Can an ISO “Excel” in 2016?
August 26, 2016
Don’t let anyone tell you that it’s too hard for a commercial finance broker to make a buck in exchange for honest work these days. One ISO in lower Manhattan is seeing more opportunity than ever before. Chad Otar, a managing partner of Excel Capital Management, sat down with AltFinanceDaily to make his case for a bright future.
“As long as there’s small businesses, there’s always going to be opportunity,” Otar said. “Business owners are always going to need money.” Ironically, his own company that he cofounded in 2013 with hometown friend Nathan Abadi, was formed without any outside debt. Bootstrapped even to this day and even as they’re expanding, they’ve seen firsthand what other businesses around the country have to go through to get ahead.
“We’ve always believed in the products that we’ve sold,” said Otar, who brokers merchant cash advances, business loans, SBA loans, factoring products and more. They want every deal to help their clients whether it’s big or small, explaining further that even he himself has to feel comfortable with what the merchant wants. When asked about size, Otar said the largest SBA loan they got done was for $4.9 million.
But when questioned if more merchants were moving towards factoring and other traditional products, he explained that some merchants just don’t want to deal with the hassle of something that might be overly invasive or a process that might take a long time. They just want to get funded quickly, he said. And that’s where they come in.
Otar and Abadi’s optimism is not just anecdotal. The two partners, who previously renewed one year leases for their small office on Maiden Lane, saw enough runway to recently sign a five year lease for a 2,700 sq ft. office on Greenwich Street, staying within the bounds of the city’s financial district. Between full time employees and contractors, they currently house about fifteen people in their new office.
Though the partners live in Brooklyn, they, like many other companies in the industry, believe a Manhattan headquarters makes the most sense. “Everything is here,” Otar said. It’s easier to recruit new hires, he explained. And they indeed have immediate hiring plans now that they’ve got the space for it, both in sales and operationally.
This new up-and-coming generation of business owners is very comfortable with the Internet and technology, Otar added, speeding up the process and allowing they and the funding partners they work with to do more deals together. One example offered was a small business owner who gave a guided tour of his establishment to an underwriter using FaceTime on his phone. Normally, the process would’ve been delayed by a few days because of the time it takes to hire a third party to perform a site inspection.
Some funding partners offer DocuSign so that merchants don’t even have to spend time printing and signing documents anymore, he said, qualifying that however by adding that while some merchants love it, others hate it and feel more comfortable doing things the old fashioned way. He acknowledged that was likely due to the generational gap that still exists.
When asked if the setbacks and gloom that had begun to envelop the consumer lending side of fintech, was also affecting the commercial side, Otar said he didn’t see it. Funders are still very aggressive with approvals and terms, he said. While paperwork required for approval is declining overall, he described one obstacle that he hadn’t really dealt with in previous years, UCC filings that are accidentally left active even when the agreements are satisfied in full.
Underwriters doing due diligence might interpret active UCCs to mean that outstanding obligations still exist. Absent a formal termination of the UCC, an underwriter may request that merchants provide documents from the secured party to support that a termination should’ve been filed. This in itself is not a burdensome task but Otar said he has seen merchants who have used alternative financing products continuously over the last eight years or so, who are then challenged to produce satisfaction letters from dozens of companies, some of whom the merchant may only vaguely remember.
But he is not discouraged when new challenges come up. “We’ve been constantly learning,” he said. And when asked what their secret to success has been up until this point, “It’s hard work and dedication,” he responded.
LendIt’s Peter Renton is Still Earning 8.72%
August 25, 2016
LendIt, speaking to LendIt USA 2016 conference in San Francisco, California, USA on April 11, 2016. (photo by Gabe Palacio)
LendIt Conference founder Peter Renton made more from his marketplace lending investments in the last twelve months than some people earn in a year just from their nine-to-five job. $54,936 to be exact, according to his latest blog post detailing his performance. That’s a result of investments on the Lending Club platform, Prosper, P2Binvestor (which requires you to be an accredited investor), the LendAcademy P2P Fund (which includes Funding Circle, Upstart, Lending Club and Prosper), and the Direct Lending Income Fund managed by Brendan Ross (which invests with lenders such as Quarterspot and IOU Financial).
Unsurprisingly, his business loan performance through the Direct Lending Income Fund has earned the highest yield, a TTM return of 12.77%.
While reporters and critics seem to be planning the funeral for several lending platforms, Renton remains steadfast in his optimism. “Eventually, I plan to have a diversified seven-figure portfolio made up of consumer, small business and real estate loans,” he wrote on his Lend Academy website.
Though Renton is reaping the benefits of being a platform investor, it’s the platforms themselves that may be in trouble, according to a recent op-ed by Todd Baker, a senior fellow at the Mossavar-Rahmani Center for Business and Government at Harvard University’s John F. Kennedy School of Government. On American Banker, Baker wrote, “Almost all [Marketplace Lending] revenue is generated from ‘gain on sale’ fees earned from new loan sales. This dependence on origination volume and gain-on-sale margins makes MPL results exquisitely sensitive to macro and micro trends in investor demand and risk appetite.”
And if a platform isn’t sustainable, the theory is that future investment opportunities may not be as available as they have been historically.
“MPLs need to shift to a more sustainable mode — either as banks or as nonbank balance-sheet lenders — before the end of the current credit cycle brings on a real shakeout and the MPL experiment becomes a financial failure,” Baker wrote.
Renton himself acknowledged a downward trend in his yield, conceding that it may never return to previous levels. “While I would love to be earning more than 10% again I don’t expect to get back there any time soon,” Renton wrote.
He also recently rebutted a Bloomberg article that argued Lending Club was being shady with repeat borrowers.
Can Technology Be More Than Automation?
August 19, 2016
In yet another Lending Club exposé, Bloomberg revealed the identity of the man who allegedly first discovered suspicious Lending Club loans that would later be confirmed connected to disgraced CEO Renaud Laplanche in a post-resignation audit. Brian Sims, a retail investor in Lending Club loans used a specially designed algorithm to spot patterns such as multiple loans made to a single borrower at different interest rates. No easy task considering Lending Club takes great strides to protect borrower identity.
And this truly is the argument both for and against technology. Irrespective of what side of the debate you’re on, it’s hard to argue its indispensability in day to day business. It’s the one thing CEOs think long and hard about and rightly so — automation makes or breaks the size and scale of a business, vastly improves productivity and narrows if not eliminates the margin for human error (up for debate).
So, at AltFinanceDaily we were curious to discover how small business financing companies use technology in their companies, what processes are automated and which side of the man vs machine debate they fall on.
Boston-based Forward Financing that makes merchant cash advances, working capital finance and small business loans up to $300,000 started investing in proprietary software right from the beginning, four years ago. It uses Salesforce for customer relations and basic reporting.
Its underwriting tool, channels leads and performs varying levels of automation to underwrite files quicker. The app pulls data from a number of different sources like credit bureaus, public record databases, social media and Google APIs before it goes to an underwriter. “Our goal over the next 3-4 months is to automate a percentage of all the deals that comes through the system,” said CEO Justin Bakes.
The company also has a banking application, a portal where customers log in with their bank details, with read-only access to their bank accounts to identify and analyze transactions which are then used to underwrite. Separately, it also has a portfolio management system that manages all the funding, transactions and all the collections.
While Bakes started investing in technology early on, it wasn’t until a year and a half ago that he tried automated underwriting. “Some hear the word automation and think they are going to lose their jobs,” said Patrick Hereford, Director of Technology at Forward Financing. “I can understand that automation can reduce jobs, but here, they found that they could underwrite more deals faster and with more accuracy.”
Hereford was hired in October last year from the TV show America’s Test Kitchen where he was working as a software engineer. Hereford makes a case for automated underwriting with proof — “We went from spending 20 minutes per file to six minutes per file,” he said. “We were expecting 50 percent efficiency in underwriting but we got more and increased productivity.”
The company hired full-time engineering staff last year to move all their tech support and development in house. “A majority of our new hires and investments have been in technology. The tech team has grown the most over the last year,” said Bakes. He noted that the company has spent over a million dollars in building proprietary software alone and 20 percent of its selling, general and administrative (SG&A) is allocated to technology development.
“There is no doubt that we are a financing company but we are a tech-minded financing company. To be a true industry leader, you have to automate a certain amount. Our philosophy is we plan to keep improving our technology and the ability to approve faster than anyone else,” Bakes said.
Forward Financing is among other companies moving in that direction. California-based lender National Funding who has deployed $1.5 billion to small businesses over the last 17 years is also preparing for a technology overhaul, trying to get access to data pools to automate underwriting. “We need to be tech driven, as deals get smaller, we need to automate them to make it affordable,” National Funding CEO Dave Gilbert told AltFinanceDaily earlier.
And five-year-old Pearl Capital is on a similar journey. The company grew its tech team from two to twelve people over a year and a half ago including data analysts and statisticians and is making significant investments in scoring technology, portfolio management and risk assessment. “We had a human model running successfully for years and they produce good results but move to machine is additive and supplemental,” said CEO Sol Lax. “Data and tech add a lot more texture and nuance to the market, it’s like the weather radar, you have visibility and can price accordingly.”
But technology doesn’t have to necessarily mean automating underwriting. In fact, there is a strong bastion of people actively resisting it. Isaac Stern, CEO of New York-based Yellowstone Capital is one of them. “I am going to get my underwriters as much information as possible – background check, credit check to make good decisions but that does not mean I am going to let a computer decide whether to fund or not.”
That doesn’t mean Stern doesn’t care about efficiency. In fact, Yellowstone has invested over a million dollars over the last year in ramping up technology. It hired AIG’s chief data scientist and has improved data mining with access to over 140 data points including SIC codes, credit scores and loan history. The company uses an application called Clear®, a Thomson Reuters product, through which it can conduct background checks as well as review business history and public records.
No matter what camp you belong to, there are strong arguments to be made for each side and it really comes down to the philosophy of the matter. But in a crowded lending market, does it make sense to grab every opportunity to scale better?
“Different people have different thoughts on whether this is frankenstein going off the rails or not and whether that will blow up or not,” said Lax. “But the barrier to entry is low as a funder, and the spend on tech can be small yet profitable.”
There are many alternative finance companies who believe that staying in the game requires some change in incumbent models to boost efficiency and speed that’s driven by auto approvals and declines. But there are also some like Stern who treat technology as an aid rather than an aim.
Perhaps time will tell which system is better.
Calling Timeout On Financial Regulations, A Pump For Trump?
August 10, 2016
Only 24% of small business owners say that Hillary Clinton is the presidential candidate that has their best interest at heart, according to a survey conducted by Capify, a business financing company based in New York. 53% selected Donald Trump.
And whatever your opinions about Trump, his proposed moratorium on new financial regulations could entice both small businesses and alternative financial companies to consider a Trump presidency.
“Under my plan, no American company will pay more than 15% of their business income in taxes,” Trump said in Detroit on August 8th.
A report published by the National Federation of Independent Business (NFIB) last month found that 20% of business owners ranked taxes as the single most important problem facing their business. Only 2% reported that financing was their top business problem.
Message received? It appears not
In states like Illinois, some legislators are focusing their efforts on finding ways to make it harder for small businesses to obtain financing, convinced that questionable lending practices are the source of their problems, not taxes. But in a call with Bryan Schneider, secretary of the Illinois Department of Financial and Professional Regulation, he told AltFinanceDaily that no one has complained of any small-business lending problems in Illinois to state regulators.
Regulators should not indulge in creating solutions in search of problems, Sec. Schneider cautioned. “When you’re a hammer, the world looks like a nail,” he said, suggesting that regulators sometimes base their actions on anecdotal isolated incidents instead of reserving action to correct widespread problems.
And that’s why a moratorium on financial regulations (albeit on the federal level) might also resonate with small businesses. Lawmakers don’t appear to be addressing their grievances and ironically, passing new laws that make it harder to obtain financing could potentially even exacerbate the problems they’re already vocalizing.
Small businesses seemed to have become aware of the government-as-obstructionist role however since 22% of them surveyed in the NFIB study, said that government requirements and red tape were the single most important problem they faced, more than anything else.
The Finance Side
A timeout is not a sure-fire way to woo Wall Street however, since a moratorium on federal regulations could actually serve as a hindrance for some financial companies hoping to reach some legal framework consensus down the road. Last year, Bizfi founder Stephen Sheinbaum, said that a 50-state patchwork of laws would make operating companies like his more challenging. “Personally, I’d be glad to see it on the federal level, we won’t have to deal with 50 individual states, which is more unruly,” Sheinbaum said in regards to potential regulation.
But a timeout on making any moves might indeed be in order anyway, given the questions that are being asked by some federal legislators. Last month during a hearing, Rep. David Scott asked what made business loans different from consumer loans. Parris Sanz, the Chief Legal Officer of CAN Capital, who was there testifying on behalf of the Electronic Transactions Association (ETA), gave his answer.
But there is a fear, just by those questions, that some legislators are still having trouble understanding the fundamentals. And that may be why a dozen trade associations and lobbying groups have formed in the last year to provide educational resources about alternative financing.
In states like Illinois, Scott Talbott, SVP of government affairs for the ETA, said they are encouraging legislators to adopt a “go-slow approach” that affords enough time to understand how the industry operates and what proposed laws or regulations would do to change that.
Keep it Simple?
With Trump, despite all his quirks, it’s possible that his ideas about a moratorium, could be a deciding factor in how small business owners and those employed by alternative financial companies vote. Lower taxes, timeout on regulations, has the potential to resonate far and wide.
60% of small business owners think that the outcome of the presidential election will have a severe impact on small businesses, according to the Capify survey. 29% said it possibly will have a severe impact. With taxes and government red tape at the top of their list of grievances, there might just be a pump for trump on both sides of the alternative finance aisle.
Have You “AltFinanceDaily” Yet?
August 5, 2016If you’re not already subscribed, you can make sure that you receive the July/August 2016 edition in print by subscribing here.
Among the featured stories and content are:
- The role of MCA/business-loan brokers around the world contrasted with the U.S.
- The continued growth of alternative commercial finance
- How to grow an MCA or business loan brokerage
- Uber’s new finance program
- And much more!
Are you involved in funding businesses outside the bank? It sounds like you’ve de-banked! We hope you enjoy this issue. The digital version will be online later this month.
How Lendio Reached $250 Million in Funded Transactions On Its Platform. Hint: Partnerships
August 5, 2016
Utah-based marketplace Lendio said that it has help facilitate over $250 million in funding transactions on its platform to over 10,000 small businesses. $55 million was originated in Q2 alone.
Lendio’s partnerships have been paying off. Deals with GoDaddy and Staples originated $14 million and $4 million, respectively in Q2 of this year.
Last month (July 21), the company joined hands with digital marketing firm Townsquare Media in cross-promoting products and services. The company has also been pushing the SMART Box initiative spearheaded by the Innovative Lending Platform Association.
“As leaders and stewards in this industry, we feel it is imperative to rally around a common ground of best practices so the responsible flow of capital to Main Street continues and expands,” Blake added. “Providing business owners with the most complete information is one way to make sure that happens.”
Marlette Closes Proprietary Securitization Deal Worth $205 Million
August 3, 2016After a personal-loan bond sale last month, marketplace lender Marlette Funding closed its first proprietary securitization worth $205 million. “MFT” consists of Best Egg collateral financed via three classes of Notes and one class of Certificates.
Best Egg is Marlette’s personal loan platform with $2 billion in originations since 2014. This transaction, done through Goldman Sachs was the second securitization of unsecured consumer loans originated by Cross River Bank on the platform. In July, Marlette securitized personal loan bonds worth $180 million in Single A notes rated by Kroll Rating Agency.
This news comes at a time as online lenders and marketplaces alike feel the need to diversify sources of capital. “Accessing the securitization markets represents the third major component of a diversified funding plan, which also includes building strong relationships with institutional investors and developing on-balance sheet asset backed credit facilities,” said Paul Ricci, CFO of Marlette Funding.
Hold The Loans Or “Marketplace”? It Depends
August 1, 2016
At the risk of stating the obvious, the motivation to keep loans on balance sheet or sell them off through a marketplace is related to the type of lending one does. But even then, opinions on the best strategy varies. Is there a winning formula?
Not all online lenders are marketplaces. Some consumer lenders like Affirm, for example, hold all the loans they issue on their balance sheet. Avant, another consumer lender, has either held all or some of the loans on its balance sheet, making it a kind of hybrid.
But for companies like Lending Club, long considered to be the definition of marketplace, their May debacle showed the weakness that model can have, at least with those lending to consumers.
Interest rates, terms and risk profiles associated with businesses are different from those for retail consumers. According to Fora Financial co-founder Dan Smith, this changes the economics of the game since consumer loans are typically longer (3-5 years) compared to business loans where the weighted average term could be as short as under 12 months. This, not only makes consumer lending a lot more capital-intensive it also begs for diversification of sources.
“When I started the business, I had one lender in 2007 and they said they couldn’t work with us. Today, my credit facility has eight different lenders,” said Stephen Sheinbaum, founder of Bizfi which buys future receivables with its balance sheet in addition to running a loan marketplace. “We are undoubtedly seeing a shift from the B2C side. Any model that has sources of funds concentrated in one area is risky.”
Relying on your own balance sheet can lead to handsome returns, sources say. Sheinbaum, said that his company can make twice as much by holding than gains on sale. For companies engaged in consumer lending, that margin can be anywhere between 5 percent to 20 percent depending on borrower profiles and the type of loans, said student lender CommonBond CEO David Klein.
The unit economics of assuming risk can be higher if risk is assessed well. “If you do it well, balance sheet lending provides better unit economics,” said Fora Financial’s Smith. “You have to have the right capital structure, a low cost of capital and need to be able to underwrite effectively so it can scale.”
Smith however warned that this is not prescriptive and consumer lending companies like Lending Club might be forced to take a multi-pronged approach given the barriers to entry and the regulation around balance sheet lending for consumer loans. “There is clearly a more significant regulatory environment to get into on balance sheet consumer lending and that might be a barrier to entry.”
Often referred to as ‘having skin in the game,’ balance sheet lending potentially forces companies to assess risk better and be scrupulous about underwriting. But marketplaces whose prerogative may be seen as trying to make as many loans as possible, will inevitably be scrutinized over perceived conflicts of interest in their underwriting.
There are arguments to be made for each of the models but a better case is made for hybrid models which aims to take the best of both. Klein of CommonBond, said that his company leans heavily on balance sheet at times and the marketplace at other times. “Unless your investors are broad in profile and deep by type, then it is possible for a loan sale purchaser to walk away.” Klein said. “It all comes down to control. If you have more of it, there’s less risk.”
While more consumer lenders gravitate towards hybrid models, Lending Club at the end of Q2 held only 2 percent of the loan volume on balance sheet and CEO Scott Sanborn is very clear about the company operating purely as a marketplace.
“Some of our investors have observed the funding environment and asked: Are you going to become a balance sheet lender, just like a regular bank? Has Lending Club’s business model changed?”
“Let me be very clear: Lending Club is committed to the marketplace model and we do not plan to become a balance sheet or ‘hybrid’ lender. Our mission of connecting borrowers and investors has not changed,” wrote Scott Sanborn in a letter to investors.
The letter reiterated that the limited use of balance sheet does not affect Lending Club’s Notes. And while the company soldiers on, Lending Club’s story has taught many lessons to other lenders.
“In the wake of Lending Club’s news, you realize that if you have a hiccup on the way, it’s good to control some of your capital and assets because if you are truly marketplace, a hiccup in investor confidence can meaningfully change their trajectory,” said Klein who believes that for a pure marketplace player to survive, it needs to have more retail investors than institutional investors.
And there seem to be more people who agree than disagree. “The B2C model of selling 100% to a secondary market will cease and fault,” said Sheinbaum. “If buyers go away, your entire model is jeopardized. In a perfect world you want options. You see whichever way the wind is going and you try to go with it.”
The challenge then is in telling which way the wind will blow and be prepared for a storm.
