25 Jan 2015
What’s next for online lending
Many sectors of the economy have seen online providers leverage technology to deliver a better customer experience while doing so at levels of scale and efficiency that brick and mortar stores can not readily achieve. However online lending is an area that is still very nascent when compared with other sectors with only 1% of small to medium enterprise and consumer lending being originated through online platforms.
At the recent iGlobal 3rd Specialty Finance Summit, panelists from online lenders and VCs debated how much this figure might grow and what the roadblocks are to getting there.
Only up from here?
The speakers at the event noted some powerful forces, including economic and regulatory that are accelerating the growth of this sector. Several cited their ability to be far more efficient than banks, as banks physical locations consume 30-35% of typical operating costs. Other advantages such as the use of big data allow some of these firms to underwrite much faster, more efficiently and possibly accurately than traditional bank methods.
Jeffrey Rogers, CEO of LiftForward, has streamlined his approval process while integrating the company’s proprietary Pre-approval App with call centers, which allows a small business customer instant approval when they call to purchase equipment.
On the regulatory side, capital requirements and other fallout from the financial crisis has pushed banks away from doing small ticket loans, while the crisis itself forced nearly 11,000 financial institutions out of business.
The big data play
One of the firms that spoke, Upstart which originated $35M in loans last year, relies heavily on educational data when making loan decisions. Their platform takes into account a borrower’s university, major and work experience as a means to underwrite more efficiently.
Enverto, a lender specializing in equipment finance, uses diverse sources including data such as Yelp ratings when making loans to restaurants, however some of the these sources do not always provide trustworthy data.
Other panelists cited usage of sites such as LinkedIn or Facebook to analyze a borrower’s creditworthiness. All of this adds up to faster approval processes and typically better quality borrowers for the lenders.
It’s not all roses
There are however some real challenges for online lenders. Due to the lack of human contact, fraud is a larger risk for these lenders, and many still need to supplement their online and data analytics with old fashioned phone calls and borrower interviews. For these firms, repeat customers are also important, and in the opinion of some panelists, nothing electronic can truly replace rapport and trust established with individual loan representatives.
Capital for these lenders can also be a hindrance, with some having difficulty convincing the larger financial institutions that novel underwriting methods of e-lenders are secure and that there is still distrust of electronic contracts at the banks. Balancing supply and demand of capital, particularly on peer to peer platforms is also a challenge, and at this stage most commented that online lending still requires traditional capital sources as a backstop.
The VC angle
The recent IPO of Lending Club, which raised just over $1B at a valuation of nearly $9B, and the following IPO by OnDeck, have breathed more wind into the sails of the industry while supporting valuations. Only 2% of VC capital has been directed towards this space however, as many VCs don’t fully understand lending and the associated servicing process, which can either lead to reluctance to invest or overly optimistic valuations.
The space is also attracting interest from larger companies, including one of the kings of big data, Google, which recently announced a partnership with Lending Club to provide loans to members of Google’s network.
All bets seem to be that this space will continue to grow quickly. According to RealtyShares, 2014 was a record year for online lenders with $8.6B in loans made, which surpasses all other years combined.
As the space continues to mature, it will attract an increasing amount of both institutional and peer to peer capital, fueling supply and lowering capital costs for these firms. This industry may well become the latest example of a structural major change to the consumer and SME banking market, and further pain for the banks as 20th century business models are replaced by more efficient use of technology and direct peer to peer lending.
Greg Berman works at Shift Forex, a firm that helps grow businesses in the currency trading and fintech industries by providing strategic consulting, advisory services and technology commercialization. He was also formerly in real estate development and private equity, primarily funding and developing large scale residential and mixed use projects.
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Image by iGlobal Forum.