yearly for its SBA loan portfolio, Deer reports. Included among the industries to which the bank made an average SBA loan of $1.29 million last year: Agriculture and poultry, family entertainment, funeral services, medical and dental, self-storage, veterinary, and wine and craft-beverage.
The bank has a team of financing specialists dedicated to each of the designated industries. Among Live Oak’s current SBA borrowers are Martin Self Storage in Summerville, S.C.; Utah Turkey Farms in Circleville, Utah; Pinballz Arcade, Austin, Tex.; and Council Brewery Company in San Diego. Steve Smits, chief credit officer at the bank, told NerdWallet: “When you specialize in something, you become efficient. Because we do it every day and we have professionals and specialists, we tend to be more responsive and quicker.”
The heady combination of technological sophistication and banking expertise has allowed the lender to slash its loan-origination time to 45 days, about half the three-month industry average for SBA loans. To speed up loan sourcing and generation, the bank developed its own in-house technology, which led to the formation of the Wilmington-based technology company nCino, which was spun off to shareholders in 2014.
Live Oak did not return calls to discuss its lending strategies, but in SEC filings bank management declared: “The technology-based platform that is pivotal to our success is dependent on the use of the nCino bank operating system” which relies on Force.com’s cloud-computing infrastructure platform, a product of Salesforce.com.
Natalia Moose, a public relations manager at nCino told deBanked in an e-mail interview: “We work with Live Oak Bank, in addition to more than 150 other financial institutions in multiple countries with assets ranging from $200 million to $2 trillion, including nine of the top 30 U.S. banks. nCino was started by bankers at Live Oak Bank who found the logistics of shuffling paperwork among loan stakeholders to be unwieldy, inefficient and time-consuming.
“nCino’s bank operating system,” Moose adds, “leverages the power and security of the Salesforce platform to deliver an end-to-end banking solution. The bank operating system empowers bank employees and leaders with true insight into the bank, combining CRM (customer relationship management), deposit account opening, loan origination, workflow, enterprise content management, digital engagement portal, and instant, real-time reporting on a single secure, cloud-based platform.”
Live Oak, meanwhile, is not resting on its technological laurels. According to Deer’s report, the bank’s parent company, Live Oak Bancshares, has formed a subsidiary to inject venture capital into fintech companies. It’s already taken a small equity stake in Payrails and Finxact, “the latter of which is developing a completely new core processor to compete against the old legacy systems used by most banks,” the Sandler O’Neill analyst writes. “Quite simply,” he asserts elsewhere in his report, “the company is far beyond any other bank we cover in its technical capabilities and the growth outlook remains outstanding.”
Five hundred and thirty-three miles due north along the Atlantic coast in southeastern Connecticut, Darien Rowayton Bank is also experiencing tremendous success as a lender using a home-grown technology platform. State-chartered by the Connecticut Department of Banking and regulated as well by the Federal Deposit Insurance Corp., the $600 million-asset bank is winning attention in banking circles for its online student-loan refinancing.
A few years ago, DRB, as it is known, was looking to go beyond mortgage and commercial lending — “the bread and butter for most community banks,” bank president Robert Kettenmann explained to deBanked in a telephone interview – and was somewhat at a loss. The bank considered but then rejected the credit card business. Finally, DRB struck paydirt refinancing student loans. “Our chairman really seized on the opportunity,” Kettenmann says, adding: “It’s a $35 billion market.”
Thanks to the National Bank Act, it’s able to operate in all 50 states. As a regulated commercial bank with a strong deposit base, DRB can also offer low rates well below any state’s usury prohibitions.
What is most striking about DRB’s program is its nationwide targeting of upwardly mobile, affluent young professionals. According to a PowerPoint presentation obtained by deBanked, all of the bank’s super-prime borrowers, who are mainly in the 28-34 age bracket, have a college degree and a whopping 93% have graduate degrees. Average income is $194,000.
Forty-eight percent of those refinancing student loans with DRB are doctors or dentists and another 22 percent are pharmacists, nurses or medical employees; only about 20% are paying off their law degrees or MBAs. The heavy concentration of refinancing in the medical field reduces economic risk in an economic downturn. Forty-three percent of the borrowers are home-owners, the rest are renters – and prime candidates for an online, DRB-financed mortgage.
(Once known as “yuppies” today this cohort is “known by the acronym ‘HENRY,’” remarks Cornelius Hurley, a Boston University banking professor and executive director of the Online Lending Institute, explaining the initials stand for “High Earners Not Rich Yet.”)
The Connecticut bank partnered with a third-party on-line vendor, Campus Door, when it commenced making student loans in 2013. In the fall of 2016, however, DRB built out its own, proprietary loan-origination system, Kettenmann reports, emphasizing that CampusDoor had been an excellent partner but that the bank wanted to exercise end-to-end control over the process. DRB employs a seven-pronged, “omni-channel” marketing approach that includes interactive marketing, affinity partnerships, digital/online advertising, direct mail, mass-media advertising, and public relations/brand awareness campaigns.
DRB’s online enrollment provides “pre-approved rates” in less than two minutes with final approval on rates in 24-48 hours. Refinancers can complete the online application at their own speed. Through May, 2017, DRB had made $2.48 billion in refinancing to 20,000 student-loan borrowers, with only ten defaults, five of which were attributed to deaths or “terminal illness.”
On Yelp! the bank has received a batch of reviews ranging from very favorable, five-star (“I had a truly wonderful experience”) to one-star (“awful” and “truly a nightmare”). Many fault the application process as laborious, describing it as “time-consuming.” But for those who have succeeded, like the reviewer who counseled “patience,” the result can be “the lowest rate with DRB…my loan payments went down $100 a month.”
Just about an hour’s drive south and taking its name from its proximity to New York city just over the George Washington Bridge is New Jersey-based, state-chartered Cross River Bank, which has a reputation as a partner-in-arms to fintech companies. “We’re both users and producers of technology,” declares Gilles Gade, the bank’s chief executive.
The bank provides “back-end” and infrastructure support to 17 marketplace lenders that offer a suite of lending products including personal loans, mortgages and home-equity loans. Following loan origination by a fintech company – Marlette Funding, Affirm, Upstart, loanDepot, SoFi, and Quicken Loan, among other partners — Cross River does the actual underwriting. Last year, Gade reports, the bank underwrote 1.9 million loans valued at $4-4.5 billion, about 10% of which Cross River kept on its books. The bulk of the loans are sold “back to the marketplace lenders” or to a third party. “We’ve created a high-velocity automated system,” he says.
Gade is manifestly unapologetic about the bank’s role in assisting fintechs in their competition with the banking establishment. “We’re a banking infrastructure services provider for those who want to disrupt the banking system,” he says. “Consumers expect a lot better than they’ve been getting from traditional banking services.”
Back in Boston, Radius Bank’s chief executive reports that forging partnerships with fintechs to provide the full panoply of online banking services was no easy proposition. In its mating ritual, Radius not only had to determine that a fintech company’s offerings were sound and that it had the right characteristics – most especially “a long-term, sustainable business model” – but that its corporate culture meshed comfortably with Radius’s.
After meeting with as many as 500 fintechs and after a fair amount of trial and error, Radius formed partnerships with LevelUp, which enables customers to make mobile payments; with online lender Prosper, for refinancing consumer debt and “credit rehabilitation”; with SmarterBucks, for refinancing student loans; and with online investment firm Aspiration Partners – which allows investors to name their own fees and markets itself to a predominately middle-class audience as the firm “with a conscience.”
Radius employs advertising on social media websites and employs “psychographics” to appeal to “anyone who is zealous about using technology, not necessarily millennials,” Butler says. The data show that 65% of adults in the U.S. would prefer to use a traditional bank and have face-to-face interactions with a teller, he notes, leaving the remaining 35% as Radius’s target audience.
Christopher Tremont, executive vice-president for virtual banking, told deBanked that a typical Radius customer is 42 years old, lives in Boston, New York, Chicago “or one of the bigger cities in the West,” is a “technophile,” earns $75,000 a year, and has $100,000 in personal assets.
Radius’s performance since it went paperless has been stellar. The bank has seen a rapid rise in deposits, spurting to $782 million through the first quarter of 2017, up from $565 million at year-end 2014. With little fee income but ample deposits and low-cost funds, Radius realizes the bulk of its revenues – and profits — on the interest-rate spread generated from its loan portfolio.
The bank booked $43.5 million in SBA loans last year, ranking it in the top 50 banks on the SBA’s league tables, while carrying another $105 million in its commercial leasing business at the end of the first quarter this year. Loan generation is driving asset growth, which are currently at $973 billion, up more a third from $726 million in 2014, and Butler expects the bank’s assets to top $1 billion sometime this year.
“Community banks love that part of the business—lending money,” Butler says.
Online lending M&A is under way. PayPal is bolstering its merchant lending capabilities with the addition of Swift Financial. While the deal was kept under wraps, some industry participants heard some buzz about a possible combination.
PayPal has been investing in its lending arm of late, evidenced by the addition of former Amazon executive Mark Britto as senior vice president and general manager of global credit in July.
Noah Grayson, South End Capital managing director and founder, weighed in on the deal.
“A merger of two industry leaders like this is not surprising. As the economy continues to improve and small business owners have access to more financing options, alternative business lenders are going to continue to consolidate to stave off competition, retain deal flow and secure profitability,” said Grayson.
Dave Girouard, founder and CEO at Upstart, a consumer lending platform that uses machine learning, reacted to the deal:
“I expect to see more consolidation in online lending across both consumer and small business in the next year. Platforms with either giant balance sheets or proprietary technology will likely stick around, but others will struggle to compete,” Girouard told deBanked.
Alternative lender LendUp was a recent recipient of a PayPal investment. Sasha Orloff, LendUp’s CEO, had this to say about the deal:
“I’m not surprised to see an acquisition in the fintech credit space and expect this will kick off a wave of acquisitions. PayPal is a force to be reckoned with and we have seen them lead the industry again and again. Whether it is the partner model like with Synchrony, the acquisition model like Swift, Braintree/Venmo, Xoom, or the investment model like LendUp, they are proving again and again why they are leading innovation in financial services decade after decade,” said Orloff.
Meanwhile don’t expect to see a PayPal/LendUp pairing anytime soon.
“For our part, we’re going after a very different market and we’re focused on driving consumer financial inclusion — and we’re very focused on remaining an independent company and helping companies like PayPal and banks offer better products for millennials and the emerging middle class,” Orloff added.
PayPal was already working with Swift on a white-label basis for one of its products, PayPal Business Loan, which is a term loan with structured repayments.
“Swift Financial offers complementary business financing solutions and advanced underwriting capabilities that accelerate our ability to acquire new merchant partners with business financing solutions and to deepen our relationships with existing merchants and channel distribution partners,” said Darrell Esch, VP and Commercial officer, Global Credit, PayPal, pointing to Swift’s advanced underwriting and product capabilities and seasoned management team.
Swift was launched just over a decade ago and has extended loans to 20,000-plus merchants.
When deBanked reached out to fintech market participants for comment on Ron Suber’s sudden departure as Prosper’s president, the responses were the same — ‘anything for Ron.’ Dubbed the Godfather of fintech, Suber might deserve superhero status given the recapitalization that he and the Vermuts led half a decade ago to save Prosper Marketplace. That type of rescue inspires the kind of loyalty that investors and other fintech participants are displaying not only for Suber but also the Prosper brand.
“Ron is an incredible business partner. His word is always good. He doesn’t overpromise, and he always follows through. We were honored to work with a guy like that,” said Matt O’Malley, co-founder and president of Looking Glass Investments, which has been investing on the Prosper platform since 2008.
Perhaps he has never seen him overpromise but in recent weeks he and many other investors on the Prosper platform did observe an overstatement of returns. O’Malley calls it a forgivable mistake.
“In my view, it is our responsibility to track our returns. Prosper provides an extremely robust data set. We have the ability to calculate our returns daily,” said O’Malley, pointing to a nascent fintech market that is still evolving. “This asset class is new. If you compare it to investing in stocks and bonds, it’s in its infancy. When preparing returns, it’s very challenging to determine what they are,” he said.
Looking Glass has been investing in individual loans on the Prosper platform since before Suber’s time and has watched as the former Wells Fargo executive has transformed the peer-to-peer lender to welcome institutional investors.
“He didn’t have to let us stay on the platform. They could have chosen to replace the little guy. But that isn’t how he does business. He knew the investment banks and [other] banks would get involved, however he knew there was enough room for everyone,” said O’Malley.
That day is here, evidenced by Prosper’s previously announced deal with a consortium of institutional investors to purchase $5 billion worth of loans via the Prosper platform over the next couple of years.
FT Partners was the lead advisor on that deal.
“When they needed capital they could have chosen anybody to help. We were excited to be the chosen one to help them on the deal. It was one of fintech’s largest deals and certainly the largest of its kind,” said Steve McLaughlin, founder of FT Partners.
McLaughlin went on to explain the unique circumstances surrounding the transaction, including a lack of diversification tied to Prosper’s capital sources, which he added was a learning experience not only for the peer-to-peer lender but for all of fintech.
“They were focused on getting capital from hedge funds in a steady stream. When the capital markets had a blip, lots of that capital backed away. It was an unprecedented thing to go out and get a $5 billion forward agreement from a series of investors. “There was nothing cookie cutter about it,” said McLaughlin.
Since then the rest of fintech seems to be catching on.
“FT Partners is getting a lot of attention and a lot of calls for all of the other activity we are doing in the space as well. We raised capital for Prosper and a bunch of other companies, including Earnest, GreenSky, Upstart, Kabbage and others. We get a lot of calls, and we’re doing a lot of deals in the space. It’s a lot of fun,” McLaughlin said.
Much of the success of the multi-billion dollar Prosper deal was thanks to Suber.
“A lot of people are very familiar with Ron and the Prosper story and view Prosper as a high-end institution that while having some issues on financing had a very big and long-term future. Lots of Ron’s connections from before came into play in the round,” said McLaughlin.
Now that Suber is out of the picture in an official capacity, investors have every right to be disappointed. But as McLaughlin pointed out, Suber remains a big shareholder in Prosper and the peer-to-peer lender’s greatest supporter, two things that the FT Partners founder does not expect to change.
“This is not a major blow for Prosper. They maintain Ron as a friend of the firm and as an advisor. He has great friends and colleagues at Prosper. He is not going to work for anybody else. He won’t be doing anything with any other lending companies, I don’t think. He may be able to do more good from the outside than the inside at Prosper. I think Ron will always be part of the Prosper family,” McLaughlin said.
If things were going so well for Suber ushering Prosper into its chapter that included expanding the role of institutions on the platform then why is he leaving now? While Suber himself was not available to answer that question, the answer seems to be that it is personal. The fintech community knows Suber for his role in advancing this new asset class but what people might not know is that he is also a husband and a father.
“I think he just feels like this is more of a personal shift,” McLaughlin said.
O’Malley’s impression was similar. Upon joining the fintech startup, Suber made it a point to get to know the Looking Glass team.
“Ron invited us to breakfast. We did this three times. I remember meeting him and thinking this guy is exactly what we need – extra bright, charismatic and he talked lovingly about his children and his wife. He even joked that marriage is like yoga – it’s harder than it looks,” O’Malley said. “My guess is they are going to spend some time together as a family. And he is going to come back bigger and better than ever.”
Meanwhile Both O’Malley and McLaughlin were familiar with Prosper before Suber came on board, and both will remain engaged with Prosper even after Suber’s departure.
“They’re terrific and we have a great relationship. If they do something, we’re definitely the banker for it,” said McLaughlin.
O’Malley’s commitment is steadfast “We will remain loyal,” he said.
Tesla has autopilot. Apple has Siri. And Upstart has its own high-tech software model that places the startup in a category of its own for online lending. All three of these companies may be very different but what they have in common is a reliance on artificial intelligence and machine learning for their proprietary technology.
“You hear so much about how Tesla cars will drive themselves, how Google or Amazon home assistants talk to you to as if you’re human. In lending we are the first company to apply these types of technologies to lending,” Dave Girouard, Upstart co-founder and CEO told deBanked.
So what is machine learning exactly, particularly as it relates to finance? One of the main components that goes into machine learning is not looking at the same data everybody else does. “We are known for looking beyond FICO and the credit report. We look at who the employer is, what industry you work in, where you went to college, what you studied, several hundred variables affect how we price credit,” he said.
Upstart, a direct-to-consumer lending platform, uses artificial intelligence and machine learning for everything from verifying a potential borrower’s identity, to making a credit decision, to pricing credit. Today 25 percent of the company’s loans are 100% automated.
“This is a radical departure from the industry,” said Girouard. “It’s a function of being able to build more automation to verify information about the borrower.”
Indeed the differences between machine learning and traditional credit models is kind of like comparing a self-driving vehicle to walking.
“The whole term machine learning implies that software gets smarter and better on its own with no human intervention. Every day thousands of repayments are made to Upstart along with delinquencies, and defaults. As this happens the software is adjusting its pricing on the next loan, learning in real time every day,” Girouard said, without even the slightest concern of tipping his hand.
“We have a several year head start and a data science team that are math and statistics PhDs. These are the types of people hired by Google or Tesla or Amazon. Traditional consumer credit doesn’t tend to have machine learning skills,” he added.
Nevertheless his vision for artificial intelligence and machine learning in the lending community is far greater than as it applies to Upstart alone. “We think virtually all flavors of lending will depend on AI/ML within 10 years. We’re at the very early stages, but it’s hard to imagine a successful lender anywhere who doesn’t use similar technology over time,” Girouard said.
Upstart is a hybrid lender that funds 20% of loans from their balance sheet. Two months ago they began licensing software as a service (SaaS). The software is managed by Upstart but it appears on the partner’s website. “A bank could use our technology to originate loans,” said Girouard, adding that the company is in conversations with two-to-three dozen banks about future partnerships.
The machine learning approach seems to lend itself to favoring certain demographics. In the case of Upstart, this happens to be millennials, evidenced by the lender’s average customer age of 28, almost all of whom have college degrees.
“Obviously we understood early that the millennial generation doesn’t have 20 years of credit history and they have a hard time getting loans. It struck us, tell me you wouldn’t give a loan to a 25 year old just because they have a thin credit file? It doesn’t make sense. What if they studied at Stanford and work at Google? There is more to be known about an individual than a FICO score,” said Girouard.
Perhaps the greatest evidence of whether or not Upstart’s approach is working is to catch a glimpse of the company’s balance sheet. Upstart expects to reach the $1 billion milestone for loan originations in calendar 2017. And perhaps even more telling is they anticipate being profitable by the summer. “An IPO for us would be a couple of years out,” Girouard said.
That timing could be perfect, particularly considering Wall Street’s apparent love/hate relationship with some players in the alternative lending space.
“People tend to paint the whole industry with one brush and it’s not a very pretty brush at the moment. But soon they will begin to appreciate there is a significant difference between these companies. Upstart really does have a very differentiated and unique product,” said Girouard.
Just a few years ago, the financial services community was fixing for a battle of David and Goliath proportions—with scrappy, upstart online lenders threatening to rise up and vanquish the fearful and mighty brick and mortar banks. Instead, the unexpected happened: a number of well-respected online lenders and banks set aside their battle arms and began looking for ways to collaborate with their rivals—offloading loans, making referral agreements and establishing more formal partnerships, for example.
“In the real world, sometimes David wins. Sometimes Goliath wins. Just as plausibly, sometimes both sides carve up a market and they often have different offerings that target unique customers,” says Brayden McCarthy, vice president of strategy at Fundera, a New York-based marketplace for small business lending that works with a variety of lenders, including traditional banks.
Certainly, the change didn’t happen overnight. But over time, both online lenders and banks have been forced to tailor their expectations more closely to market realities. Despite their fast growth trajectory, several online lenders have come to realize that they lack several things many banks have, namely a strong, time-tested brand, a solid customer base and ample capital. Banks, meanwhile, have realized that their slow start out of the gate with respect to technology is a severe competitive disadvantage, and that they need more nimble, savvy partners to stay in the game.
Given these shifts, more and more online lenders and banks are taking the approach that if you can’t beat ‘em, join ‘em. Although some industry leaders are actively pursuing strategies that put them in direct competition with banks, partnerships of varying degrees between traditional banks and alternative players are increasingly common. As a result, the lines separating the two are getting increasingly blurry.
“Market forces are acting as a shotgun at the wedding. Whether the two sides are entirely comfortable with the marriage is irrelevant, they need one another,” says Patricia Hewitt, chief executive of PG Research & Advisory Services LLC in Savannah, Georgia. “They’re stronger together than they are alone.”
The evolution of Square is a prime example. The San Francisco-based company really packed a punch in the merchant services world with its mobile card reader designed for small businesses. From there, the payments company sought additional ways to diversify, eventually turning to merchant cash advance as a way to help small business customers obtain funds quickly. Then, in March of last year, Square moved into online lending, teaming up with Celtic Bank of Utah to offer small business loans online. The partnership got off to a running start. In its most recent earnings report, Square said it facilitated 40,000 business loans totaling $248 million in the fourth quarter of 2016—up 68 percent year over year—while maintaining loan default rates at roughly 4 percent.
Even SoFi, the San Francisco-based online lender that has been pointedly outspoken in its anti-bank rhetoric, now has bank-like aspirations. In February, the lender acquired mobile banking startup Zenbanx, giving it the ability to offer checking accounts and credit cards in 2017. Also in February, SoFi teamed up with Promontory Interfinancial Network to enable community banks to purchase super-prime student loans originated by the online lender. Large banks have been buying SoFi loans for several years.
COLLABORATION IS THE WAVE OF THE FUTURE
Many see collaboration between banks and online lenders as a logical step in the industry’s evolution. Online disrupters have forever changed the face of lending—in the same way that online brokerage shaped the financial advisor industry, according to Bill Ullman, chief commercial officer of Orchard Platform.
“There’s a tendency to want to view things as either black or white, online lenders vs. banks. The reality is that the entire financial services industry is undergoing a transformation with technology as the core driver,” he says. “I am of the view that both traditional financial services companies and fintech players can survive and thrive,” Ullman says.
For its part, Orchard recently inked a deal with Sandler O’Neill that provides access to the Orchard platform for the investment bank and brokerage firm’s bank and specialty finance clients. The deal is expected to help small banks better evaluate their options with respect to online lending opportunities.
Partnerships between online lenders and banks take many forms. Some of them are behind the scenes, where marketplaces sell loans to banks or banks informally refer customers. Others are more public. For example, in September 2015, Prosper and Radius Bank of Boston teamed up to offer personal loans to certain customers through the bank’s website using the Prosper platform. Customers can borrow from $2,000 to $35,000 in this manner.
Then in December 2015, JPMorgan Chase and OnDeck joined forces in order to dramatically speed up the process of providing loans to some of the banking giant’s small business customers. In April 2016, Regions Bank and Avant announced a partnership to better serve customers who don’t meet Regions’ credit criteria.
Avant’s customers typically have a credit score between 600 and 700, while Regions sets the bar higher. “The benefit for banks is that they do not need to worry about a platform taking away customers that meet their own credit criteria,” according to Carolyn Blackman Gasbarra, head of public relation at Avant.
She notes that Avant expects to replicate this model with more banks in 2017. “Lately many platforms and banks have come to realize their counterparts are more friend than foe,” she says.
Given the changing tides, industry watchers expect to see more relationships develop between online lenders and banks over time. These could include referral agreements, technology licensing arrangements, formalized revenue-sharing partnerships and perhaps even outright acquisitions.
Certainly, working together can be mutually beneficial for both online lenders and banks. For new online lenders and other fintech players, partnering with an established bank allows them to bypass significant regulatory and compliance hurdles because the necessary requirements are already in place.
“Why jump through all the hoops when you can just have a buddy system with an existing lender?” says Kerri Moriarty, head of company development at Cinch Financial, a Boston-based company dedicated to helping people make smarter investment decisions.
Fintechs that license their technology to banks still have to meet the high standards of third-party vendors determined by bank regulators, notes Stan Orszula, co-head of the fintech team at the Chicago law firm Barack Ferrazzano Kirschbaum & Nagelberg LLP.
“But it’s still less onerous than being a direct lender,” says Orszula, who works closely with banks and fintech providers on legal, regulatory and corporate issues. “They are learning that they need banks. They really do.”
Even seasoned online lenders that have a regulatory framework in place can benefit from bank relationships by using banks’ established brands as leverage. “Everyone knows Chase, Bank of America and American Express,” says McCarthy of Fundera. “They have a solid name and a solid in-built customer base to be able to offer product to them,” he says.
Teaming up with a bank gives added credibility to an online lender, at a time when the public’s confidence has faltered due to highly publicized troubles at certain firms. “Partnering has a very important signaling effect that these online players are here to stay,” McCarthy says.
Banks, meanwhile, need the nimbleness and innovation that online lenders provide. “Banks realize they have to catch up with the fintech disrupters,” says Mark E. Curry, president and chief executive of SOL Partners, which provides strategic management and information technology consulting services to financial services companies.
DIFFERENT TYPES OF PARTNERSHIP OPPORTUNITIES ABOUND
When it comes to partnerships between banks and online players, there are numerous options. In the small business lending space, for example, McCarthy of Fundera says he expects banks to continue buying loans from online lenders, as they have been for many years. He also expects more banks will route declined applicants to online lenders or online loan brokers. “This is a partnership that will allow them to make up some incremental revenue by referring business,” he says.
In addition, McCarthy says he expects banks to make products available through online marketplaces and use an online lender’s technology for online loan applications. He also expects banks will use online lenders’ technology for underwriting and servicing loans.
Years ago, before John Donovan joined Bizfi, he recalls talking to a salesman for a large national bank. The bank didn’t offer a lending product that he could give to small businesses and the salesman was losing customers as a result. “That’s where we see a lot of those opportunities,” says Donovan, chief executive of the online marketplace for small business loans.
For instance in March 2016, Bizfi partnered with Western Independent Bankers, a trade association, for over about 600 community and regional banks, to link small business clients to financing options through Bizfi. Many banks don’t offer small business loans below $150,000, whereas the average loan Bizfi does is $40,000, Donovan says, adding that the company would like to develop additional relationships similar to its agreement with Western Independent Bankers.
In the future, he predicts fintechs will continue to be more receptive to the idea of working with banks and vice versa, as the industry digests the impact of deals that are still in their early days.
FINDING STRATEGIC GROWTH OPPORTUNITIES
As banks and online lenders become increasingly accustomed to working together, there may be more opportunities for strategic acquisitions. For instance, Sandeep Kumar, managing director of Synechron, a global consulting and technology firm, expects to see banks—especially mid-tier players that don’t have the resources to innovate like big banks buying lending-related start-ups. He says banks will likely be most interested in companies that can help them with AI and other techniques to pinpoint where they should spend more efforts on cross-selling and customer profiling, for example. “There are many start-ups in this area that have very compelling technology,” he says.
On the other hand, Chris Skinner, an independent commentator at The Finanser Ltd., a research and consulting firm in London, points out that the two cultures don’t always mesh. “Quite a few startups have young, entrepreneurial founders that would loath the idea being acquired by a bank. So it really depends on the circumstances,” he says.
Valuation differences between large banks and leading online lenders may also be a sticking point for some deals, Ullman of Orchard points out. Banks’ concern over their valuation “will place a certain amount of restraint and discipline on the tech M&A activities they pursue,” he says.
ANTICIPATING TROUBLE IN PARADISE
While increased collaboration between online lenders and banks sounds good on the surface, John Zepecki, group head of product management for lending at D+H in San Francisco, urges both sides to proceed with caution. “You have to find an arrangement where you don’t have conflict,” he says. “If your innovation partner also is a competitor, it’s a challenge. If you have an inherent conflict, it doesn’t get better over time.”
That’s one reason why companies like Chicago-based Akouba have come on the scene. In Akouba’s case, its goal is to provide banks with the technology such that they don’t have to partner with an online lender that has the potential to compete for business. “We don’t compete with the bank in any way whatsoever,” says Chris Rentner, the company’s founder and chief executive.
Akouba’s business lending platform—which the American Bankers Association endorsed in February—provides banks with leading edge technology that integrates the bank’s own unique credit policies into a convenient, online process—from application to documentation— all the way to closing and funding. The bank uses its own credit policies, originates its own loans and owns the entire brand and customer relationship.
Rentner says he started the business with the idea in mind that the online lending model wouldn’t be sustainable long-term and that working alongside banks—as opposed to competing head to head— was the direction to go. “The idea that they could somehow get all of the consumers out of the banking world and onto their platforms was never going to happen. That’s why we exist today,” he says.