Articles by Cheryl Winokur Munk
For alternative lenders and funders, 2021 is starting out with a question mark and will lead (hopefully) to a resounding exclamation point of recovery.
Many industry participants waved goodbye to 2020 with relief, and are welcoming a bounce-back in 2021, despite some trepidation about potential bumps along the way and how long a full recovery will take. While things started to improve somewhat toward the latter half of 2020 after grinding to a halt earlier in the year, the pandemic is still raging, with economic growth highly dependent on the immunization trajectory. Then there’s the incoming Democratic administration and the possibility of new rule- making, along with January’s runoff elections in Georgia that could change the balance of power in the Senate, and thus impact the new president’s law- making abilities.
Beyond these macro-issues, the funding industry is also dealing with its own uncertainties. Small business lenders and funders have been hit particularly hard, with underwriting decidedly more difficult in this environment. Some industry players have been forced to find alternative revenue streams in order to ride things out. Not only that, but there are scores of small businesses still reeling from pandemic-induced shutdowns and lighter foot traffic, with some gloomy estimates about their ability to bounce back. Many alternative players are weighing diminished returns against a widely-held bullish outlook for the industry long-term. Many are simply hoping they can hunker down and stick it out long enough and to avoid additional carnage and consolidation that’s widely expected over the short-term.
Ultimately things will get better, but it’s unclear precisely when, says Scott Stewart, chief executive of the Innovative Lending Platform Association. “It’s going to be a bumpy ride for the next year to figure out who is going to be able to survive,” he says.
Here’s a deeper dive into how industry participants see 2021 shaping up in terms of the challenges, competition, M&A, regulation, changing business model, expansion opportunities and more.
SPECIFIC CHALLENGES FOR SMALL BUSINESS FINANCERS
Companies that focus on consumer financing haven’t struggled quite as much amid the pandemic as their small business brethren, and they could continue to see demand grow in 2021. Even amid high unemployment rates, many consumers still need loans for home repairs or as a stop-gap to pay necessary expenses, helping to mitigate the impact on firms that focus on personal loans.
Small business financers, however, got pummeled in 2020 and the situation remains precarious, especially given the prognosis for small companies broadly. Consider that 163,735 Yelp-listed businesses closed from the beginning of the pandemic through Aug. 31—at least 97,966 of them permanently. Further underscoring how dire the situation is for small businesses, 48 percent of owners feared not earning enough revenue in December to keep their businesses afloat, according to a recent poll by Alignable, an online referral network for small businesses. What’s more, 50 percent of retail establishments and 47 percent of B2B firms could close permanently, according to the poll of 9,204 small business owners.
A SHRINKING COMPETITIVE LANDSCAPE
For many lenders and funders, the latter part of 2020 proved more successful for originations, though business is still a far cry from before the pandemic. A number of players who suspended or reduced business operations for a period of time during the first wave of the pandemic have dipped their toes back in and are in the process of trying to adapt to the new normal. For some, though, the challenges may prove too great, industry observers say. Given that many brokers and funders that were on the fringe have been hurt by the pandemic, more shake- out can be expected, says Lou Pizzileo, a certified public accountant who advises and audits alternative finance companies for Grassi in Jericho. N.Y.
And, with fewer competitors, there will be more of a need for those who are left to pick up the slack, says Peter Renton, founder of Lend Academy. Beyond being a lifeline for many alternative financers, PPP loans helped open the eyes of many small businesses who hadn’t previously considered working with anyone but a bank. In the beginning, when it was so difficult for small businesses to get these funds, they looked beyond banks for options and some found their way to online providers. This could be a boon for the industry going forward since alternative providers are now on the radar screen of more small businesses, says Moshe Kazimirsky, vice president of strategic partnerships and business development at Become.
He predicts that larger, stronger players will gradually ease some of their lending and funding criteria early on in 2021, but no one is expecting a quick revival, with some predicting it could be well into 2022 before the industry is on truly stable footing. “I think it’s going to be a very slow recovery,” Kazimirsky says.
In 2020, the industry saw bellwethers like Kabbage and OnDeck get swallowed up, and with so many businesses pinched, there are likely to be more bargains ahead from M&A standpoint, Pizzileo says. “The damage from Covid is palpable; we just haven’t seen the real impact of it yet,” he says.
No matter what product you are providing, if you’re a smaller player who can’t find your way, you’re going to have a hard time staying in business,” says Stewart of the Innovative Lending Platform Association. “There will be some collateral damage going into next year,” he predicts.
In terms of likely buyers, Renton says he expects other fintechs to step in, and possibly even mid-size community banks snap up some alternative providers. If you can buy something for “a song” it’s compelling, he says. “I expect to see a few more offers that are too good to refuse,” he says.
CHANGING BUSINESS MODELS
Pizzileo, the CPA, predicts there will be ongoing opportunities in the year ahead for well-positioned, strong businesses with available capital. In some cases, however, this may require tinkering with their existing ways of doing business.
Before the crisis, some lenders applied the same or very similar lending model across industries. “That is going the way of the dinosaur. That’s not going to be a successful model going forward,” Renton says. Lenders will focus more on having a differentiated model for the businesses they serve. “I think the crisis created this necessity to treat each industry on its own merits and create a model that has some level of independence, he says.
The year ahead is also likely to be one in which e-commerce lending continues to thrive. According to the third quarter 2020 report from the U.S. Census Bureau, U.S. retail e-commerce stood at $209.5 billion, up 36.7% year over-year. E-commerce accounted for 14.3% of total retail sales in Q3. Because it’s such a high-growth area, and many businesses that didn’t have this vertical before are moving in this direction and more lenders are focusing on it and growing that part of their business, says Kazimirsky of Become.
It will also be interesting to watch how lenders and funders continue to reshape themselves. Sofi, for instance, is continuing to pursue its goal of receiving a national bank charter. Other lenders and funders may also seek to reinvent themselves as they attempt to stay afloat and compete more effectively.
“Monoline lenders that rely on a single product will have more difficulty supporting customers in the wake of Covid,” says Gina Taylor Cotter, senior vice president and general manager of global business financing at American Express, which purchased Kabbage in 2020. “Small businesses need multi-product solutions to not only access working capital, but also real-time insights to help them be more prudent with their cash flow and accept contactless payments safely to encourage more business,” she says.
CHANGES IN RISK MODELING
Another pandemic-driven change is that lenders have had to tweak their risk modeling. Everyone understands the economy is not in the greatest spot, but their challenge in 2021 will be developing a way to assess future losses in the absence of a baseline, says Rutger van Faassen, head of product and market strategy for the benchmarking and omnichannel research group at Informa Financial Intelligence.
Consumer behaviors have changed, for instance. So even though the pandemic will end, it’s too soon to say what the structural impacts on an industry will be and how that affects the desirability of lending to especially hard-hit businesses, such as restaurants, cruise lines and fitness centers. “Clearly the behavior that everyone is showing right now is because of the pandemic. The question is: how will people behave once the pandemic ends,” he says.
“In the meantime, a lot of lenders will have to do more in-the-moment decision-making, until we get to a point when we’re truly in a new normal, when they can start recalibrating models for the longer-term,” he says.
OPPORTUNITIES TO HELP SMALL BUSINESSES
One certainty in the year ahead is the need to help existing small businesses with their recovery, says Cotter of American Express. “Small businesses represent 99 percent of all jobs, two-thirds of new jobs and half of the non-farm GDP in America. Our country’s success depends on small businesses, and financial institutions have a great opportunity to meet their needs to recover and return to positions of growth in 2021,” she says.
How to make this happen is something many alternative financers will grapple with in 2021. Another opportunity may exist in providing funding solutions to new businesses or those that have pivoted as a result of the pandemic. Cotter points to the inaugural American Express Entrepreneurial Spirit Trendex, which found 76% of businesses have already pivoted their business this year and 73% expect to do it again next year. “New-business applications have reached record heights as entrepreneurs pivot and adapt, indicating a surge of new ventures that will require financial solutions to build their business,” Cotter says.
Several regulatory issues hang in the balance in 2021, including state-based disclosure laws, expected rules on third-party data aggregation and demographic data collection, and the status of a special purpose charter for fintechs, says Ryan Metcalf, head of U.S. public policy, regulatory affairs and social impact at Funding Circle. With a new administration coming in, the regulatory environment could become more favorable for measures that stalled during Trump’s tenure.
Armen Meyer, vice president of LendingClub and an active member of the Marketplace Lending Association, says he’s hoping to see a bill pass in 2021 that requires more transparency for small business lending. He would also like to see more states follow the lead of California and Virginia and make the 36% interest rate standard of Congress’s Military Lending Act, which covers active- duty service members (including those on active Guard or active Reserve duty) and covered dependents, the law of the land. “We’re calling for this to be expanded to everybody,” he says.
Meanwhile, our neighbors to the North have their own challenges and opportunities for the year ahead. The alternative financing industry in Canada originated out of the 2008 recession when banks restricted their credit box and wouldn’t lend to certain groups. While conditions are very different now, “this period of economic uncertainty is going to be an incredible fertile period of time for fintechs to come up with new and interesting and creative credit products just like they did entering the last financial crisis,” says Tal Schwartz, head of policy at the Canadian Lenders Association.
Open banking continues to be on the Canadian docket for 2021 and how the framework shapes up is of utmost interest to fintech lenders in Canada. Schwartz says he’s also hopeful that alternative players in Canada will have a role to play in subsequent government- initiated lending programs. He’s also expecting to see more growth in the e-commerce area, particularly when it comes to extending credit to e-commerce companies and in financing solutions at checkout for online shopping.
On Friday, American Express announced that it had completed its acquisition of Kabbage.
“Kabbage, An American Express Company will continue to provide quick and easy cash flow management solutions for small businesses, now backed by the trust, service, and security of a American Express,” American Express wrote on social media. “We’re excited to welcome Kabbage’s talented colleagues to American Express. Together we will combine our over 60 years of experience backing small businesses with Kabbage’s innovative technology to support our customers through this challenging time, and help them get back on their feet and thrive.”
Meanwhile, below is a copy of a Q&A deBanked had with Kabbage co-founder Kathryn Petralia that appeared in our magazine’s July/August issue.
Q: How specifically do you think the pandemic will change the way SMEs bank?
A: The pandemic will first change with whom they bank, and that choice will change the way they bank. For perspective, one hundred percent of Kabbage customers have a bank account, but very few of them can get a loan from their bank. We launched Kabbage Checking earlier this year to serve the smallest of businesses without sacrificing the features they expect and offering other products banks don’t. We’re focused on making cash flow tools accessible to the businesses traditionally underserved and overlooked, and the pandemic has been a catalyst for businesses to find new solutions.
Q: How might the dynamic of banking change after the crisis?
A: It was well-reported that businesses without an existing credit relationship with their bank were turned away from applying for PPP loans. We’ve heard directly from many of our PPP customers that this will compel them to change banks, and the demand for Kabbage Checking has reflected that sentiment since its launch. In the short term, businesses of all sizes and ages will seek out and sign up for new, tech-forward banking partners. In the long term, that shift will change customers’ expectations of what banks should offer. For example, prior to the PPP, Kabbage had issued well over a billion dollars to customers during non-banking hours. On-demand, 24/7 access to funding and cash flow insights, or faster settlements and money transfers will soon become commonplace, and large retail banks will need to adapt if they want to capture or reclaim these customers.
Q: How are these changes likely to impact alternative lenders and funders?
A: For starters, single-product lending companies will realize they must diversify their offerings in order to compete in the new financial-services marketplace. I would expect to see lenders launch new products to more resemble a bank. Conversely, traditional banks will need to begin adopting automated ways to serve customers with a tech-forward experience. Especially in the new normal where customers may be apprehensive about in-person banking meetings, they must adapt online to acquire and serve customers.
Q: What’s still needed to help Main Street recover?
A: The PPP was only the first phase; we’re not out of the woods yet. Businesses now need to restart and eventually grow. The crisis made business owners realize they need tighter controls over their cash flow, as many found themselves on the back foot and ill-equipped to withstand a long-term crisis such as the one through which we are all muddling.
They’ll need cash-flow tools to be more prudent and appropriately plan for similar events. Having said that, it’s not only on the shoulders of small businesses or tech solutions. They need customer demand, and local economies need to begin to reopen safely so consumers feel comfortable returning to normal commerce. That will take the support of cities and states encouraging consumers to shop local so small businesses have greater incentive to recall their employees and get back to work.
Q: How can alternative lenders and funders best play a role in this recovery?
A: Much of what we’re already doing is exactly what our economy needs. For the most part, fintech companies serve the customers banks won’t or can’t. That reality is unfortunately unchanged today. That’s why during the pandemic Kabbage made every effort possible to provide products that helped SMBs through this crisis. With respect to PPP, we helped nearly 300,000 small businesses access over $7 billion, helping preserve an estimated 945,000 jobs. Our payments product saw a near 4X spike in adoption as businesses sought contactless payment options. We built www.helpsmallbsuiness.com in three days to allow any small business to generate needed revenue by selling online gift certificates. We also launched Kabbage Checking, giving small businesses a new banking option, and Kabbage Insights remains available and free to access for any small business.
Q: What changes do you expect to see in the alternative lending and funding industry as a result of the pandemic?
A: Everyone will expand their services. Whether it’s larger companies expanding their solutions through acquisitions, or start-ups investing beyond their primary product, everyone will aim to enhance their offerings to give customers more data-driven products that help them rebuild.
Q: Kabbage just agreed to be purchased by American Express. Should we expect to see more consolidation in the alternative lending/funding space? If so, over what time frame and why do you expect this to happen?
A: I would not be surprised if we saw more deals announced before the end of the year.
Q: Tell us a little about why Kabbage decided to sell and why the timing was right?
A: For us, it has always been about finding the right company with the right mission and intentions. We just happened to be in the middle of a crisis when the conversations started, despite having the financial capacity to support operations for multiple years. American Express shares our vision to be an essential partner to small businesses, and we couldn’t be more excited at the opportunity to continue the important work of providing solutions and innovative capabilities that address a range of small business cash flow needs alongside AmEx.
A number of small businesses—including those in the merchant cash advance industry—faced with little or no way to make money for months—have pivoted to selling personal protective equipment.
It’s no wonder businesses across the U.S. have shifted gears. With the pandemic raging, and consumers and businesses trying to return to some sort of normalcy, there’s high demand for these products, causing even businesses that previously had no connection to them to spring into action.
“It’s not my forte; I had to pivot just to make sure I could stay afloat before things turned around,” says John DiCanio, founding partner of Direct Merchant Funding in Bethpage, N.Y.
This past spring, at a time when everything in the MCA business stopped, he heard from a merchant in the medical supply field that masks were becoming very important. The merchant connected him to a contact in Hong Kong from whom he was able to buy hospital-grade and non-medical grade masks and sell them to local hospitals, local businesses and others.
DiCanio says he did it for a short time only—two months—which was enough to tide him over under his
regular business started coming back. Mask-making is still a big business and a lot of people are still doing it, but he prefers to stick to merchant cash advance, which he’s been doing for around 15 years. He says business has picked up enough that he no longer has the need to do anything on the side—and he hopes it stays that way.
Many funding industry participants are still selling these types of products, but it’s somewhat of a hush-hush business. Not everyone wants to talk about it for any number of reasons, including embarrassment and fear of looking weak to customers and business connections. Even so, small businesses that pivoted say they are doing the best they can to stay afloat—and there’s no shame in that.
Kat Rosati, founder of Apparel Booster in Riverside, Calif., a product development agency for luxury and socially conscious brands, began hand-sewing masks to help support her business that had been hit-hard by the pandemic.
She has manufacturing partners all over the world, and production was at a standstill for her various products. She couldn’t import fabric needed for the company’s various projects and a lot of production partners were forced to close. Luckily, she had a connection to a fabric mill in Pennsylvania that focuses on antimicrobial products that was willing to provide her with material.
She hired temporary workers to help her make masks, which she’s producing at a rate of about 150 a week. She sells them to consumers and small businesses. The revenue has helped defray overhead expenses, among other things. “It hasn’t been super profitable, but it’s definitely helped keep the business alive,” she says.
She had to furlough her four-person team because she can’t afford to pay them without regular client work coming in. Her husband, who works in the restaurant industry, was also furloughed. So whatever money she can bring in, helps. “I’m watching small business owners around me that haven’t made any kind of pivot close left and right,” she says. “The fact that I can keep mine alive makes it worth it for me.”
To be sure, small businesses pivot for all sorts of reasons, and it’s not always because they are struggling. Francis Perdue, a publicist and business consultant in Birmingham, Ala., began selling PPE products including gloves, kn95 masks, surgical masks, customizable cloth masks, child and adult-sized shields, suits, gowns and the Xenon Fever Defense machine which uses AI technology to measure skin temperature and detect potential fever. She says she saw a need for these types of products in local schools as well as in hospitals and clinics in predominantly black neighborhoods. She is still consulting, but doing this as a side gig while the need persists.
Another example is MORGAN Li, a retail and hospitality manufacturer in Chicago Heights, Ill. The company identified the need and opportunity to help businesses remain open or reopen to customers while abiding by new recommendations to support public health. Thus, the company began producing customized social distancing materials including sneeze guards, safety shields, signage and floor graphics for various businesses to remind employees and customers to comply with social distancing requirements, according to a spokeswoman.
More recently, Andy Rosenband, the company’s chief executive, saw another opportunity to help communities prepare for another critical stage—reopening schools. He created a line of personal protective equipment that specifically addresses the challenge of social distancing in schools to keep students, teachers and staff safe.
For some small businesses, the shift is likely to be a permanent one.
JB Herrera, founder of Perceptive Insights a San Diego-based small and medium business consulting and mentoring company, says his firm was growing, but PPE products offer the ability to create a broader impact and are likely to be more profitable than merely a consulting business.
He has clients in China and back in December when things were starting to get bad there, he realized that the problem could spread massively to the U.S., and if it did, 80 percent or more of businesses would be negatively impacted, in his estimation. Using his business expertise regarding supply chains and pre-existing and new contacts, his company shifted gears to introduce in March a line of FDA-registered products designed to create and maintain safe environments. The products include commercial and personal cleaning solutions, masks, light technology disinfectants, air filtration, and personal sanitizing kits.
Even before the pandemic, the PPE market was worth several billion, he says, and that’s likely to grow exponentially over the next five to 10 years. So much so, that he expects the new business line to represent 90 percent of his revenue for the next three years—at least.
“Even after the spike goes away, it’s still going to be a profitable business in its own right,” he says.
With the doors to 2019 firmly closed, alternative financing industry executives are excited about the new decade and the prospects that lie ahead. There are new products to showcase, new competitors to contend with and new customers to pursue as alternative financing continues to gain traction.
Executives reading the tea leaves are overwhelming bullish on the alternative financing industry—and for good reasons. In 2019, merchant cash advances and daily payment small business loan products alone exceeded more than $20 billion a year in originations, deBanked’s reporting shows.
Confidence in the industry is only slightly curtailed by certain regulatory, political competitive and economic unknowns lurking in the background—adding an element of intrigue to what could be an exciting new year.
Here, then, are a few things to look out for in 2020 and beyond.
There are a number of different items that could be on the regulatory agenda this year, both on the state and federal level. Major areas to watch include:
- Broker licensing. There’s a movement afoot to crack down on rogue brokers by instituting licensing requirements. New York, for example, has proposed legislation that would cover small business lenders, merchant cash advance companies, factors, and leasing companies for transactions under $500,000. California has a licensing law in place, but it only pertains to loans, says Steve Denis, executive director of the Small Business Finance Association. Many funders are generally in favor of broader licensing requirements, citing perceived benefits to brokers, funders, customers and the industry overall. The devil, of course, will be in the details.
- Interest rate caps. Congress is weighing legislation that would set a national interest rate cap of 36%, including fees, for most personal loans, in an effort to stamp out predatory lending practices. A fair number of states already have enacted interest rate caps for consumer loans, with California recently joining the pack, but thus far there has been no national standard. While it is too early to tell the bill’s fate, proponents say it will provide needed protections against gouging, while critics, such as Lend Academy’s Peter Renton, contend it will have the “opposite impact on the consumers it seeks to protect.”
- Loan information and rate disclosures. There continues to be ample debate around exactly what firms should be required to disclose to customers and what metrics are most appropriate for consumers and businesses to use when comparing offerings. This year could be the one in which multiple states move ahead with efforts to clamp down on disclosures so borrowers can more easily compare offerings, industry watchers say. Notably, a recent Federal Reserve study on non-bank small business finance providers indicates that the likelihood of approval and speed are more important than cost in motivating borrowers, though this may not defer policymakers from moving ahead with disclosure requirements.
“THIS WILL DRIVE COMMISSION DOWN FOR THE INDUSTRY”
If these types of requirements go forward, Jared Weitz, chief executive of United Capital generally expects to see commissions take a hit. “This will drive commission down for the industry, but some companies may not be as impacted, depending on their product mix, cost per lead and cost per acquisition and overall company structure,” he says.
- Madden aftermath. The FDIC and OCC recently proposed rules to counteract the negative effects of the 2015 Madden v. Midland Funding LLC case, which wreaked havoc in the consumer and business loan markets in New York, Connecticut, and Vermont. “These proposals would clarify that the loan continues to be ‘valid’ even after it is sold to a nonbank, meaning that the nonbank can collect the rates and fees as initially contracted by the bank,” says Catherine Brennan, partner in the Hanover, Maryland office of law firm Hudson Cook. With the comments due at the end of January, “2020 is going to be a very important year for bank and nonbank partnerships,” she says.
- Possible changes to the accredited investor definition. In December 2019, the Securities and Exchange Commission voted to propose amendments to the accredited investor definition. Some industry players see expanding the definition as a positive step, but are hesitant to crack open the champagne just yet since nothing’s been finalized. “I would like to see it broadened even further than they are proposed right now,” says Brett Crosby, co-founder and chief operating officer at PeerStreet, a platform for investing in real estate-backed loans. The proposals “are a step in the right direction, but I’m not sure they go far enough,” he says.
Precisely how various regulatory initiatives will play out in 2020 remains to be seen. Some states, for example, may decide to be more aggressive with respect to policy-making, while others might take more of a wait-and-see approach.
“I think states are still piecing together exactly what they want to accomplish. There are too many missing pieces to the puzzle,” says Chad Otar, founder and chief executive at Lending Valley Inc.
As different initiatives work their way through the legislative process, funders are hoping for consistency rather than a patchwork of metrics applied unevenly by different states. The latter could have significant repercussions for firms that do business in multiple states and could eventually cause some of them to pare back operations, industry watchers say.
“While we commend the state-level activity, we hope that there will be uniformity across the country when it comes to legislation to avoid confusion and create consistency” for borrowers, says Darren Schulman, president of 6th Avenue Capital.
The outcome of this year’s presidential election could have a profound effect on the regulatory climate for alternative lenders. Alternative financing and fintech charters could move higher on the docket if there’s a shift in the top brass (which, of course, could bring a new Treasury Secretary and/or CFPB head) or if the Senate flips to Democratic control.
If a White House changing of the guard does occur, the impact could be even more profound depending on which Democratic candidate secures the top spot. It’s all speculation now, but alternative financers will likely be sticking to the election polls like glue in an attempt to gain more clarity.
Election-year uncertainty also needs to be factored into underwriting risk. Some industries and companies may be more susceptible to this risk, and funders have to plan accordingly in their projections. It’s not a reason to make wholesale underwriting changes, but it’s something to be mindful of, says Heather Francis, chief executive of Elevate Funding in Gainesville, Florida.
“Any election year is going to be a little bit volatile in terms of how you operate your business,” she says.
The competitive landscape continues to shift for alternative lenders and funders, with technology giants such as PayPal, Amazon and Square now counted among the largest small business funders in the marketplace. This is a notable shift from several years ago when their footprint had not yet made a dent.
This growth is expected to continue driving competition in 2020. Larger companies with strong technology have a competitive advantage in making loans and cash advances because they already have the customer and information about the customer, says industry attorney Paul Rianda, who heads a law firm in Irvine, Calif.
It’s also harder for merchants to default because these companies are providing them payment processing services and paying them on a daily or monthly basis. This is in contrast to an MCA provider that’s using ACH to take payments out of the merchant’s bank account, which can be blocked by the merchant at any time. “Because of that lower risk factor, they’re able to give a better deal to merchants,” Rianda says.
Increased competition has been driving rates down, especially for merchants with strong credit, which means high-quality merchants are getting especially good deals—at much less expensive rates than a business credit card could offer, says Nathan Abadi, president of Excel Capital Management. “The prime market is expanding tremendously,” he says.
Certain funders are willing to go out two years now on first positions, he says, which was never done before.
Even for non-prime clients, funders are getting more creative in how they structure deals. For instance, funders are offering longer terms—12 to 15 months—on a second position or nine to 12 months on a third position, he says. “People would think you were out of your mind to do that a year ago,” he says.
Because there’s so much money funneling into the industry, competition is more fierce, but firms still have to be smart about how they do business, Abadi says.
Meanwhile, heightened competition means it’s a brokers market, says Weitz of United Capital. A lot of lenders and funders have similar rates and terms, so it comes down to which firms have the best relationship with brokers. “Brokers are going to send the deals to whoever is treating their files the best and giving them the best pricing,” he says.
Profitability, access to capital and business-related shifts
Executives are confident that despite increased competition from deep-pocket players, there’s enough business to go around. But for firms that want to excel in 2020, there’s work to be done.
Funders in 2020 should focus on profitability and access to capital—the most important factors for firms that want to grow, says David Goldin, principal at Lender Capital Partners and president and chief executive of Capify. This year could also be one in which funders more seriously consider consolidation. There hasn’t been a lot in the industry as of yet, but Goldin predicts it’s only a matter of time.
“A lot of MCA providers could benefit from economies of scale. I think the day is coming,” he says.
He also says 2020 should be a year when firms try new things to distinguish themselves. He contends there are too many copycats in the industry. Most firms acquire leads the same way and aren’t doing enough to differentiate. To stand out, funders should start specializing and become known for certain industries, “instead of trying to be all things to all businesses,” he says.
Some alternative financing companies might consider expanding their business models to become more of a one-stop shop—following in the footsteps of Intuit, Square and others that have shown the concept to be sound.
Sam Taussig, global head of policy at Kabbage, predicts that alternative funding platforms will increasingly shift toward providing more unified services so the customer doesn’t have to leave the environment to do banking and other types of financial transactions. It’s a direction Kabbage is going by expanding into payment processing as part of its new suite of cash-flow management solutions for small businesses.
“Customers have seen and experienced how seamless and simple and easy it is to work with some of the nontraditional funders,” he says. “Small businesses want holistic solutions—they prefer to work with one provider as opposed to multiple ones,” he says.
This year could be a “pivotal” year for open banking in the U.S., says Taussig of Kabbage. “This issue will come to the forefront, and I think we will have more clarity about how customers can permission their data, to whom and when,” he says.
Open banking refers to the use of open APIs (application program interfaces) that enable third-party developers to build applications and services around a financial institution. The U.K. was a forerunner in implementing open banking, and the movement has been making inroads in other countries as well, which is helping U.S. regulators warm up to the idea. “Open banking is going to be a lively debate in Washington in 2020. It’ll be about finding the balance between policymakers and customers and banks,” Taussig says.
The funding environment
While there has been some chatter about a looming recession and there are various regulatory and competitive headwinds facing the industry, funding and lending executives are mostly optimistic for the year ahead.
“If December 2019 is an early indicator of 2020, we’re off to a good start. I think it’s going to be a great year for our industry,” says Abadi of Excel Capital.
Depending on your vantage point, a slowdown is either already in progress, just around the bend or several years away. But some alternative commercial real estate professionals are trying to filter out the noise.
Instead, they are more aggressively forging ahead with growth plans, including trying to grab market share from banks.
The commercial real estate lending market remains highly competitive and alternative lenders say they remain focused on looking for opportunities to expand their business, even as the possibility of recession looms. At present, a number of professionals don’t see an imminent threat of recession, and even if there is one, they say they stand to benefit from picking up business banks don’t want to take on—or can’t—because of increased regulatory controls imposed on them since the last recession.
There are plenty of opportunities for alternative commercial real estate lenders to get ahead, even in this environment, says Chris Hurn, founder and chief executive of Fountainhead Commercial Capital, a Lake Mary FL-based, non-bank direct small business lender in the commercial real estate lending space.
To be sure, alternative commercial real estate lenders say that for the most part, there hasn’t been a major pullback in their space. But due in part to mounting economic concerns and changing business priorities, banks—which had already scaled back from their pre- Great Recession exuberance—have been taking an even more cautious approach to lending. This is especially true in certain regions of the country, or in sectors deemed higher-risk such as hospitality and retail, alternative lenders say. While the pullback hasn’t been broad-based, it’s been enough in some cases to create strategic pockets of opportunity for opportunistic non-bank lenders such as private equity funds, debt funds, crowdfunding portals and others.
For many of these commercial real estate professionals, whether or not a recession is on the horizon is not a guessing game that’s worth playing. And with good reason, given how much disagreement there is among market watchers, investment management professionals and others about where the economy is headed.
Certain economic data continues to be strong, for instance, but political and geopolitical factors such as trade wars continue to raise red flags. Then there’s the fatalistic notion that the economy has been on a tear for so long that it’s due for a pullback at some point. This all translates into a hodgepodge of speculation and indecision about the economy’s direction. The dichotomy is evident from the difference in sentiment expressed in two fund manager surveys from Bank of America Merrill Lynch taken a month apart. October’s survey was decidedly bearish; by November, the bulls were back, muddying the waters even more.
Instead of wavering in indecision, however, some alternative commercial real estate players are hunkering down and highly focused on building their business in a cautiously optimistic and strategic manner.
Hurn of Fountainhead Commercial Capital predicts a number of increased opportunities for alternative commercial real estate lenders due to pullback from banks and a growing need for capital. He cautions alternative lenders against being too pessimistic and losing out on potentially lucrative market opportunities as a result.
“I think we might be going into a period of slightly slower growth, but none of the indicators suggest we’re remotely close to where things were 10 years ago,” Hurn says. “If we’re not careful, we’re going to talk our way into recession. It’s a self-fulfilling prophecy.”
Indeed, even as perplexing questions about the economy’s long-term health persist, some alternative commercial lenders anticipate growth in the coming year. Evan Gentry, chief executive and founder of Money360, a tech-enabled direct lender specializing in commercial real estate, says the company’s loan origination business is on track to close between $650 million and $700 million in 2019. That’s expected to increase to about $1 billion in 2020, fueled by growth in some strategic markets, including Washington DC, Atlanta, Miami and Charlotte, N.C., where the company is seeking to add loan origination personnel. Gentry says the company also continues to experience strength in many of the western markets, including the intermountain west markets of Colorado, Utah and Idaho, where growth is expected to continue.
CommLoan, a commercial real-estate lending marketplace in Scottsdale, Ariz., also sees strategic opportunities to grow in this environment. Mitch Ginsberg, the company’s co-founder and chief executive, predicts 2020 will be a strong growth year for his company, after a several-year beta period. CommLoan has plans, for example, to start hiring account executives to build relationships in additional states. Initially, the focus will be on institutions in the Southwestern U.S., with plans to add lenders in Texas, Utah, Colorado and New Mexico in the early part of 2020, Ginsberg says.
Though certain regions or business lines within commercial real estate may be experiencing some pullback, he says his overall outlook for the economy and commercial real estate remains strong. “There is still an enormous amount of activity,” he says. “If and when a correction does happen, it’s going to be a lot softer and not that deep and not that long because of the fundamentals in the economy.”
FINDING WAYS TO COMPETE MORE EFFECTIVELY WITH BANKS AND OTHERS
Some commercial real estate professionals say they are focusing more attention on sectors, regions and concentrations that the banks aren’t going after so readily.
If an alternative lender can offer more money than a bank on a particular deal or offer more flexible terms, or do deals that traditional lenders simply won’t do, for example, then it’s a boon for them. For a slightly higher price, alternative lenders—especially those whose business model relies heavily on technology—are able to take on slightly riskier deals than a bank might be able to stomach, says Jacob Goldsmith, managing partner of Goldwolf Ventures LLC, a privately held alternative investment and asset management company with offices in Miami and Austin.
“Alternative lenders are a lot more nimble,” says Goldsmith, who keeps close tabs on the commercial real estate lending industry.
Especially given the ambiguous economic climate, there are several areas that could be prime opportunities for savvy alternative commercial real estate lenders to gain a leg up. For instance, some banks of late have shied away from certain special purchase property types like hotels, day care facilities and free-standing restaurants, says Hurn of Fountainhead Commercial Capital. These types of properties are traditionally seen as riskier in the latter part of an economic cycle.
Nonetheless, “there’s opportunity here for non-traditional lenders to step in and fill that gap,” he says. Retail loans are another category where banks have been pulling back. One reason banks are being more cautious is the sentiment that as online shopping becomes more pervasive, there’s less of a need for brick-and-mortar shops. This trend is underscored by the recent announcement of Transform Holdco—the company formed to buy the remaining assets of bankrupt retailer Sears Holdings Corp.—that it would close 96 Sears and Kmart stores by the end of February. Still, some industry watchers aren’t ready to concede retail’s demise.
While these types of announcements fan fears, concern over the death of retail is largely overblown, according to Troy Merkel, a partner and real estate senior analyst at RSM, which provides audit, tax and consulting services. “The banks are being too overly cautious,” he opines.
The opportunity for alternative lenders, he says, is not in funding loans that add to the supply, but rather in funding loans that change the existing supply. While the need for new development may not be as great, there is a growing demand for repurposed properties, he says. This includes upscaling an older mall or turning an existing retail building into a mixed use property, namely a mix of retail stores and multi-family apartment complexes. There is still a real need for these types of developments, Merkel says, and with banks shying away, the door is open for alternative lenders to “make a play,” he says.
Real estate professionals say they also see opportunities for alternative commercial real estate lenders to make loans in areas outside major metro cities, where the competition isn’t as strong.
“There will always be opportunities in the ups and downs, the ebbs and flows of the cycle. You just have to be a lot smarter in this part of the cycle,” says Goldsmith of Goldwolf Ventures.
Pockets of opportunity notwithstanding, alternative commercial real estate lenders have to play it smart, professionals say. For instance, they should not be overly bullish on a particular sector or throw caution to the wind when it comes to their underwriting practices.
That’s because when the market turns—as it inevitably will at some point—there will likely be more defaults and lenders that haven’t dotted their I’s and crossed their T’s will understandably face stronger headwinds. They need to keep their close eye on expenses as well, which may have ticked upward over the past several years. “People get complacent when times are good. This is probably not the time to be complacent anymore,” says Hurn of Fountainhead Commercial Capital.
Another protective measure against an eventual downturn is to diversify sales channels and property types. “If you put too many eggs in one basket, it’s a problem,” Hurn says.
It’s also important for lenders to have their guards up since higher risk deals can lead to losses if a recession hits. Lenders have to be smart when it comes to taking on risk, says Tim Milazzo, co-founder and chief executive of StackSource, an online marketplace for commercial real estate loans. “They have to have a certain expertise in underwriting these transactions correctly and assessing risk,” Milazzo says.
In light of significant ambiguity about where the economy is heading, Gentry of Money360 says his company is protecting itself by taking an ultra- conservative approach. This means, for instance, only making first-lien position loans secured against income producing properties at a loan-to-value ratio on average of 65 percent, he says. Some alternative lenders are making these loans at a loan-to-value ratio of 80 percent or 85 percent, but Gentry says this is too high a rate for his taste. Also, Money360’s loans are also generally short- term—in the two-to-three-year range, which reduces some of the risk and seems especially prudent at this point in the cycle, he says.
When the market turns—as it inevitably will at some point—there will be more loan defaults, and those that are on the more aggressive end of lending will bear most of the challenges, he says.
He cautions other alternative lenders to avoid taking on excessive risk. “You’ve got to be thinking ahead and planning and lending as if the downturn is right around the corner—because it could be,” he says. Even taking a conservative approach, there are still significant business opportunities, he says.
BE ON THE LOOKOUT FOR RECESSIONARY OPPORTUNITIES
Meanwhile, if a recession does hit, alternative commercial real estate lenders say they will have even more opportunities to gain market share, participate in workout financing and hire key personnel. Alternative lenders that are more steeped in technology may potentially have even more of an upper hand since this can enable them to close deals much more efficiently and quickly and at a lower cost, while at the same time giving borrowers broader access.
“In a tighter market, every reduction in rate and cost will make more of a significant difference to borrowers than it does at the moment,” says Ginsberg of CommLoan, the commercial real-estate lending marketplace.
Although there are a growing number of alternative commercial real estate lenders who are relying more heavily on technology than they did in the past, commercial real estate lending still hasn’t flourished online to the extent personal and small business lending has. One reason is that the loans are larger and human intervention is often seen as beneficial, says Gentry of Money360.
However, online lending within the commercial real estate lending space is still on the horizon, according to Ginsberg of CommLoan. “It’s slow-go, but it’s inevitable,” he says.
The definition of accredited investor, which the SEC is tackling this year, is causing a fair amount of debate.
At issue is the fact that under federal securities laws only persons who are accredited investors may participate in certain types of securities offerings.
As it now stands, to be deemed an accredited investor, a person needs to earn income of more than $200,000 ($300,000 with a spouse) in each of the prior two years and reasonably expect to earn the same for the current year. Alternatively, the person needs to have a net worth of $1 million or more (alone or with a spouse), excluding the value of a primary residence.
The goal of these rules, of course, is investor protection. In theory, the rules are supposed to ensure investors are sophisticated enough to invest in riskier investments and, on top of that, have adequate cushioning against the risk of financial loss.
The trouble, critics say, is that the rules aren’t doing a very good job of achieving these objectives. There’s widespread agreement that the current definition is flawed. Where it gets trickier is in deciding how it should be fixed.
There are some who say the current bar is too high, others who say it’s too low. Some contend that the wealth-based test should be scrapped altogether in favor of a sophistication test. Others promote a sliding scale approach to investing in riskier offerings. This would allow all investors to participate, but in increments that are proportional to their wealth—similar to what happens in the crowdfunding arena today. Some industry players support a combination of measures, a sophistication test in connection with a sliding scale, to maximize investor protection and still open the playing field for others who can’t participate today based on their income or net worth.
The varying opinions are likely to be debated by the SEC as it reviews the accredited investor definition, which it’s required to do every four years by a provision in the Dodd-Frank Act. The SEC is taking the opportunity to do a broad-based review of the regulatory framework for investing in alternative assets; the accredited investor definition is just one of the areas on its docket to examine. The comment period for this review ended on August 30th.
At this point, what the SEC actually decides to do about the accredited investor definition is anybody’s guess. The thrust of these conversations is likely to focus on what constitutes an appropriate degree of protection, which is where many of the disagreements—and alternative suggestions on how to best accomplish this— come into play.
VETTING THE VARIOUS OPINIONS
On one hand, consumer advocates want to maintain the highest degree of investor protection possible. The concern is that consumers generally don’t have enough prowess or information to safely invest in unregistered offerings, which can carry more risk than registered investments.
“We don’t want the definition to be any weaker than it is now because that would do the vast majority of consumers a disservice,” says Brian Young, public policy manager at the National Consumers League. “With these exempt products, there are a lot of unknown variables and there’s a lot more vulnerability,” he says.
One suggestion that’s being proposed is to raise the wealth and income levels to adjust for inflation. It’s a step in the right direction because it would further limit who is eligible to be considered an accredited investor, says Barbara Roper, director of investor protection for the Consumer Federation of America. “The levels haven’t kept pace with inflation since they were set,” she says.
This alone, however, wouldn’t be sufficient to protect investors, consumer advocates say, since there are plenty of wealthy people who have little to no investment prowess.
“Just changing it to correct for inflation doesn’t change it to correct for sophistication and still places investors at risk,” says Ed Mierzwinski, who oversees U.S. PIRG’s federal consumer program, helping to lead national efforts to improve consumer credit reporting laws, identity theft protections, product safety regulations and more.
On this point consumer advocates and industry professionals seem to agree: that limits based on income or net worth aren’t all that useful.
Roper of the Consumer Federation of America gives the example of a 64-year-old who has $200k in income or $1 million of assets in his or her retirement accounts. This doesn’t mean he or she is financially literate, let alone sophisticated enough to take part in certain types of riskier alternative investments, she says. “That would be an inappropriate investment recommendation if it were made by your broker or investment advisor,” she says.
Some industry professionals also find fault with the wealth test, but, unlike consumer advocates, they’d like to see more investors allowed to participate, not fewer. It’s not right, they contend, that a wide range of highly educated people are prevented from investing in certain offerings because of arbitrary limits on net worth and income.
Many promising investment opportunities are not even being offered to a huge majority of American investors, based on the standards that exist today, according to Nat Hoopes, executive director of the Marketplace Lending Association, an industry trade organization.
“By harmonizing and simplifying complex rules and adjusting the current accredited investor standards, my hope is that the SEC will find that they can permit many more Americans to gain access to a wider range of well regulated investment opportunities, without leaving those citizens exposed to fraud or abuse. Done right, changes from the SEC in this area will help to promote more equality of opportunity in our economy, without adding new red tape,” he says.
Brew Johnson, co-founder and chief executive of PeerStreet, an online platform for investing in real estate debt, says it’s “crazy” that people who are highly educated—such as MBAs, accountants, attorneys and other businesspersons can’t invest in certain offerings simply because they don’t have the income or wealth levels. He takes issue with the fact that he didn’t qualify to invest on his own platform when it was first getting off the ground. Some of his employees today also don’t qualify to invest in the platform they are helping to build, which is troubling, he says.
“You don’t want people to make terrible decisions. But the idea that the average person is too dumb to make decisions with their money…is offensive,” Johnson says. Today, there’s much more readily available information and transparency—a significant change from when the rules were first put in place—when only the largest investors had access to the types of information necessary to make critical investment decisions, he says.
Johnson doesn’t take issue with the goal of protecting investors from getting into things they don’t understand. Rather, he says, “I don’t believe wealth is a determiner of sophistication.”
ALTERNATIVE PROPOSALS TO A WEALTH-BASED TEST
That’s where another idea being floated by members of the Marketplace Lending Association and others may come in. The thought is to create a new way to measure an investor’s level of sophistication and ability to withstand loss. An example of this could be some kind of test to identify investors who are deemed to have sufficient investment prowess, despite falling below the SEC’s threshold based on wealth or net worth, to participate in certain types of offerings.
It’s an option that, if adopted, could open up the playing field to additional investors—while still trying to accomplish the SEC’s goal of investor protection, industry participants say.
Ryan Metcalf, head of U.S. Regulatory Affairs at Funding Circle, says the Financial Industry Regulatory Authority Inc. (FINRA) could develop a test to be administered online when an investor who doesn’t meet the wealth or income bar wants to invest. This would allow quick-decisions to be made. People who want to invest a few thousand dollars shouldn’t have to do it in person; this would be too onerous, he says.
There could even be different tests based on what investors are seeking to invest in, says Mark Atalla, owner and managing director at private lending firm Carlyle Capital.
For a private placement in a mortgage fund, there could be questions related to the risks involved there, whereas for a private placement in a start-up technology company, there could be other types of questions pertaining to risk. The goal would be to ensure the investor has a sufficient level of understanding about the particular products they are considering.
Otherwise, Atalla says, there’s too much room for people to lose on a large scale. “These are people’s livelihoods you’re responsible for at the end of the day,” he says. “I think it’s important for investors to understand what they are really doing.”
Some industry professionals say there may be too many practical limitations for this type of an assessment to work. Certainly details would have to be worked out including what the scope of the test or tests should be. Decisions would also have to be made about who would be in charge of creating and administering a test or tests and how and where they would be administrated, among other things.
In theory, if someone can pass a test to show he or she is knowledgeable about investing, the person should be able to invest, says PeerStreet’s Johnson, adding that there’s something to be said about people accepting personal responsibility for their decisions, provided they have been given adequate information from which to make informed, knowledgeable decisions. “The devil is in the details of what [this type of test] would look like,” he says.
Another idea being floated—that could stand on its own or be implemented together with a sophistication test—is to allow all investors to invest on a scale that’s similar to the crowdfunding exemption. Under rules adopted by the SEC in 2015, the general public now has the opportunity to participate in the early capital raising activities of start-up and early-stage companies and businesses by way of crowdfunding. Because of the risks involved with this type of investing, however, investors are limited in how they can invest during any 12-month period in these transactions. The limitation depends on the person’s net worth and annual income.
Some industry watchers say the sliding scale idea is a viable one because it would allow more investors a chance to participate in more risky offerings, while providing a safety net for loss.
This type of model has the potential to offer investors a reasonable amount of protection, says Vincent Petrescu, chief executive of truCrowd, Inc., an equity crowdfunding portal that connects startups and emerging businesses with non-accredited and accredited investors. “If you have less money, you are allowed to invest less, but you still can play your hand,” he says.
Johnson of PeerStreet also supports this approach because it allows investors who otherwise wouldn’t have access a chance to broaden their exposure to areas that could potentially allow them to increase their wealth.
Certainly, questions about this approach persist as well. What should the investment limits be? Would it depend on the type of investment? Would investors need to self-certify as they do in crowdfunding, or would their information need to be verified by a third party? These questions and more are also likely to be probed more deeply during an SEC review.
The Marketplace Lending Association would also like employees of private funds to qualify as accredited investors for investments in their employers funds. The trade group contends that a private fund’s employees likely have sufficient access to the information necessary to make informed decisions about investments in their employer’s funds.
The suggestion would be for the SEC to consider adding a new category of the definition to include “knowledgeable employees” of “covered companies” as those terms are defined in Rule 3c-5 of the Investment Company Act.
Industry watchers are hopeful to have some clarity on these issues within the coming months, so stay tuned.
“The SEC’s mandate is to protect investors, which sometimes is needed,” says Petrescu of truCrowd, the equity crowdfunding portal. “There needs to be checks and balances,” he says.
The Australian alternative lending market continues to gain momentum, bolstered in part by increased awareness, heightened competition and growing dissatisfaction with the status quo.
Indeed, there’s been significant growth in the few years since deBanked first wrote about the nascent alternative lending business down under. Notably, Australia’s alternative funding volume surpassed $1.14 billion in 2017, up 88 percent from $609.59 million in 2016, according to the latest data available from KPMG research. It’s the largest country in terms of total alternative finance market volume in the Asia Pacific region, excluding China, according to KPMG.
To be sure, the Australian market is still relatively small—at least compared with the U.S. Digging deeper, the largest share of market volume in 2017—the latest data available—came from balance sheet business lending, accounting for more than $574 million, according to KPMG. P2P marketplace consumer lending had the second largest market volume at $256 million. Invoice trading was the next largest segment of the Australian alternative finance market, accounting for $142.65 million, according to the KPMG report.
Its small size notwithstanding, what makes the Australian market particularly interesting is the potential promise it holds for the companies already established there and the opportunities it may offer to new entrants that find ways to successfully compete in the market.
Certainly alternative lending opportunities in Australia are growing, as awareness increases and the desire by consumers and businesses for favorable rates and faster service intensifies. The Australian alternative lending market is similar to Canada in that a small number of large banks dominate the market both in terms of consumer lending and small business lending. But, like in Canada, alternative lenders are gaining ground amid a changing customer mindset that values speed, favorable rates and a digital experience.
Equifax estimates that alternative finance volume in Australia is now growing at about 10 percent to 15 percent per year; that compares to a decline of approximately 20 percent for some major traditional lenders in terms of credit growth, says Moses Samaha, executive general manager for Equifax in Sydney. This presents an opportunity for alternative lenders to serve parts of the market the banks don’t want and those that are more attuned to a digital experience.
Even so, challenges persist. For instance, digital disruptors are still working on gaining brand awareness, and the market is only so big to be able to accommodate a certain number of alternative players. Time will time whether there will be consolidation among alternative lenders and more bank partnerships, which haven’t been so successful to date. “It doesn’t feel like they are as active as they were announced to be,” Samaha says.
At present, the Australian market consists of a few dozen alternative lenders pitted against four major banks. RateSetter, SocietyOne and Wisr are among the largest alternative players in the consumer lending space. On the small business side, Capify, GetCapital, Moula, OnDeck, Prospa and Spotcap are some of the leading companies. PayPal Working Capital also has a growing presence in the Australian small business lending market.
New lenders continue to eye the Australian market for entry, but it’s not an easy market to crack, according to industry participants. The market consists of mostly home-grown players and that’s not expected to change drastically. (Capify, OnDeck and Berlin-based Spotcap are notable exceptions. Another U.S. major player, Kabbage, previously provided its technology to Australia’s Kikka Capital, but that agreement is no longer in force.)
There can be a steep learning curve when it comes to outsiders doing business in Australia. What’s more, there’s no longer the first-to-market advantage that existed a decade or so ago. It’s also a relatively limited market in terms of size, which can be off-putting. Australia has a population of around 25 million, making it less populated than the state of California, with an estimated 39.9 million residents.
Still, for alternative players that are able to successfully navigate the challenges the Australian market presents, there’s ample opportunity to grab market share away from traditional players—similar to the pattern that’s emerged elsewhere around the globe.
Take consumer lending, for example. The unsecured consumer lending market in Australia sits at about $70 billion, with the large banks occupying maybe a 90 percent share of that, says Mathew Lu, chief operating officer of Wisr (previously known as DirectMoney Limited). Compared with other markets such as U.K. and the U.S., who went through a similar journey around a decade ago, “Australia is probably three or four years into that same journey of growth. It’s shifting and changing,” he says.
Alternative lenders have made strides in undercutting the large banks by offering generally lower rates and typically faster loan times. Unfavorable press related to bank lending practices has also benefited alternative lenders. Lu refers to these conditions as “a perfect storm” for growth.
Wisr, for instance, saw loan origination volume spike 409 percent in fiscal year 2018. The company secured $75 million in loan funding agreements last year and boasts more than 80,000 customers, according to a company presentation.
Marketplace lender, SocietyOne, which in March reached $600 million in loan originations, is another example of an alternative lender that has benefited from the momentum. The company— celebrating its 7th anniversary this summer—is hoping to reach $1 billion in loans by 2020, according to its website.
RateSetter—another major player in this space—has also experienced significant growth since launching in Australia in 2014, and is now funding over $20 million in loans each month, according to its website. In April, the company soared past $500 million in loans funded and in May it saw a record number of new investors register. The company has more than 15,000 registered investors by its own account.
One question for the future is whether the consumer alternative lending space in Australia will ultimately be too crowded amid a spate of new entrants. Wisr’s Lu says “there’s a big question mark” regarding how many alternative lenders the market can sustain. “Will there be a level of consolidation or amalgamation? These are questions ahead of us,” he says.
For its part, alternative lending to small businesses is also a growing force within Australia. As a testament to the development of this market, in June 2018, a group of Australia’s leading online small business lenders released a Code of Lending Practice, a voluntary code designed to promote fair terms and customer protections. Currently, the Code only covers unsecured loans to small businesses. Signatories include Capify, GetCapital, Moula, OnDeck, Prospa and Spotcap.
Capify—an early entrant to Australia—has been pursuing businesses there since 2008. The company, which integrated its U.S. business in 2017 to Strategic Funding Source (now called Kapitus) is now operating only in Australia and the U.K. In Australia, it has executed more than 7,500 business financing transactions for Australian businesses and has more than 50 staff members in its Australian offices.
The company recently closed a deal with Goldman Sachs for a $95 million line of credit for growth in Australia and the U.K., which includes building out its broker program to increase distribution and technology investment.
David Goldin, the company’s chief executive, says Capify is hoping to grow its Australian business between 25 percent and 30 percent in 2019. The company is looking at M&A activity as well as organic growth.
Since Capify has been in the market, he has seen a number of new entrants—some more successful than others. One concern Goldin has is the lack of experience by some of these competitors. Many aren’t pricing the risk properly and not underwriting prudently to be able to weather a downturn, he says. They are so new, he questions whether they have the expertise to be able to survive a downturn given what he characterizes as pricing and underwriting missteps.
“You can’t go out 24 months on a 1.25 factor rate – that’s crazy,” he says, referring to some contracts he’s seen. “I’ve seen this movie in the U.S. before and it doesn’t end well.”
Meanwhile, competition has driven down prices and made moving quickly on potential leads more of a necessity. When leads come in today, if you’re not on the phone in 30 minutes, you could lose it to a competitor, he says.
While the small business market is an enticing one for alternative lenders, raising awareness of their offerings continues to be a challenge.
“The small business market is fragmented and raising awareness is expensive,” says Beau Bertoli, co-founder and co-chief executive of Prospa, another prominent small business lender in Australia. “There hasn’t been much innovation in small business banking, but many Australians still don’t think of switching from banks and traditional lenders,” he says.
That said, more small businesses are turning to alternative lenders and these companies say they expect growth to increase over time. Recent research commissioned by OnDeck found that 22 percent of small and medium-sized businesses would consider an online lender, up from 11 percent in the past. This could be buoyed further by the introduction of Open Banking in Australia, which was set to be introduced in Australia in 2019, but this was pushed back to early 2020.
“We look forward to the introduction of Open Banking in Australia as it should allow lenders to use incremental data points to improve risk modeling, and increase competition in the SME lending space, ultimately providing SMEs with improved access to cashflow solutions to grow and run their businesses,” says Cameron Poolman, chief executive of OnDeck in Australia.
Bertoli of Prospa, which recently listed on the Australian Stock Exchange, says the Australian alternative lending market will also benefit from strong support from industry and government to increase competition and improve consumer and small business outcomes. The government recently established a $2 billion Australian Business Securitisation Fund, which is a huge win for small business, he says, that will ultimately make the finance available to small business owners more affordable by lowering the wholesale cost of funds for alternative lenders. “We expect this will boost credibility and consideration of alternative lenders among small business owners,” he says.
Declining property values is another factor helping alternative lending. “In November 2018 we saw the largest annual fall in property prices in Australia since the global financial crisis in 2009,” says Simon Keast, managing director of Spotcap Australia and New Zealand.
“As property prices decline, business owners find it more difficult to use their home as loan security and as such, turn to alternative lenders such as Spotcap that can provide them with unsecured loans for their business,” he says. What’s more, the SME Growth Index in March showed for the first time that business owners are almost as likely to turn to an alternative lender as they are to their main bank to fund growth, says.
Overall, the market opportunity for alternative lending to small businesses is compelling, says Bertoli of Prospa. “We estimate the potential market for small business lending in Australia is more than $20 billion per annum and we’ve penetrated only about 2 percent of the market so far. There are 2.3 million small businesses in Australia, and they’re crying out for capital,” he says.
Keast of Spotcap says he expects to see more banks and non-financial enterprises looking to leverage the technology fintech lenders have built to provide swift and digital lending products to small businesses. He offers the example of a partnership Spotcap, a German-based company, has with an Austrian Bank to provide same-day finance to SMEs in Austria as an example of the types of partnerships the company could also seek in Australia. “We have already partnered with an Austrian Bank that is leveraging our lending platform to provide same-day finance to SMEs in Austria, and there is plenty of interest for similar partnerships on the ground here,” he says.
OnDeck, meanwhile, expects to see a shake-out within the alternative finance sector, which will result in a smaller number of bigger players, with the ability to scale and serve multiple customers with a variety of products, according to Poolman, the company’s chief executive.
For his part, Goldin of Capify is bullish on the Australian small business market, but he cautions others that it’s not a gold rush type of place where everyone who comes in can make money.
“The state of California has more opportunity than the entire continent of Australia,” he says.
Canadians have been slow out of the gate when it comes to mass adoption of alternative financing, but times are changing, presenting opportunities and challenges for those who focus on this growing market.
Historically, the Canadian credit market has traditionally been dominated by a few main banks; consumers or businesses that weren’t approved for funding through them didn’t have a multitude of options. The door, however, is starting to unlock, as awareness increases about financing alternatives and speed and convenience become more important, especially to younger Canadians.
Indeed, the Canada alternative finance market experienced considerable growth in 2017—the latest period for which data is available. Market volume reached $867.6 million, up 159 percent from $334.5 million in 2016, according to a report by the Cambridge Centre for Alternative Finance and the Ivey Business School at Western University. Balance sheet business lending makes up the largest proportion of Canadian alternative finance, accounting for 57 percent of the market; overall, this model grew 378 percent to $494 million in 2017, according to the report.
Industry participants say the growth trajectory in Canada is continuing. It’s being driven by a number of factors, including tightening credit standards by banks, growing market demand for quick and easy funding and broader awareness of alternative financing products.
To meet this growing demand, new alternative financing companies are coming to the market all the time, says Vlad Sherbatov, president and co-founder of Smarter Loans, which works with about three dozen of Canada’s top financing companies. He predicts that over time more players will enter the market—from within Canada and also from the U.S.—and that product types will continue to grow as demand and understanding of the benefits of alternative finance become more well-known. Notably, 42 percent of firms that reported volumes in Canada were primarily headquartered in the U.S., according to the Cambridge report.
To be sure, the Canadian market is much smaller than the U.S. and alternative finance isn’t ever expected to overtake it in size or scope. That’s because while the country is huge from a geographic standpoint, it’s not as densely populated as the U.S., and businesses are clustered primarily in a few key regions.
To put things in perspective, Canada has an estimated population of around 37 million compared with the U.S.’s roughly 327 million. On the business front, Canada is similar to California in terms of the size and scope of its small business market, estimates Paul Pitcher, managing partner at SharpShooter, a Toronto-based funder, who also operates First Down Funding in Annapolis, Md.
Nonetheless, alternative lenders and funders in Canada are becoming more of a force to be reckoned with by a number of measures. Indeed, a majority of Canadians now look to online lenders as a viable alternative to traditional financial institutions, according to the 2018 State of Alternative Lending in Canada, a study conducted by online comparison service Smarter Loans.
Of the 1,160 Canadians surveyed about the loan products they have recently received, only 29 percent sought funding from a traditional financial institution, such as a bank, the study found. At the same time, interest in alternative loans has been on an upward trajectory since 2013. Twenty-four percent of respondents indicated they sought their first loan with an alternative lender in 2018. Overall, nearly 54 percent of respondents submitted their first application with a non-traditional lender within the past three years, according to the report.
Like in the U.S., there’s a mix of alternative financing companies in Canada. A number of companies offer factoring and invoicing and payday loans. But there’s a growing number focused on consumer and business lending as well as merchant cash advance.
Some major players in the Canadian alternative lending or funding landscape include Fairstone Financial (formerly CitiFinancial Canada), an established non-bank lender that recently began offering online personal loans in select provinces; Lendified, an online small business lender; Thinking Capital, an online small business lender and funder; easyfinancial, the business arm of alternative financial company goeasy Ltd. that focuses on lending to non-prime consumers; OnDeck, which offers small business financing loans and lines of credit; and Progressa, which provides consolidation loans to consumers.
By comparison, the merchant cash advance space has fewer players; it is primarily dominated by Thinking Capital and less than a dozen smaller companies, although momentum in the space is increasing, industry participants say.
“The U.S. got there 10 years ago, we’re still catching up,” says Avi Bernstein, chief executive and co-founder of 2M7 Financial Solutions, a Toronto-based merchant cash advance company.
In terms of opportunities, Canada has a population that is very used to dealing with major banks and who are actively looking for alternative solutions that are faster and more convenient, says Sherbatov of Smarter Loans. This is especially true for the younger population, which is more tech-savvy and prefers to deal with finances on the go, he says.
Because the alternative financing landscape is not as developed in Canada, new and innovative products can really make a significant impact and capture market share. “We think this is one of the key reasons why there’s been such an influx of international companies, from the U.S. and U.K. for example, that are looking to enter the Canadian market,” he says.
Just recently, for example, Funding Circle announced it would establish operations in Canada during the second half of 2019. “Canada’s stable, growing economy coupled with good access to credit data and progressive regulatory environment made it the obvious choice,” said Tom Eilon, managing director of Funding Circle Canada, in a March press release announcing the expansion. “The most important factor [in coming to Canada] though was the clear need for additional funding options among Canadian SMEs,” he said.
OnDeck, meanwhile, recently solidified its existing business in Canada through the purchase of Evolocity Financial Group, a Montreal-based small business funder. The combined firm represents a significantly expanded Canadian footprint for both companies. OnDeck began doing business in Canada in 2014 and has originated more than CAD$200 million in online small business loans there since entering the market. For its part, Evolocity has provided over CAD$240 million of financing to Canadian small businesses since 2010.
“There is an enormous need among underserved Canadian small businesses to access capital quickly and easily online, supported by trusted and knowledgeable customer service experts,” Noah Breslow, OnDeck’s chairman and chief executive, said in a December 2018 press release announcing the firms’ nuptials.
There are also a number of home grown Canadian companies that are benefiting from the growth in the alternative financing market.
2M7 Financial Solutions, which focuses on merchant cash advances, is one of these companies. It was founded in 2008 to meet the growing credit needs within the small and medium-sized business market at a time when businesses were having trouble in this regard.
But only in the past few years has MCA in Canada really started picking up to the point where Bernstein, the chief executive, says the company now receives applications from about 200 to 300 companies a month, which represents more than 50 percent growth from last year.
“We’re seeing more quality businesses, more quality merchants applying and the average funding size has gone up as well,” he says.
NAVIGATING THROUGH CHALLENGES
Despite heightened growth possibilities, there are also significant headwinds facing companies that are seeking to crack the Canadian alternative financing market. For various reasons, some companies have even chosen to pull back or out of Canada and focus their efforts elsewhere. Avant, for example, which offers personal loans in the U.S., is no longer accepting new loan applications in Canada at this time, according to its website. Capify also recently exited the Canadian business it entered in 2007, even as it continues to bulk up in the U.K. and Australia.
One of the challenges alternative lenders face in Canada is distrust of change. Since Canadians are so used to dealing with only a few major financial institutions to handle all their finances, they are skeptical to change this behavior, especially when the customer experience shifts from physical branches to online apps and mobile devices, says Sherbatov of Smarter Loans. He notes that adoption of fintech products in Canada has lagged in recent years, partially because there has been a lack of awareness and trust in new financial products available.
One way Smarter Loans has been working to strengthen this trust is by launching a “Smarter Loans Quality Badge,” which acts as a certification for alternative financing companies on its platform. It is issued to select companies that meet specified quality standards, including transparency in fees, responsible lending practices, customer support and more, he says.
The Canadian Lenders Association, whose members include lenders and merchant cash advance companies, has also been working to promote the growing industry and foster safe and ethical lending practices. For example, it recently began rolling out the SMART Box pricing disclosure model and comparison tool that was introduced to small businesses in the U.S. in 2016.
Another challenge that impacts alternative lenders in the consumer space is having restricted access to alternative data sources. Because of especially strict consumer privacy laws, access is “substantially more limited” than it is in any other geography,” says Jason Mullins, president and chief executive of goeasy, a lending company based in Mississauga, Ontario, that provides consumer leasing, unsecured and secured personal loans and merchant point-of-sale financing.
From a lending perspective, goeasy focuses on the non-prime consumer—generally those with credit scores of under 700. Mullins says the market consists of roughly 7 million Canadians, about a quarter of the population of Canadians with credit scores. The non-prime consumer market is huge and has tremendous potential, he says, but it’s not for the faint of heart.
Another issue facing alternative lenders is the relative difficulty of raising loan capital from institutional lenders, says Ali Pourdad, co-founder and chief executive of Progressa, which recently reached the $100 million milestone in funded loans for underserved Canadian consumers. “The onus is on the alternative lenders to ensure they have good lending practices and are underwriting responsibly,” he says.
What’s more, household debt to income ratios in Canada are getting progressively worse, with Canadians taking on too much debt relative to what they can afford, Pourdad says. As the situation has been deteriorating over time, there is inherently more risk to originators as well as the capital that backs them. “Originators, now more than ever, have to be cautious about their lending practices and ensure their underwriting is sound and that they are being responsible,” he says.
On the small business side of alternative lending, getting the message out to would-be customers can be a challenge in Canada. In U.S. there are thousands of ISOs reaching out to businesses, whereas in Canada, most funders have a direct sales force, with a much smaller portion of their revenue coming from referral partners, says Adam Benaroch, president of CanaCap, a small business funder based in Montreal.
He predicts this will change over time as the business matures and more funders enter the space, giving ISOs the ability to offer a broader array of financing products at competitive rates. “I think we’re going to see pricing go down and more opportunities develop, and as this happens, the business is going to grow, which is exactly what has happened in the U.S,” he says.
Generally speaking, Canadian businesses are still somewhat skeptical of merchant cash advance and require considerable hand-holding to become comfortable with the idea.
“You can’t wait for them to come to you, you have to go to them and explain what the products are,” says Pitcher of SharpShooter, the MCA funding company.
While Pitcher predicts more companies will continue to enter the Canadian alternative financing market, he doesn’t think it will be completely overrun by new entrants—the market simply isn’t big enough, he says. “It’s not for everyone,” he says.