By Steve Cinelli , CrowdFundBeat Sr. Editor,
As the crowdfunding space moves into its pubescence years, not quite a babe, yet not quite mature, there seems to be increasing activity in its apparent novelty. I muster the word “apparent” as I envisage an industry calling itself new and novel and disruptive, yet its fundamental premise is one of finance engagement. True, the accelerated aggregation of capital to support aspiring artistic endeavors through online means has been inspirational. Allowing artists a shot, while availing patrons here and far to participate.. more the better.
In the world of corporate and real estate finance, the move to online syndication is certainly efficient and has enabled early stage tech plays to sponsored real estate projects to enable an opportunity. Whether the proposition pans out, will only be a matter of time… and execution. Nonetheless, they may have raised funding in a 21st century framework. So good for the capital raiser.
There certainly was an exuberance with the initial public offerings of Lending Club and OnDeck Capital, purportedly proving the broader markets are receptive to the new digitized financing models. Yet, the acclaimed opening-curtain valuation upticks have now reverted to the offering prices, and may still go lower, as I submit, these are financial services companies and should be valued as such, particularly since the products and services they get paid to provide exist, but in different wrapping, whether from Wells Fargo or Capital One. And yes Wells and Capital One do deploy technology to intermediate, but they are not priced as technology gems. For certain, the cost of intermediation within a tech platform may be streamlined, and underwriting done by algorithm, but is this really anything new? I recall my early years at BankAmerica (in the 1980s), learning the consumer loan business. Rather than the conventional review of historical credit performance, personal balance sheet strength, and employment and cash flow analysis, we migrated to a ten question scoring system. The prospective borrower got X points for time on job, Y points for owning a home, Z points for payment history and credit score, and when you tallied the points, if 28 points were achieved, s/he got the loan. This process moved the underwriting and decision process from ten hours to ten minutes. Were there gaps? Absolutely. But this was and still is a portfolio game. Have a large enough portfolio, and the successes should hopefully offset the losses, and an attractive net return on the portfolio will be achieved. Does technology add to the ultimate credit review process or just allow it to be done a bit faster? As a banker, one would still look for certain attributes and characteristics of the customer whom you are looking to extend credit. The five “c’s” of credit are still fundamental.
I don’t mean to disparage the financial marketplace platforms. I have often pontificated that finance is an information business. The user of capital provides information to the supplier of capital and there is an iterative process to bring the knowledge between the two so that the supplier is comfortable in his extension of credit. The facilitation of such information flows, and from the outset is seemingly the real benefit. Customer acquisition and origination costs is the value added proposition here. Rather than branch offices, in situ bankers, and a generally robust overhead, the tailored UI/UX of web intermediation reduces much cost to where banks are actually engaging the platforms in their quest for new business. We will hold the paper, just not create it, as that costs too much.
Besides the consumer lending market, small business lending is a province of marketplace platforms too. OnDeck has done an admirable job in extending business credit to aspiring enterprises, funding over $400 million in the last quarter alone. With even further analysis required to assess credit worthiness of a business as opposed to an individual, the rapidity of decision making from OnDeck is admirable. From application to funding in days not weeks or months, it sets a new standard in efficiency. But alas are the decisions and the underlying analysis risk mitigating or again is this portfolio theory in a new wrapper? The secret sauce in the OnDeck sandwich is the pricing of the credit. SME loans are high risk, thereby the prospect of loss is considerable. So in order to produce a portfolio return on high risk assets, one prices them accordingly, and with a average APR of over 50% on its loans, OnDeck can and does absorb some losses. Sure there is an underwriting process, and ongoing monitoring, and the credit risk exposure, but 50% yields cover a lot of ills. Similar to why normal bank card rates are in the mid-teens if not higher, as bankcard providers know the risk of loss, so address the losses with rich pricing on the rest and an attractive portfolio can be had. OnDeck does this well, and even with high risk borrowers, its delinquencies are relatively low, as they define delinquencies.
But as a borrower, yes availability of capital is key to keeping the business afloat and hopefully launching into a growth and profitability mode. But small and large businesses alike, how many can sustain a source of capital costing 50% a year. If that comes from capital appreciation, such as claimed by the venture capital community, that is one thing. But a current pay cost of capital of such level is not fundamentally sustainable. Is this transition financing? Could and should be, but OnDeck seems to have stable borrowers willing to pay the freight intermittently. Is this a good business model? Is it sustainable and, further, is this a longer term source of finance for the engine of our economy? Maybe.
In current days, there has been discussions on Capitol Hill about the role of marketplace lenders, a subset of the accelerating shadow banking construct. Performing the roles played by regulated banking entities, these new facilitators are truly shaking it up. While in one respect, the platforms are seeking accommodations from the folks on the Hill, separately the regulators are saying maybe we should oversee this activity too, even though depositor funds are not at risk, and the government is not on the hook.
Times are indeed changing, and as the SEC needs to adapt to online intermediation of securities transactions, the OCC, FDIC and banking regulators need equally adjust or adapt to new business models which are changing the lending game, whether they like it or not. We have an incredible investment in our banking industry. Might it be time to evolve it for the benefit of all?