The Green Sheet Online Edition
May 11, 2015 • Issue 15:05:01
The evolving online 'lendscape'
Nonbank lending is an integral part of the payments ecosystem. When bank loans became scarce during the Great Recession, nonbank lenders rushed in, filling the gap with "alternative" forms of finance. The industry's exponential growth combined with changing regulatory and commercial environments continue to present investment and business opportunities for payment professionals.
Many merchant level salespeople (MLSs) associate alternative lending with merchant cash advance (MCA), a popular practice of providing a merchant with a fixed amount of cash in exchange for a percentage of future credit card receivables. In reality, MCA is just a small part of this fast-growing space, which includes factoring, SBA loans, angel investments, microfinance, asset-based and peer-to-peer transactions, crowdfunding, marketplace lending, and more.
David Sederholt, Chief Operating Officer of New York-based Strategic Funding Source Inc. estimates that online lending for small businesses is growing at 175 percent per year. This article will focus on the fast-growing online segment, with insights from industry leaders on how business owners can leverage the Internet to make informed financial decisions.
From paper to online lending platforms
Mobile and online technologies are driving innovation in payments and lending. Consumers and business owners increasingly use smartphones and tablets to make and process payments and apply for lines of credit. A growing number of companies offer online loans with easy applications and a fast approval process.
Orchard Platform Advisors LLC, established in 2013 and based in New York City, is a marketplace lender that connects institutional investors, investment managers and online loan originators. The company provides reporting, analytics, investment strategy and real-time trade execution. Its focus is on building intelligent, scalable architecture to facilitate the global growth of marketplace lending. While Orchard doesn't work directly with ISOs and MLSs, it offers investment opportunities and a wealth of information on the evolving "lendscape" on its website and blog.
Angela Ceresnie, Orchard co-founder and Chief Financial Officer, previously managed risk and underwriting teams at American Express Co. and Citibank. After years of working with data analytics, operations and regulations associated with consumer lending, she participated as an individual investor in several consumer lending platforms.
"Just for fun, I built my own credit model, using my analytical experience to determine the risk of the borrowers and achieve higher than average returns," she said. After some initial success with her homegrown system, she began to think about developing broader applications for the algorithm to serve other investors, which became the basis for
From tribes to artificial intelligence
Alternative lending's journey follows the arc of civilization, from primitive forms of barter to automated, data-driven platforms. Orchard Platform co-founder and Chief Product Officer David Snitkof described data analytics and advanced communications technologies as the primary drivers of global growth and product innovation in marketplace lending.
He said technology has simplified and accelerated the process of launching new products and providing lines of credit. This has led to diversified and tailored finance products and services.
"In an earlier era, scalable industry meant standardizing everything, which resulted in cookie-cutter solutions and a limited set of financial products," Snitkof said, adding that large banks, layered with decades of acquisition, have difficulty competing with "lean organizations that have access to transparent data, advanced algorithms, and diverse pools of institutional investors."
To further illustrate technology's role in creating economies of scale, Snitkof described the four phases of economic civilization, paraphrased as follows:
Hunter-gatherer/tribal: In the beginning, we started out as hunter-gatherers. It was every man for himself, fighting to the death over finite resources with zero or little trade.
- Villages/towns: Then came the rise of villages and towns. Every town needed a butcher, a cobbler and a builder. If you needed a loan, you would borrow money from someone you knew very well – all lending was peer to peer. So, we had the beginnings of economic differentiation, but at a very local scale.
- Industrial/global: Next came the industrial revolution and the rise of global mega-corporations driving rapid economic growth. Highly standardized processes allowed for vast efficiency and scale, but at the cost of becoming increasingly impersonal. If you needed a loan, you would apply to one of a handful of very large banks offering highly commoditized products.
- Scalable humanity: In the past five to 10 years, we have been entering a new phase, one in which technology allows us to be highly personal, but at a global scale. We live in a time when large consumer brands have teams that actively engage with customers on Twitter; algorithms predict what songs you will like, what wine you will drink, and who you might want to marry; and you can go online to get a loan not from four or five large institutions, but from a diverse marketplace of investors.
From micromanagement to outsourcing
Merchant Cash and Capital LLC, based in New York City and established in 2005, has leveraged Internet lending trends with Bizfi, an online lending portal launched in April 2015 where business borrowers can research and obtain funding from a variety of capital sources.
Stephen Sheinbaum, MCC founder, said clients were requesting a technology solution that simplifies and expedites the funding process for small to midsize business owners. He called Bizfi and similar automated online platforms "the future of alternative lending."
Mike Grossman, Vice President of Business Development at MCC said that large ISOs are using a simple application programming interface to integrate Bizfi into their websites. The platform offers a full line of business finance products. Prospective clients can explore options, "get qualified in thirty seconds" and get funded, he added.
"This is an exciting product that's fully automated and can be used in multiple ways, including as a sales tool," Grossman said, noting that some ISOs are directing merchants to the website and others are sending them a link via email. He agreed with other industry executives that lending has evolved beyond cash advance and traditional banking silos.
While commenting on the higher risks involved with alternative lending, Grossman pointed out that unscrupulous salespeople are one of the biggest threats to the industry. He suggested that negative experiences with lenders or concerns about privacy and security may prompt merchants to explore online lending.
From competitors to partners
Andrew Reiser, Chief Executive Officer at Strategic Funding Source Inc., previously worked as an investment banker. In that role, he frequently syndicated with other firms in preparation for initial public offerings (IPOs). He noticed that executives who had an ownership stake in an IPO generally outperformed others and were highly motivated.
Reiser introduced the concept of ownership at Strategic Funding Source, thus enabling ISOs, acquirers, MLSs and lead generators to invest in their customers' deals and earn considerably more than their customary split or one-time referral fee.
"I don't have competitors; I have partners," Reiser said. He noted that any broker who brings in a deal has the right to participate in the deal. He went on to say that the syndication model works well in other industries where businesses syndicate with partners to spread risk and share rewards.
Reiser called the payments industry a "not-so-silent partner" of nonbank finance. Strategic Funding Source provides ISO loans, when needed, to funding partners who want to invest in their own deals. Partners and investors can track the status of their contracts in real-time using the company's syndicate web portal. "When agents co-invest with us, their willingness to put their own money on a particular note is the ultimate measurement of how they feel about the deal," Reiser said.
Steven Kirincic, Strategic Funding's Vice President, Business Development, commented on the company's holistic approach to risk management, which he described as looking beyond the credit score to the business as a whole and how it operates.
He said, "If the credit is bad, why is it bad? Why not give them the opportunity to make it better?" He noted that sometimes being a good lending partner means using a bit of tough love. Just because a customer qualifies for a certain amount of money doesn't mean the individual should get it. "Give them what they need, not what they want," he said. He pointed out that there's no shortage of money, and if customers don't know what they're doing, "they'll be broke before they know it."
From branch to online banking
Banks are facilitators and institutional investors, not competitors, Reiser and other alternative lenders believe. Banks don't fund most small to midsize businesses, and alternative lenders don't originate loans that are based on collateral, at least not today. Snitkof noticed an increased number of traditional bankers at LendIt USA 2015, the largest annual conference of the online lending community. Orchard exhibited at the show; Ceresnie and Snitkof also participated in panel discussions.
"Marketplace lending is generating a lot of hype, more people are taking part in it and banks sent their people to LendIt to find out what's going on," Snitkof said. He further noted that some banks are already active in the space while others are beginning to get involved.
From credit scores to social technology
Financial analysts have observed that banks are exploring new business models that will help them win back market share and compete against other funders. One such model is Happy Mango Inc., a New York startup founded in 2013 that uses social media and online income, as well as saving and spending behaviors, to create an alternative consumer credit score.
Founder and CEO Kate Hao, a Certified Public Accountant who holds an MBA degree from Harvard University, wanted to make credit reporting more transparent and accessible, especially for the estimated 70 million unbanked and underbanked U.S. consumers.
Hao created a consumer credit assessment algorithm that became the basis for what is dubbed "The Happy Mango Score." Data derived from the timeliness of cable, mobile phone, and utility bill payments, combined with how frequently consumers change addresses, are also factors in the alternative credit score.
The new online service has the potential to help millions of Americans who are unable to qualify for credit, mortgages and other kinds of loans, including business loans. Hao and her team would like to see social technology play a larger role in shaping finance products and credit scoring.
They are working with three community banks that apply Happy Mango data to their risk management practice to make loans available to traditionally bypassed borrowers.
The service is free to people who opt in to enable Happy Mango to collect their data. Participating banks will initially provide free credit scores. Some traditional credit bureaus have expressed an interest in accessing Happy Mango data to derive a more holistic view of the consumer and possibly reassess their degree of credit risk.
From turf wars to freedom of choice
Payment analysts and retail business leaders have seen a steady increase in showrooming, the consumer practice of researching products in stores and buying online. IBM found that a majority of big-box retailers have embraced showrooming by offering to meet or beat competitive offers. This spirit of cooperation in the larger marketplace has sparked a "reverse showrooming" trend, with increasing numbers of consumers researching online and buying in-store.
In a similar context, marketplace lenders take an egalitarian approach to lending. They don't try to sell prospective borrowers or investors; they educate them, by providing a broad, transparent view of all possible options.
Unlike previous forms of banking and lending, the online lending marketplace offers one-stop comparative shopping, fast approvals and data transparency. Consumers and business owners use the marketplace to research, invest and borrow. They can work directly with lenders to customize products and services according to their individual needs. Ceresnie described the paradigm shift in the way that loans are originated and distributed as "the democratization of credit."
"We're in a unique moment in time where different market and technological forces are coming together to remove historical inefficiencies that have existed for consumers and business owners for more than 1,000 years," she said.
ONLINE LENDING ECOSYSTEM:
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