2014 was an unbelievable year!
I kicked off last year by opening an account with Lending Club so that I could understand their product. Today I have tens of thousands of dollars invested on their platform and picking up new loans has become part of my daily routine. You could say I’m not surprised they went public a few weeks ago.
I also launched the industry’s first trade publication and ran it as both publisher and chief editor. We produced 6 issues and distributed more than 20,000 print copies combined. Unfortunately the publication will not be continuing further. It is wild to think that it both started and concluded in 2014 as the magazine had a cult-like following.
7 conferences in 4 cities. Las Vegas (twice), San Francisco, New Orleans, and here in New York. I spoke at two of them. Hoping for at least 1 Miami conference this year. Please??? It’s so cold here right now.
OnDeck Capital took a lot of flak in 2014 from both industry insiders and the media. They shrugged it all off and went public on December 17th. Considering they’ve operated on the fringe of the merchant cash advance industry for so long, it was one of those things you had to see to believe. I didn’t get inside the building but I saw the IPO was real from the outside.
I started off 2014 not knowing what a Bitcoin was. Now I have a copy of the entire blockchain, operate a full node (don’t worry I have port 8333 open), have 10 dedicated mining devices running 24/7, have made purchases with bitcoin, conducted countless transfers, and just finished coding a working prototype application using Coinbase’s API. And when I realized that bitcointalk.org and my cryptography books weren’t enough to satisfy my appetite, I found myself talking about bitcoin on IRC; #bitcoin and #bitcoin-pricetalk on irc.freenode.net. I also know who Satoshi Nakamoto really is now too but he made me promise not to tell anyone.
I rebranded Merchant Processing Resource to deBanked, retiring a name I’ve used for 4 years.
I interviewed former Congressman Barney Frank, one of the two architects of the Dodd-Frank Wall Street Reform and Consumer Protection Act (it was only a few questions).
I got asked by a credible movie producer if I would help him on a storyline for a script about Wall Street and the alternative business lending industry. Don’t worry I turned it down!
I jumped on the payment disruption bandwagon and used Square to process credit card transactions all year. You should know that I previously did merchant account sales. I could’ve boarded my own account and set my own fees but I went with Square anyway.
I finally got set up to syndicate on merchant cash advances.
I ran my first 5k in Central Park.
I moved to a different part of Manhattan.
Of course a whole lot more happened. It was a roller coaster year which leads me to believe that 2015 will be impossible to predict. There’s a lot more room to grow in FinTech but it might be time for fresh ideas. Everyone and their mom built an online lending marketplace platform in 2014.
Similarly, it’s also a tough time to become a loan broker or MCA ISO especially if you’re undercapitalized. The easy profit ship has sailed. Press 1s and UCCs aren’t winning business models, at least not ones that will invite outside capital or ensure survival long term.
2014 changed finance but in many ways it stayed the same.
It still takes 2-4 days to confirm an ACH didn’t reject! This is annoying all around. If I add funds to Lending Club on a Monday, it’s not accessible until Friday evening. If you debit a merchant on Monday, you won’t really know if you have it until a few days later. Believe it or not I actually mailed out more checks in 2014 than in any other year of my life. The ACH system appears to be fine until you use something that is far more advanced, something I will probably write about over the next month. Instantaneous payments, low transaction fees, no bank involvement. Yeah, it’s time for ACH to go away…
And with banks, well… I have opened business bank accounts over the last few years with 3 different banks. The one I opened in 2014 required a two hour in-person interview, a process that involved filling out forms by hand and being threatened that the government would shut everything down in a heartbeat if they found out that I so much as breathed wrong on an ATM. It was a repeat of prior account opening experiences. Although I’ve never had an account closed for doing anything wrong (because I’m not actually doing anything wrong), it is easy to see how much regulatory pressure banks are under. Swiping your debit card upside down could cause the entire bank to get an Operation Choke Point subpoena. They want your business but they’re scared to death of anything you might do with a bank account.
All the major peer-to-peer platforms of 2014 became centralized. Lending Club and Prosper don’t even fall in the p2p category anymore. The market trend has been to create a platform designed for the little guys and then hand it over to a bank or institutional money to do all the funding. In some ways it’s easier to deal with a handful of big players instead of thousands or millions of retail investors. But with the regulatory environment uncertain on so many new investment products, it’s probably also safer to deal with institutional investors, lest the regulators claim they violated a consumer protection law they thought up this morning.
Banks continue to be the biggest obstacle to innovation because at the end of the day, all payments flow through them. How can one deBank and truly disrupt?
Hopefully we’ll find out in 2015. Happy belated New Year.
According to Investopedia, “Getting a piece of a hot IPO is very difficult, if not impossible.”
The Motley fool says:
If the bankers think a stock will soar, they earmark much of the shares for their favorite institutional clients (ones that bring in the most in commissions). In a sense, brokerages use lucrative IPOs to curry favor with big clients, to win and retain their business. When brokers aren’t so confident about the company’s prospects, they will try to sell the stock to less-favored institutional clients.
Admittedly these are generalities, not unyielding truths.
But when Lending Club mass e-mailed all their platform lenders on November 17th that they would be rewarded with a chance to get in on the IPO, people got excited. They wouldn’t just automatically get stock though, they’d be given the chance to buy it. An allocation was not guaranteed and a limit as to how much was not immediately disclosed, though it was recently revealed that platform lenders could buy up to a maximum of 350 shares.
At $10-$12 a share, that’s an opportunity to spend a max of $3,500 to $4,200 on the IPO. Getting in won’t make you a millionaire but it’s a little way for Lending Club to say thank you to all those who invest on their platform.
I got the offer and turned it down. I’m very bullish on Lending Club stock but I feel like I’m already invested enough in them as a company through platform lending to need to get even more in. For those not sure how Lending Club really works, their system is not actually peer-to-peer. Investors buy Lending Club notes that are tied to the loans they issue. You are ultimately only investing in Lending Club with every note you buy. You have no relationship or claim to the borrower.
With that being the case, my tens of thousands invested in them is enough, especially from a retail investment standpoint. But I enjoyed the proposal nonetheless because it felt like a gift for getting in on the ground floor of something huge.
I also liked telling people over the last two weeks that I could get in on the Lending Club IPO.
“You hear about Lending Club going public?” I’d ask a friend. And then brag, “Yeah, well I have a chance to get in on the IPO if I want. I could talk to my guy to try to get you in but I don’t know if I can swing it. Maybe though.”
I was pretty damn important.
Until someone told me they could get in on the OnDeck IPO today. He apparently had an inside guy and that inside guy was E*Trade, as in he could apparently get in on OnDeck’s IPO just for having an E*Trade account.
One had to wonder why any schmo with a brokerage account was being asked to buy in. It didn’t sound good for OnDeck but I let my friend have his moment. His guy could try to get me in, etc.
The mass blanket invitation to get in might appear that brokers aren’t so confident about the company’s prospects. But actually back in January of this year E*Trade forged a “retail alliance” with middle-market investment bank Jefferies LLC. A Reuter’s story said that, “E*Trade is betting that it can score points with investors by guaranteeing access to IPOs that brokerage firms normally reserve for their best customers.”
OnDeck’s underwriters include Morgan Stanley, Bank of America Merrill Lynch, JPMorgan Chase, Deutsche Bank and Jefferies. This is in line with “giving its customers access to initial public offerings and follow-on offerings underwritten by middle-market investment bank Jefferies LLC” though I haven’t confirmed the alliance is the cause of this.
Just as with Lending Club’s allocation offer, no one is guaranteed anything with OnDeck through E*Trade. There’s a required approval process which may ultimately yield nothing.
And yet it still feels a little weird, maybe because I’ve been hearing about an OnDeck IPO for years now and I just can’t grasp it’s actually happening. It’s one thing for a big banker to talk about it and another for an old college buddy, my doorman, and Jim who’s the cashier at the local hardware store ask me if I know anything about this OnDeck loan stock advance thing they heard about.
All I know is that sentiment on them is mixed but that ultimately insiders believe it’s great for the industry.
As for both of these the IPOs? I don’t know. I’m not getting in on either of them but it has nothing to do with how I feel about the companies. I can’t wait to watch this all unfold though.
Check out the 224 page OnDeck Prospectus!
A week away from IPO day, Lending Club is undergoing a supposed unannounced mid-day prolonged “upgrade”. There is no word about it on their twitter account. As many probably know, this down time coincides with one of the day’s four normal feeding times when fresh loans are loaded onto the platform in bulk.
Are they just polishing up the old gears before IPO time or did something happen?
The 3rd revision of their S-1 registration was published two days ago.
For quite possibly the first time ever, Google has blessed merchant cash advance with its own array of In-depth articles. What are In-depth articles? Why, they’re featured stories at the bottom of the normal search results. The In-depth feature launched in 2013 and has only worked for certain keywords.
Today it appeared for the very first time for the keyword merchant cash advance
Since Google experiments constantly and shows different results to everyone, it’s possible that you’ve been seeing this for some time already.
I had this to say about the feature 16 months ago:
If you’re wondering how websites can prepare themselves to benefit from such rich snippets, I published Schema.org Markup and Rich Snippets for the Little Guy back in August 2013.
Businessweek, NY Times, and Forbes… I’m not surprised that they’re the chosen publications. Truth be told, there may not have been enough written about merchant cash advance to implement this feature until now. Consider this a milestone.
Back in July 2010, I launched www.merchantprocessingresource.com as an independent resource for merchant processing and merchant cash advance. At that time I was celebrating my 4th anniversary of working in the merchant cash advance business and realized there was little to no information about the industry online.
For the last 4 and a half years, this website under that name has been visited by hundreds of thousands of people, many of whom were new to the business or interested in getting into it. I’ve received thousands of emails and responded to an insane amount of questions.
In 2010, 95% of all merchant cash advances relied on merchant processing. For those that remember, funding was in many ways secondary to acquiring merchant accounts. But the industry has evolved and other related financial alternatives have sprouted up around it.
Over time I found myself exploring new avenues and relaying what I’ve learned or what I knew with the rest of the world.
Merchant Cash Advances may have started off as a product for those underserved by banks but it has morphed into an option for bankable businesses that would rather skip the bank. In a sense, today’s capital-seeking merchants are deBanking.
Consumers too are turning to peer-to-peer platforms and crowdfunding campaigns instead of credit cards and bank loans.
And then there’s myself. I started buying into Lending Club loans in January of 2014, almost a year ago. The returns crush what I could earn with a savings account or CDs. The bank is the least attractive option if you want to earn a return on your money.
But it goes beyond lending and earning interest. All the big conferences this year were filled with bitcoin enthusiasts, a payment technology and currency that is not only independent of government, but of banks. Of course I gave it a look and loved it. I shared my feedback in a post titled, My Journey to Bitcoin.
Merchant Processing and Merchant Cash Advance may have kicked off this blog, but four and a half years later, it’s time to acknowledge the other forces, many of which I have already been covering for quite some time.
With 2015 right around the corner, the world is deBanking in more ways than one.
Now that I’ve bought into nearly 1,800 personal loans on Lending Club, I think I’ve got a good enough sample to start running analyses.
The data isn’t perfect especially since none of the loans have reached maturity yet. Most are still between two and four and a half years away from completion. But strangely, 70 loans paid off early and a good number have already defaulted or are more than 16 or 30 days late and are on their way there.
With at least that to work with, I compared three groups:
- Early payoffs
- 16+ days late or defaulted
- All others
I examined 4 initial factors and I will surely examine many more. While I saw some weak correlation regarding FICO score, it’s borrower income that really stood out.
Ignoring all other factors, the accounts that paid off early reported earning 29% more annual income than the accounts that are bad.
I had heard Peter Renton preach the high income borrower strategy and truthfully I ignored income as a factor in my decision making up until this point. On equities.com, Renton said, “I typically like more than $50,000 in annual income, although $75,000 is even better, and $100,000 is better still.”
Looking at my own sample, there is indeed correlation between the $75,000+ income earners with paying off Lending Club loans early.
Unlike some business loan products, Lending Club personal loans accrue interest rather than bake interest into a fixed total cost. That means a borrower that paid back a 5 year loan in just 3 months only paid 3 months worth of interest.
It was surprising to see that 70 borrowers repaid the loans in their entirety within a matter of months.
Regarding FICO, the score spread between bad loans and early payoffs was only 8 points, a lot smaller than I’d expect. But the portfolio is young and some loans have only just issued in the last few months. With another 2+ years left to go, the sample size of defaults will get bigger and I will be running the numbers on this again.
In in meantime, low income borrowers regardless of all other factors appear to be more risky investments. I guess you could say I’m not surprised, but it’s exciting to see data that supports a hypothesis.
“Your business has been approved for a loan…”
Last week, Chicago Public Radio (WBEZ 95.1 FM) investigated a trend in the small business community, the use of merchant cash advance financing. The station called me in advance to answer some questions about merchant cash advances and I gave my best explanation of the industry and its products.
Of the discussion that lasted more than 30 minutes, only about five of my sentences made it on the air. While I clarify some of my positions below, it was sobering to learn the context of how they were used, as a defense to real life merchant complaints.
The satisfaction rate with merchant cash advances are pretty high and I say that mainly because it’s so rare to hear complaints from anyone other than journalists that can’t believe anyone would accept rates above 6% APR. And while there are indeed bad actors in the industry (as there are in any industry), the gripe one merchant had about phone solicitations that just won’t stop is a recurring theme.
It’s happening to me too.
As an account representative in 2010 calling real time leads sold to five parties at once, I did what anyone would do, I pretended to be a small business myself and inquired through the website that we bought leads from and entered my cell phone as the point of contact
Ring. Ring. Ring…
Within a half hour, representatives from four companies called me, and I learned exactly who my competition was, how they explained the product, and what they would say to win me over. Two of the four were really good and one even referenced my name personally, saying something to the effect of, “If you get a call from Sean Murray, his rates are worse than mine.” Obviously he had already done what I was doing now, which was pretend to be a small business so he could prove to the prospect he was well informed about the alternatives. He had heard my pitch already and was now throwing me under the bus by planting the seed that I was going to offer something more expensive even if it wasn’t the truth.
In the end none of them won because it was all a farce. One never called me again after the first call. Another kept at it for a week and the remaining two followed up for a month.
And then it got quiet…
I had been marked as a dead lead and forgotten about until three months later when one company sent a follow up email. “Smart,” I thought. But then a call came six months later, and then more emails, some from companies I didn’t originally engage with.
And they continued at regular intervals, every couple of months an email or call. Was it interesting? Yes. Annoying? No.
Until this year.
The volume of emails have slowed but I’ve somehow ended up on robo calling lists. “Press 1 to talk to a funding specialist or press 9 to be added to the Do Not Call list”
The press 9 option doesn’t work for me. Sure, I might be removed from that marketer’s list, but it in no way removes you from anyone else’s list. I knew that already of course because I’ve been on the other end before.
The first time I got one of these calls, I was excited to tell the sales representative who I really was, level with him, and explain that it was a really good idea to take me off the list. But much like other business loan robo call complaints, the representative wouldn’t tell me anything about himself or his company.
I got yelled at.
Every time I tried to ask a question, he’d get louder, insisting I tell him my monthly gross sales volume for the “cash advance I wanted.”
A rogue actor maybe, but I’ve since gotten additional business loan robo calls and have made no progress in getting myself removed. I just hang up now.
Call it sweet irony perhaps. Or maybe a wake up call (pun intended). I applied on a website once four years ago and the rest is history.
My experience with repeat solicitations is marginal compared to somebody that has actually used a merchant cash advance. With the filing of a public UCC-1, anyone in the industry can easily access that data and convert it into a marketing list. And they do.
Brokers that scorn UCC marketing acknowledge that these businesses could be getting called 5-10 times a day. My own clients had reported repetitive calls back when I was an account representative. And while UCC marketing is very cost effective, in today’s market where more than a thousand companies are offering similar financial products, it’s probably safe to say it’s overly saturated.
And if 5-10 calls per day were even remotely accurate, I’d surmise that level of volume is marring the industry’s reputation as a whole.
I could argue though that when customers have a great many options to choose from, they win. With more than a thousand companies offering merchant cash advances and business loans, it’s truly a buyer’s market. Play all the companies against each other and you should end up with the best possible terms. It’s a great time to seek capital.
Except we’ve got to do something about those phone calls, or at least the robo calls.
Every angry robo dial recipient becomes one less person likely to speak positively about the the nonbank financing industry. Aged leads, UCCs and phone calls might be inexpensive, but the cost to undo negative preconceived notions is immeasurable.
Do you want to be known as the company that helped small businesses or the annoying people that won’t stop calling? If merchants are taking to the air waves to complain, it will only be a matter of time before the FTC and FCC become interested.
Regarding my comments on the radio about APRs and daily amortization, they were pulled from a conversation that compared daily payment loans to purchases of future sales. I DO believe bad actors exist and every business owner should have an accountant, lawyer, or savvy third party review any contracts they enter into, financial or otherwise.
On November 10th, OnDeck Capital finally made their S-1 public. Immediate reactions from inside the industry were mixed. The bears criticized the years of losses while the bulls pointed out that the tide is turning. With a profitable 3rd quarter, OnDeck’s bet on the long game might finally be proving itself.
And without delving into their S-1 for now, the industry should be bracing itself for change. The mysterious world of daily funders (financial companies that deal in daily payments) is about to come under the scrutiny from another body, stock analysts.
Unlike journalists which have bruised the industry with sensational headlines and surface level criticism (high costs, light regulation), analysts will be tasked with truly understanding the fundamentals of nonbank business lending. Not to mention that everyday retail investors looking for an edge will want to learn more about the industry than what a single company’s quarterly financials will tell them.
Daytraders might make decisions based on melodramatic stories but those buying and holding for the long run will be conducting something that’s rarely taken place in this industry, research. Expect these questions to be asked and deeply considered:
- Who are OnDeck’s competitors? (and not just the top 3, but the hundreds that follow them)
- What are ISOs/brokers and how do they operate?
- How do they generate deal flow?
- What is Merchant Cash Advance and how is it similar or different to OnDeck?
- What is the real regulatory environment? (Because there are actually applicable regulations despite articles that say there aren’t any)
- Why does OnDeck collect payments daily?
- Why is OnDeck’s model so much different than Lending Club’s?
Look for the last bullet point to be explored greatly. If OnDeck and Lending Club are both innovative small business lenders broadly targeting the same market, why is OnDeck charging an average of 50% APR paid daily over 6 months and Lending Club charging as low as 5.9% APR paid monthly up to 5 years?
Their products couldn’t possibly be more different. And while Lending Club’s IPO path has curiously stalled, there is nothing to indicate that it will not proceed. That means we should expect comparisons between the two upcoming tickers LC and ONDK, a lot of them.
Details about commissions, closing fees, marketing practices, and transparency will be talked about in open forums by the general public. If it’s controversial, it will be debated. If it’s unique, it will be scrutinized. To an extent, OnDeck, Lending Club, and many of their competitors will cede control of their destiny to the general investing public.
There are folks in the industry giddy over the chance to buy and sell stock in both companies. They have years of experience on the front lines. But just as they’re gearing up to trade ONDK and LC, so too is everyone else.
Get ready for major change…
Another company has joined the TV commercial party and this one’s a little different. Atlanta-based Kabbage has chosen Puddles the Clown as their spokesman. What do you think?
Below are some of their competitor’s commercials:
Now that institutional money is flowing into the alternative lending industry, some retail investors are starting to express concern that the rules are changing. Lending Club for example is no longer considered a peer-to-peer lending platform, but rather an online credit marketplace.
Investors don’t exactly make loans to individuals in that marketplace, but that’s sort of how the concept began. Today, a bank issues the loan to the borrower, Lending Club buys the loan and creates a note tied to the performance of the loan, and then sells that note to investors.
Lending Club holds all the power and that worries retail investors who believe that the company is not always forthcoming about what they’re doing. It’s not easy to find dissenting voices when the market is growing rapidly especially since the media is cheering the revolution on.
But in the back corners of the Internet there are groups of investors growing suspicious, if not downright paranoid that all is not right in Lending Club land.
On Peter Renton’s Lend Academy forum for example, healthy discussions are being replaced by collaborative investigations into Lending Club’s practices. As a retail investor myself, I can’t help but be drawn to it. Below is a list of some of the issues:
The Borrower Member ID number is never reused
If a consumer borrows money from Lending Club in 2013 and again in 2014, it would probably be useful for investors to know about the previous Lending Club loan. Instead, borrowers are issued additional Member IDs with each successive loan, masking the history of past loans.
Borrowers may be taking two loans simultaneously
Acknowledging that Member IDs can never be reused, curious retail investors used other data points disclosed by Lending Club to link borrowers together. They believe they discovered a number of borrowers who got two Lending Club loans back-to-back, sometimes within days of each other.
The concern here is that the borrowers were taking on much more debt than the investor was led to believe. For instance, an investor might feel comfortable with the borrower taking a $10,000 loan, but has no idea that another $20,000 is being issued to them days later under another Member ID number.
Whether or not this is actually happening and the scale of how often it is happening is tough to say, but a little detective work by others indicates that it has possibly occurred.
What happens if Lending Club goes bankrupt?
While a poll with so few responses (52 total) on the Lend Academy forum may not be statistically relevant, 75% of the respondents claimed to be concerned in some capacity that Lending Club has no Bankruptcy Remote Vehicle for retail investors. 21% said they were extremely concerned. Absent a BRV, a Lending Club bankruptcy endangers all retail investors from getting paid regardless of whether or not the borrowers are actually paying their loans.
Anil Gupta, the founder of PeerCube wrote the following on the Lend Academy forum in response to the BRV issue:
You are not alone. I am also in the extremely concerned category when it comes to BRV for LC. This segment has been wild-wild west and reminds me of combination of dot-com bubble in 1999 and housing bubble of 2007. Overall, I am very concerned with platform risks.
Premature IPO attempts by p2p platforms is also concerning. I am taking that as indication of founders, VCs and early employees want to cash out and exit while the market is hot. They may be seeing the growth reaching a plateau and increased competition. I believe we will see a lot of shake out when interest rate start to rise. Potentially stepped up government regulations of p2p platforms once investors lose money.
Retail investors, particularly those that have deployed a substantial amount of their capital in Lending Club notes gripe that sometimes the financial reports they get are missing data, experience glitches, or are just totally wrong. While usually resolved to everyone’s satisfaction, as a seven year old company, one might expect for Lending Club to be much more careful at this stage in the game. With an IPO in the works at this very moment, they should be way past problems such as data in the downloadable files not matching the website.
In August, Lending Club announced they would begin charging investors 18% of the delinquent amount recovered if the loan is at least 16 days late and no litigation is involved. When investors pushed back, it turned out that was always their written policy, they were just waiving it for everyone’s benefit until now.
While the move means a few more dollars out of every investors pocket, it was noticed that loans that have been restructured at the borrowers request are not marked as current for the duration of the payment plan even if they are in fact current on the payment plan itself. So when loans get restructured, Lending Club begins taking 18% of every payment as if it were a continuing collections problem.
From a firsthand perspective, I had several loans entering into payment plans almost immediately following the issuance of the loans. Basically the loan would be issued, the borrower would make their first payment, they’d plead hardship, go on a payment plan, and then Lending Club would begin deducting 18% of every payment going forward.
In these situations, our interests are not aligned. By entering a payment plan, not only is the amount the borrower is paying monthly reduced, but 18% of each of my payments now belongs to Lending Club instead of me. Basically, the appearance that Lending Club has a personal incentive to place borrowers on a modified plan at my expense and without my consent is a conflict worth monitoring.
Automated Investing under delivers?
For those with too much money or too little time to choose notes to buy themselves, Lending Club offers Automated Investing, a program that will automatically buy notes within parameters you set when they become available. The draw back is that the filters are limited and some investors are complaining that they’re ending up with notes they never would’ve bought manually.
On October 6th, Lending Club announced that investors would have to sacrifice several days worth of accrued interest to WebBank, the bank that issues the loans for Lending Club.
Citing the move as necessary to keep Lending Club robust in a changing environment, the run up to the IPO has had some investors feel like they are suddenly being nickel and dimed.
Not that this is necessarily bad, but there’s evidence that shows Lending Club is encouraging its own borrowers to refinance their loans to a lower rate. If they do it, it results in the original note being paid off. The payoff returns the cash to the investor who then may have to wait two weeks or more to put that money back into a new note.
It must be said that any time I’ve published a gripe about something Lending Club is doing, my account representative there has called me to try and resolve it. That’s surprisingly good service!
But while I feel safe enough about my investments now to keep them there, there’s nothing wrong with reminding Lending Club and all of the other disruptive financial companies out there that investors are watching their every move.
As long as they have your money, it’s healthy to keep them honest.
Back on August 14th, the Wall Street Journal reported that OnDeck was preparing to file for an initial public offering. Since then, industry insiders have been bustling with anticipation to see the S-1 filing, the document that would reveal once and for all their true financial standing.
In between then and now, Lending Club, their rival in the business loan market, filed their S-1 on August 27th. The peer-to-peer lending world went nuts and merchant cash advance veterans such as AmeriMerchant’s David Goldin were asked to comment on BloombergTV.
And then… things quieted down. OnDeck went radio silent on August 14th, despite the SEC requiring such only after the S-1 form had actually been filed. Speculation began to build as to whether or not the WSJ report in August was a false alarm or misinformation. And with no word from the industry’s beloved charismatic superstar Noah Breslow, something seemed to be amiss.
And then the Financial Times dropped the bombshell that the registration documents had already been filed… last month… confidentially.
Admittedly, I didn’t even know a company could file confidentially, a process done offline so that it is not recorded electronically. Thanks to the JOBS Act, companies with less than a billion dollars in revenue can submit draft versions of their registration documents to the SEC, allowing the SEC to review, revise, and agree on a final version that will ultimately have to be made public. The takeaway here is that an OnDeck IPO is in the process and the registration documents will eventually be released. The law states that OnDeck must make the documents public at least 21 days prior to pitching investors.
The New Yorker walked readers through confidential registrations back when Twitter was planning their IPO, noting that it was not uncommon to choose this method, “Twitter is much like its peers: most small companies that have gone public since the passage of the JOBS Act have filed their S-1s confidentially,” the New Yorker said.
So why be secretive? The New Yorker continues to explain:
From the perspective of companies, the new rule has a couple of virtues. First, it allows companies that are thinking about going public to test the waters—they can gauge investor reaction, get feedback from the S.E.C. on their filings, and so on—before deciding if they want to go ahead with an I.P.O. If a company goes through that process publicly, and then decides to abandon the offering, its reputation gets damaged, even though it often makes sense for a company not to go public. Do it privately, and no one gets hurt.
OnDeck’s biggest critics are their competitors, naysayers convinced that they are recklessly undercutting pricing to acquire market share. Indeed FT reported that OnDeck posted annual losses of $16.8m and $24.4m in 2012 and 2013, and losses of $14.4m in the first half of 2014.
With $1.3 billion funded since 2006, an independent report cited in the registration by Oliver Wyman estimates the untapped market to be between $80 billion and $120 billion.
There’s plenty of runway left, but OnDeck has yet to turn a profit. In An Insider’s Perspective, I wrote, “What scares their competitors though, is that this strategy has been intentional. Very few if any players in the industry have had the luxury, guts, or the purse to lose money for seven years as part of a coup to conquer the market.”
If the IPO goes through, we can all place actual monetary bets on the company’s future. What a trip that will be. I expect the stadium of insiders to get loud once the public documents are released. Good luck OnDeck.
It’s being called the full circle of lending. Non-bank business lenders, merchant cash advance companies, peer-to-peer lenders, consumer lenders, lead generators, and Wall Street tycoons are descending on New Orleans from October 14th to 17th to attend Lend360. I’ve partnered up with the event through the DailyFunder name.
From the governmental arena, Governor Bobby Jindal (left) and U.S. Senator David Vitter (right) are speaking at the conference.
On the business side, here are some speakers you might recognize that are definitely confirmed.
- Brendan Carroll, Victory Park Capital
- Brendan Ross, Direct Lending Investments
- Scott Termini, Direct Media Power
- Bob Coleman, Coleman Report
- Heather Francis, Merchant Cash Group
- Nick Owens, Magnolia Strategic Partners
- Sean Murray, DailyFunder (myself)
- Ken Rees, Elevate
- Mark Curry, Sol Partners
- Sasha Grutman, MiddleMarch advisors
- Al Wild, Crest Financial
- Mark Doman, eBureau
- Tim Madsen, PartnerWeekly
- Dickson Chu, Ingo
- John Hecht, Jeffries
If you’re involved in MCA or business lending, you NEED to be there.
Here’s the most recent version of the agenda:
October 14-17, 2014 New Orleans, LA
In Partnership with
It was August 23, 2011, the day the Virginia Earthquake could be felt all the way up in New York City. The four of us were enjoying outdoor seating at a restaurant on the Upper East Side. The ground shook, my drink spilled and Ace looked at each one of us and said, “Okay so I’m putting you down for five deals this month.” OnDeck Capital’s relationship managers were aggressive. If you were a small Independent Sales Organization (ISO), they didn’t expect to get all of your dealflow so they roped you in little by little. It was hard to say no. If five deals was too much, Ace would say three and if three was too much, then he’d put you down for three anyway. Zero was not in the cards. OnDeck owned a specific niche and if you didn’t send your premium credit clients to them, then any ISOs you were competing against would. That was a death knell in those days. Just a few years earlier I would’ve shrugged them off, but public sentiment was changing. Merchants were embracing the fixed daily payment methodology and the merchant cash advance industry would never be the same.
OnDeck Capital is now going public. Will you buy stock?
I’m in a unique position to discuss OnDeck. I started my career in this industry before they even existed. I’ve competed against them as an underwriter at a rival firm, worked with them as a referral partner when I was in sales, and covered them in my capacity as Chief Editor of an industry trade publication.
I left my post as Merchant Cash & Capital’s Director of Underwriting in late 2008. I was 25, about a year or two older than the average employee in the industry. Several of MCC’s rivals got demolished in the financial crisis but OnDeck wasn’t one of them. They also weren’t much of a competitor either. Struggling to define themselves as the anti-merchant cash advance, their product ran counter to the spirit of the industry’s rise. The single biggest allure of a merchant cash advance wasn’t that it was easy to obtain but that there was no fixed repayment term. The funds came with a pre-determined net cost but no specific date on when the delivery of future sales would be due.
Outsiders like the news media aren’t exactly sure what separates merchant cash advance from OnDeck except for maybe the cost of funds. Cash advance just sounds expensive, doesn’t it?
Outsiders identify the company by three characteristics.
1. They’re a non-bank business lender
2. They’re more expensive than a bank
3. They’re a tech company
These bullet points gloss over the fact that OnDeck’s loans require payments to be made every day. Can you imagine a credit card company forcing you to send a payment every day of the month? Or your landlord asking for rent on the 1st of the month, the 2nd, the 3rd, 4th, 5th, and so on every day until your lease is up?
This is not to say that this system is necessarily bad for borrowers, but that it is quite possibly the most unique and important part of what makes OnDeck different. It’s their secret sauce. It is why OnDeck gets lumped in with merchant cash advance companies in many conversations. OnDeck and the legion of copycats they have spawned are part of a broader industry that includes merchant cash advance companies. I call them daily funders. Daily funders provide financing on the condition that payments are made daily. I don’t call them daily lenders because traditional merchant cash advance products are not made by lenders, but by a unique group of investors that purchase future revenue streams.
Under company founder Mitch Jacobs, OnDeck had established themselves as the de facto loan option.
The merchant’s not biting on merchant cash advance? Send it to OnDeck. The merchant doesn’t accept credit cards? Send it to OnDeck.
They were every merchant cash advance ISO’s frenemy. They’d solicit you for your deals and then throw you under the bus to journalists as evil purveyors of expensive financing. They needed us to source dealflow and we needed them to maximize closing ratios but neither was quite satisfied with the arrangement.
When the company’s first employee took over as CEO in June 2012, the rhetoric changed. While still happy to be portrayed as the anti-merchant cash advance, OnDeck transformed their image from a niche Wall Street lender to a Silicon Valley-esque tech company. Noah Breslow was a curious choice. He has a BS from MIT and an MBA from Harvard Business School. He’s tall, charismatic, and he introduced vocabulary words such as algorithm to an industry that relied entirely on manual human underwriting.
At a recent lending conference, the younger crowd characterized Breslow as the Steve Jobs of business loans. He commands a cult-like following inside and outside the company, and in 2013 was embraced by New York City’s Mayor Bloomberg.
Breslow fast tracked OnDeck. With only $43 million raised in the first 5 years, the company went on to raise more than $300 million in the first 24 months under Breslow’s leadership.
This was their plan all along
In November 2012, OnDeck entertained a buyout offer from UK-based payday lender Wonga in which they reportedly received a $250 million valuation. The deal fell apart in the late stages but at the time I believed the negotiations were all a ploy for OnDeck to get a true market valuation. With a solid offer on the table, they knew both where they stood and where they needed to go. Last week the WSJ reported that preliminary IPO discussions valued them at $1.5 billion, six times higher than where they were two years ago.
With stock options being offered to new employees at least as far back as 2012, the plan to go public should come as no surprise. Later this year, those employees may actually get to do something very few startup workers ever get to do, convert those options into real shares.
So will OnDeck ride off into the sunset of billion dollar bliss? Not so fast say several industry insiders, some of whom are itching to short the stock on the first day they can.
Smoke and mirrors?
As OnDeck took advantage of the swing in public consensus (that fixed terms were better and lower costs increased the attactiveness ), insiders began to ask an important question. Why weren’t merchant cash advance companies collectively countering with lower prices to remain competitive? Greed was fingered by journalists especially in the wake of the financial crisis. But greed is a weak prerogative if you consider that merchant cash advance companies were filing for bankruptcy left and right in 2009.
And oddly or perhaps even ominously, an entire segment of merchant cash advance companies began to raise their prices just as OnDeck was lowering theirs. When I wrote The Fork in the Merchant Cash Advance Road in April 2011, I said:
While the margins earned on high credit accounts shrank, funding providers were dealing with another challenge simultaneously, defaults. Whether the business owner intentionally interfered with their credit card processing or the store went out of business altogether, bad debt in the MCA world was mounting…FAST!
Risk was and still is the number one reason that merchant cash advances cost so much. While it’s true that OnDeck serviced higher credit businesses, insiders speculated that the spreads were too thin. For years, OnDeck’s merchant cash advance competitors have doubted the soundness of their model.
It’s a debate that continues even to this day and yet OnDeck has secured hundreds of millions in investments from companies like Google Ventures, Goldman Sachs, Peter Thiel, and Fortress Investment Group. Their notes got an investment grade rating from DBRS. And as far as volume is concerned, they have likely eclipsed the industry’s all time reigning giant CAN Capital. If they had reached none of these milestones, OnDeck would have little credibility to convince critics of their sanity.
With a mountain of circumstantial evidence through big name backing in OnDeck’s favor, it seems to be indicative that the skeptics are wrong. But maybe they’re not. Could their model be both seriously flawed and superior at the same time?
It’s all about eyeballs
Going back to the 1990s, Internet companies have been judged, valued, and made famous by the price of eyeballs and the number of site visits. It’s a measure that’s never disappeared and according to USA Today is making a comeback. And while OnDeck Capital has always been based in New York City, true to their Silicon Valley form, their model has been to conquer market share first and take on profitability second. In their case, it’s not eyeballs or site visits, it’s loan origination volume.
Five months ago Breslow was quoted in the WSJ as saying OnDeck is “imminently profitable“. With seven years in business, it’s proof that their critics have been right all along, that their model doesn’t make money.
What scares their competitors though, is that this strategy has been intentional. Very few if any players in the industry have had the luxury, guts, or the purse to lose money for seven years as part of a coup to conquer the market. Disbelievers in this long term wildly risky strategy are salivating at the opportunity to inspect the company’s financial statements in the IPO.
In When Will the Bubble Burst?, RapidAdvance CEO Jeremy Brown, whose company became part of the Quicken Loans family last winter, fired shots at OnDeck, “To accomplish high growth rates, which may be driven by a desire or need for an IPO or to raise investment or to sell to private equity, assets are being overpaid for through higher than economically justified commissions (I’ve heard 12-15 points upfront from the more aggressive companies) and stretch the repayment term of the MCA or loan even further (On Deck24, I am talking about you).”
Insiders testify that OnDeck’s strategy has not so much been about lower costs but about growth at all costs. Among the evidence is the sudden removal of an industry-wide practice of verifying the business owner is current on their rent. Repayment terms are getting stretched out, commissions have shot up, and for a while they ran a program that allowed applicants to get funding with the submission of just a single bank statement.
Merchant cash advance companies look at their own default figures and scoff at the notion that OnDeck’s aggressive practices could produce low single digit defaults as they’ve publicly claimed.
Through it all, there remains the fact that OnDeck has never claimed their methodologies to be profitable, at least not yet. Red ink at IPO time might reward their detractors with a certain delicious satisfaction, but what will they say if and when they become profitable?
I’m reminded of The 20 Smartest Things Amazon Founder Jeff Bezos ever said. Below is a few of them.
- “There are two kinds of companies: Those that work to try to charge more and those that work to charge less. We will be the second.”
- “Your margin is my opportunity.”
- “We’ve done price elasticity studies, and the answer is always that we should raise prices. We don’t do that, because we believe — and we have to take this as an article of faith — that by keeping our prices very, very low, we earn trust with customers over time, and that that actually does maximize free cash flow over the long term.”
- “If you never want to be criticized, for goodness’ sake don’t do anything new.”
- “Invention requires a long-term willingness to be misunderstood. You do something that you genuinely believe in, that you have conviction about, but for a long period of time, well-meaning people may criticize that effort. When you receive criticism from well-meaning people, it pays to ask, ‘Are they right?’ And if they are, you need to adapt what they’re doing. If they’re not right, if you really have conviction that they’re not right, you need to have that long-term willingness to be misunderstood. It’s a key part of invention.”
I wonder if the executive team at OnDeck would share these philosophies.
They’ve always claimed themselves to be a tech company, much to the bewilderment of their competitors. Will technology come through for them?
The data available on businesses has changed. Bank statements and a credit report might’ve been all there was to go on when the company first started, but in Automated Intelligence Breslow said, “the fact is most businesses operating today, in 2014, are already technology focused to one degree or another. They have computers, they have online banking, they use credit card processors, their customers are reviewing them online, there are public records, etc. All this electronic data helps paint a deeper and more accurate picture of the health of a business.”
With such easy access to important data, it might be possible that through the use of 2,000 data points, OnDeck doesn’t need to do all the manual investigations that their competitors still place high values on. The available data might be able to predict loan repayment success just as well as a human analyst.
And if that’s true, then they can reduce the cost of overhead as they scale. As their predictive algorithms get fed more data, they might be able to eliminate humans altogether. At the May 2014 LendIt conference, Breslow admitted that 30% of their loans were still manually underwritten but said that “if customers want full automation, we are prepared to deliver it.”
By that charge, a sustainable model should not be that far out of reach. Through advanced data analysis and decreasing fixed costs, profitability may indeed be imminent.
If the story of the merchant cash advance industry has been a race to the top, then OnDeck might be declared the winner in a successful IPO. It would be an ironic achievement for the company that positioned itself as the anti-merchant cash advance. In their wake today are hundreds of daily funders offering fixed payment products.
OnDeck’s critics are in a paradoxical position because a successful IPO is good for them too. They want to believe OnDeck’s model never worked, can’t work, and have it be proven a failure. But if it goes the other way, the legitimacy of the daily funder universe will be solidified in the mainstream. What’s good for the goose is good for the gander.
As AmeriMerchant CEO David Goldin said to Inc, “the OnDeck IPO shows that Wall Street is now taking this industry seriously.”
So does that mean he’d buy stock? Somewhere out there at a restaurant in New York City, an OnDeck relationship manager is probably putting Goldin down for five shares.
Cue the earthquake, the industry will never be the same.
Curious how it will change it exactly? Read my magazine published prediction, The Retail Investor.
It’s not said often, but it has been suggested by some players in the merchant cash advance industry to introduce sales licensing requirements. Anybody can sell and broker MCAs or alternative business loans, even your mom.
That’s been a boon for growth but a bust for maintaining any kind of uniformity or standards. That’s a bad position to be in when influential political leaders are beginning to talk about oversight and regulation, even if it’s way too early to sound the alarm.
Earlier today, former SBA head Karen Mills published, Can Lending Technology Revive America’s Small Businesses? in which she states, “there is already concern that, if left unchecked, small business lending could become the next subprime lending crisis.”
One way to dispel future regulation is through self-licensing, much like the payments industry worked to pull off three years ago. For the first time ever, merchant account sales reps could take an official exam and become a CPP, a Certified Payment Professional. This originated when I was still directly selling merchant cash advances and along with it, merchant accounts.
Merchant accounts were the focus of my compensation strategy and I seriously considered taking the first ever CPP exam in 2011 even though it cost $350. I considered it solely on the basis of whether or not it would convince more people to change their merchant accounts. I finally decided to wait and see if it was helping others before jumping in myself. The question in my mind was, would merchants care? If not, then why busy myself with being accredited?
Now that three years have gone by, the Green Sheet is attempting to answer this question: Is the CPP Dead on Arrival? Members of their forum reported that accreditation had no teeth because the Electronic Transactions Association (ETA) which created it, lacks industry oversight authority. Others said it was a flawed idea from the beginning. And just as I expected to find, there is belief that merchants do not recognize it as meaningful, don’t know about it, or they don’t care.
The story concludes by saying there is hope since three years is too early to judge CPP adoption. Regardless of what will become of CPPs, today any person with access to a phone or the Internet can sell merchant accounts. If you don’t understand how interchange works or what it is, it doesn’t matter.
Ironically, in the very same Green Sheet issue there is a story that argues the secret to selling merchant accounts successfully is really just about having the right tone. Accreditation? What’s that? Interchange? Huh? Instead, ask the owner a few things about their business, “match your response as closely as possible to that of the merchant. Use similar words. Try to pause as the prospect paused.”
The advice touches upon an interesting aspect of sales, that your clients don’t necessarily care about how smart or knowledgeable you are about the subject matter. They’re buying YOU even if your product sucks. Compare that to say accounting where prepared financial statements need to be constructed in such a way to comply with IRS codes or law where a lawyer needs to be admitted to the Bar to practice. In those cases the clients can’t even receive the service unless the seller meets certain professional standards.
And that’s where accreditations become murky. As a business owner, you’re allowed to wildly overpay for printer ink and buy it from someone who doesn’t know anything about printers or ink. I’ve done it myself. I don’t care if they have a certificate in printing expertise or if they’re members of the National Ink Masters of America. Part of being a business owner means being automatically qualified to make transactional decisions.
The same can be applied to merchant accounts. Need to accept cards? Find a rep you like that can articulate what’s important to you. You can make a deal based on no intellectual substance or one completely dependent on it. If it’s not legally required to be a CPP, then the target audience needs a lot of convincing as to why it should be important to them.
Tom Waters and Ben Abel of Bank Associates Merchant Services are the writers behind the CPP DOA piece in Green Sheet and they admit that success in mainstreaming accreditation can and has taken up to 25 years in other industries. That of course brings me full circle to MCA and business lending. The enormity of self-licensing could take years or perhaps even decades to nail down. And even if they were instituted, would the merchants care? That’s the question I ask myself.
With virtually no outcry from merchants over best practices currently, I think the dream some have of becoming a CMCAP (Certified Merchant Cash Advance Professional) will have to be put on hold. Of course you could always be proactive and become a Certified Lender Business Banker, though I predict it would do nothing to help you in this business.
The reality is that we should expect to live with the status quo at least for now. My advice is to be honest, fair, and a good example for everyone else. Do that and we’ll never have to worry.
Earlier today on a large group conference call with Tom Green and Mozelle Romero of LendingClub, I learned a few more details about their business loan program. In the Q&A segment, one attendee came right out and asked if they believed their competition was merchant cash advance companies and online business lenders.
According to Green, it’s not so much other companies that they feel they are up against but more of the broad challenge of market awareness. Their struggle is about getting people to know that there are non-bank options available and to make people aware of their existence.
It’s the same challenge merchant cash advance (MCA) companies have been dealing with for more than a decade. Notably though, there are many in the MCA industry that feel the market is saturated and thus a lot of the industry’s growth has been fostered through a turf war for the same merchants. Stacking (the practice of funding merchants multiple advances or loans simultaneously) is partially spurred by a belief that there are no more untapped businesses left to fund. The acquisition costs of a brand new untouched business that is both interested and qualified is so high, that it is not a pursuit some funders and brokers can afford to take on.
At present, daily funders, which are a combination of both MCA companies and lenders that require daily payments, are funding somewhere between $3-$5 billion a year. On the call Green said he believed the potential market was far larger than that, though he discredited the $200 billion figure that some independent research had predicted. That was only because LendingClub believes the potential market is substantially higher, more like $300 billion.
$300 billion?! That’s about 100x larger than the current daily funder market combined and starkly contradicts any belief that there’s no merchants out there who haven’t already gotten funded.
LendingClub’s minimum gross sales requirement is $6,250 a month and they have an upper monthly gross threshold on applicants at $830,000 a month, though they’ve had businesses apply who do even more than that. Their sweet spot as Green put it, is the segment doing $16,000 to $416,000 gross per month.
I can’t help but notice that’s the same sweet spot that daily funders have. And we mustn’t forget, LendingClub’s target business owner has at least 660 FICO. If it’s a $300 billion market for good credit applicants, then it’s got to be even bigger for the ultra FICO-lenient companies in MCA.
What’s a business?
LendingClub only needs someone with at least 20% ownership to both apply for and guarantee the loan, an unheard of stipulation in the rest of alternative business lending. One cardinal rule in MCA has been that there needs to be at least 51% or 80% ownership signing the contract. That’s had a lot to do with the fact that most MCA agreements are not personally guaranteed and the signatory is required to have absolute authority to sell the business’s future proceeds.
Summer of Fraud
In 2013 the MCA industry experienced what many insiders dubbed the summer of fraud. Spurred by advances in technology, small businesses were applying for financing en masse while armed with pristinely produced fraudulent bank statements. Fake documents overwhelmed the industry so hard that today it is commonplace for underwriters to verify their legitimacy with the banks. This is done manually or with the help of tools such as Decision Logic or Yodlee.
Knowing this firsthand, I asked LendingClub if they also take the care to verify bank statements. In the majority of cases they do not. They rely greatly on an algorithm that detects fraudulent answers on the application but the statements themselves are not scrutinized except in very high risk situations. Considering they’re wildly less expensive than MCAs, I find it odd that they are exposed to this type of risk. Fraudulent documents are the norm and in these underwriting conditions, I would expect them to charge as much or more than MCA companies, not less.
At the same time it’s important to mention that at present, business loans on their platform are only funded by institutional investors. Retail investors can only invest in consumer loans. LendingClub has been very transparent about excluding retail investors here for the very purpose of shielding them from unevaluated and unforeseen risk. My guess is that as time goes on, they will do more to validate the bank statements which is the bread and butter of assessing the risk and health of a business.
In a FICO flexible environment, it’s possible the potential for daily funders is at least $300 billion. If true, that would mean that for the 16 years that MCA players have been around, they barely reached even 1% of their target audience. I’ve been saying it since I’ve started this blog 4 years ago, every business owner I’ve spoken to has never heard of a merchant cash advance… which means saturation is a myth.
Tom Green was right, the real competition is public awareness. 99% of the potential market is untapped. If you’re fighting with 5 other companies over the same merchant, you gotta:
You gotta keep on looking now
Keep on looking now
You’re looking for love
In all the wrong places
While perusing LendingClub’s loan platform today, I came across a highly suspicious borrower. It’s member loan #23954784 who is currently a lab assistant in Albuquerque, NM. The reason for the loan request? “Other”.
This is what I suspect behind the scenes:
There’s a lot of players at the alternative lending table but there are two that have won a string of lucky hands to put them on top. Neither were the first to draw cards, nor do either of them offer something that everybody else does not. These two lenders have something in common of course, special favor with the Internet gods. Is the game rigged?
OnDeck Capital is the most celebrated alternative business lender of our time. Their daily repayment loans and fast approval times are a hit with customers. In fact, as told in their recent securitization prospectus, OnDeck has been eroding its reliance on brokers and third parties to accommodate growth through their direct channel. Direct has been good for OnDeck, very good.
LendingClub on the other hand is the big dog in consumer lending, having funded more than $5 billion since inception. Every month they shatter the previous record for volume of loans funded and they’re expected to go public within the next year. LendingClub continues to pound their distant rival Prosper in monthly loan production. Are they just better at marketing?
Curiously I can’t help but notice they have something in common, they’re both owned by Google. Google Ventures led OnDeck Capital’s series D round and Google Ventures’ Karim Faris sits on OnDeck’s board of directors. Similarly, Google owns a minority stake in LendingClub.
While neither is outright owned or controlled, It’d be surprising if Google didn’t do something to foster the success of their investments. What could a billion dollar Internet giant possibly do to give them a little push?
Stop backlinking and SEO. The game is rigged
If you reproduce a search for the same keywords, you should know that results vary depending on what kind of device you’re using (mobile vs. desktop), what zip code you’re in, what time of the day it is, whether or not you’re logged into Gmail/Google+/Youtube, and whether you’ve searched for related topics before. I performed my searches with a fresh desktop browser on a Sunday evening in NYC with all cookies, cache, and Google account sessions wiped clean.
You might not get exactly what I get and I realize that obfuscates the conspiracy I’m trying to establish here. If you do witness peculiar keyword domination though, keep an open mind that there might be more going on than good SEO and strong natural backlinking brought on by mainstream media publicity. Plenty of big businesses that dominate offline fail to rank well in the top ten results online.
Search engines say that if you’re popular, you’ll rank well. But there are plenty of cases where ranking well has made businesses popular.
Maybe, just maybe the game is rigged…
Somebody once called business loans the Cadillac of Credit products and that person is Brendan Ross, the President of Direct Lending Investments (DLI). In a newsletter he put out in September 2013, he began by saying:
Business loans are the Cadillac of credit products, with the highest yields and lowest default rates. Portfolio returns of 13-17% are the norm for successful underwriters – generally private, non-bank institutions.
He goes on to share his firm’s own investment success in these asset classes, claiming to be earning approximately 1% a month. DLI currently manages $48 million, all of which is deployed in alternative lending.
In today’s newsletter Ross admitted the goal is to “maintain unlevered, double-digit, investment returns.” With savings accounts today paying only fractions of a percent, double digits sounds too good to be true. But do you need $48 million to partake in the action?
The truth is you don’t. If you’re an ISO in the merchant cash advance industry you likely have the option to syndicate on your deals and if you’re friends with the right people you can syndicate on deals you don’t even originate.
But even then for folks who don’t have tens of thousands or hundreds of thousands at their disposal to recycle into deals, you can still strive for double digit returns through peer-to-peer lenders like LendingClub or Prosper. Through investments as small as $25 a pop you can participate in 3-5 year consumer loans that pay out monthly.
I myself opened a LendingClub account early this year to understand the experience and grew comfortable enough to begin amassing a real portfolio there. You can craft a portfolio based on your yield goals but the higher paying loans have much higher levels of default.
Investing in G-rated loans with an average annual interest rate of 25% doesn’t mean you’ll get that number or that you can even comfortably expect double digit returns. But you can try… And most do.
In fact the higher yielding loans are bought up fast and furiously every time LendingClub uploads a fresh batch to the platform. They’re added at four precise times a day: 9am, 1pm, 5pm, and 9pm EST. Savvy investors call each interval feeding time and the early bird truly gets the worm. By 9:03 a.m., hundreds of newly added loans are already fully funded and off limits to late investors looking to get the good stuff.
That doesn’t mean there is nothing to invest in if you log on an hour later, but the loans with the most desirable characteristics are nowhere to be found.
The average interest rate of my own portfolio is currently 15.72% a year before taking into account defaults. Using LendingClub’s sophisticated tools, I can compare how my portfolio is likely to play out against very similar ones on their platform (Same yield range with a minimum of 500 loans). Over the course of 30 months, it suggests that defaults will probably drop my actual yield below 10%.
I have a say in how it will actually play out. For instance if loans in Nevada and Florida are likely to default substantially more than loans in other states, then perhaps I can expect different results between a D-rated loan in Florida and one in Vermont. Using both experience as a merchant cash advance underwriter and the controversial article, The Joys of Redlining as a basis, I never make loans to consumers in Florida, Nevada, or California.
Logging into the platform between feeding times, I often notice an abundance of seemingly attractive but very available loans in those specific states.
Whether that and other aspects of my strategy allow me to prevail with consistent double digit returns is to be determined but I can’t help but contrast even a substantially worse outcome against my savings account which legitimately only pays .01% a year. Not 1% and not .1%. It actually pays .01%.
My S&P mutual funds meanwhile are up more than 6.5% this year already but stocks are far more volatile. I’d also like to add that rather than compare the performances of both and decide to choose 1 over the other, consumer lending is a great way to diversify your overall investment capital. An index fund diversifies your stock holdings but there were very few options for everyday people to invest in outside of the stock market until alternative lending came along.
I still keep some cash in the savings account, but much like Brendan Ross announced in his newsletter today, I’m going full speed ahead with buying loans. In 2014, you don’t have to have $48 million in assets to make the returns that institutional investors can. There’s yield to chase out there and anyone can grab it.
About 1% of my LendingClub consumer loan portfolio bounces their very first payment. It’s discouraging stuff, especially considering these loans range between 3 and 5 years. Granted, most manage to get caught back up at least for a little while.
LendingClub, like the rest of the alternative lending industry relies on ACH debits to retrieve those monthly payments. I’ve published my feelings before on single monthly debit payment systems (they’re like roulette). Out of 30 days of the month, you’re betting on the balance being available on just 1 particular day. When I noticed that 1% of my borrowers were failing right out of the gate, it validated two practices that originated in the merchant cash advance industry, daily payments and the analysis of historical cash flow.
For all the underwriting data points that LendingClub offers its investors, I don’t get to see average daily bank balance, overdraft activity, NSF data, or anything at all related to the borrower’s bank account. Ironically, many merchant cash advance companies consider that data to be the single most important piece of assessing a deal.
The problem my 1%-ers have is not a credit problem or a stable income problem, it’s a cash flow problem. You can have 750 credit and be broke. You can have a good job with a hefty salary and be broke. You and I knew this already, which is why it’s odd that LendingClub and other p2p lenders like them still rely mainly on employment data and FICO score.
What I want to know is if the borrower is broke…
That’s something that LendingClub can’t tell me and doesn’t know. Hence a good looking borrower like the one mentioned below, missed the first payment. That led to a negotiation for a reduced monthly payment. They then failed to pay even the reduced amount.
This was a very low risk B1 note. The borrower is a nurse that has worked at their current job for 5 years. They had over 700 credit and very little revolving debt, only $5,500 (compared to some on the platform that have more than 50k!). It was a 3 year loan and it has blown up in my face.
The borrower is broke and nobody knew it.
The Missing Puzzle Pieces
This borrower may very well have done better with a change in how the deal was both underwritten and structured. With daily payments:
- The borrower will know exactly how much cash they can really spend on any given day. They don’t have to worry about trying to set aside for that one big day.
By examining their last 3 months bank transactions:
- Their payment plan will be based on more relevant data. There are 3rd party tools like yodlee that consumers could connect their bank accounts to, so at the very least LendingClub could see what’s really going on. Why business lenders consider this essential while consumer lenders completely ignore this, I don’t understand. Business lender Kabbage for example requires applicants to connect their bank accounts in the application process before they even type in their business address. It is the single most important part of their underwriting.
Picking loans on LendingClub is like trying to complete a puzzle without half the pieces. If you guessed the puzzle on the right was an ocean scene with dolphins playing because of the pretty blue border pieces, you were wrong. It’s actually a picture of a guy on a boat holding a bank statement that shows a negative $3,000 balance and 10 NSFs.