Posted on

How lending startups are trying to edge out payday lenders

Despite transaction fees as high as 15 percent and annualized interest rates as high as 400 percent, a staggering 10 to 12 million Americans take out payday loans each year.

And a new legion of lending startups serving non-prime borrowers like LendUp and Elevate are hoping to cash in on the space traditionally held by payday lenders, a market estimated to be worth $38.5 billion. (Other online lenders like Prosper and SoFi target borrowers with high credit scores.)

“If you take out the fintech lending, what are the options? With traditional banking, it’s basically credit cards,” said George Hodges, director of strategy and fintech innovation at PwC.  Most banks and lenders don’t offer loans below a threshold, usually $3,000.

The selling point for startups: Customer experience and financial inclusion. Fintech companies like LendUp, Elevate and others have jumped in with a promise to lower fees and broaden access to credit.

These online lenders compete directly with payday lenders on customer experience. That’s not hard to do. Traditional payday lenders don’t exactly have the greatest reputations — it’s considered high-risk borrowing that preys on the poorest and often offers a less-than-glamorous in-person experience. Still, they’ve been the de facto way to get small loans quickly — especially for those with weak credit.

Fintech startups operating in the market are also pushing a customer-centric approach, saying they work with the customer on repayment terms instead of resorting to heavy-handed, predatory tactics.

“If a customer is struggling to make payments, we offer flexible terms and programs to help that person get back on track. We have a strict policy on nonaggressive collections practices,” said Elevate CEO Ken Rees. “If in the end, the individual must default on their loan, we write it off as a loss.”  

Another sell that fintech startups offer is to help get customers who are underbanked or have thin credit files into the financial system. While Elevate offers loans between $500 and $3,000, LendUp offers customers options below $500 with opportunities to increase the amounts after showing good repayment history. Both offer installment loans that allow customers to pay back the loans over time and assess ability to pay using a broader range of data than just raw credit scores.

“Along with the application of industry-leading advanced analytics, we are able to ensure that we loan money to the most deserving applicants — those who are most likely to be able and willing to pay loans back,” said Rees.

LendUp doesn’t touch traditional credit scores for many of its products including its short-term loans, relying on alternate data sources including information provided from subprime credit bureaus.  “A hard inquiry on the customer hurts their credit score — for a loan of a month, you don’t want to damage their score, so we’ve chosen not to use FICO or the big three credit bureaus,” said COO Vijesh Iyer.

The other related selling point is to position themselves as inclusive.

If fintech lenders are able to use advanced data analytics technology to underwrite a larger cohort of borrowers, it’s a win for financial inclusion, said Hodges, who acknowledges these loans aren’t a cure-all for poverty. But what happens after the loan is an important difference when compared to payday loans.

“In addition to the APR, it’s what happens at the end of the loan,” he said. “In payday lending, it rolls over [if the customer can’t pay on deadline] — it’s not designed to lift themselves up or build savings.”

By contrast, fintech startups say they help customers gain a foothold in the financial system. LendUp and Elevate say customers that have good payment histories can lower their APRs over time and have the option of getting their payment history reported to credit bureaus.

But this does come at a cost.

Both Elevate and Lendup have annualized interest rates that can go into the triple-digit percentages for new customers. Iyer said APRs depend on the state, but a look at LendUp’s sample fees for California on its website shows annualized interest rates for a new borrower that range from 214 to 459 percent, depending on the amount loaned and the repayment time frame. Meanwhile, according to Rees, Elevate’s average APR is 149 percent (but there is a range, depending on credit, employment and loan repayment history and other factors). In comparison, payday lender Advance America’s APRs for the same state are 456 percent, according to its website.

Despite the high interest rates, these loans are intended for quick payback, so to lenders — whether fintech or payday loan companies — the high interest just amounts to a fee for a service banks aren’t well-positioned to provide.

“We think of what we charge customers as more of a fee than an APR,” said Iyer. “For a 14- to 30-day loan of $250, we’re looking at a 15 percent fee; we view that as comparable and in many cases cheaper than what your bank charges you for an overdraft.” He noted that converting interest rates into APRs doesn’t make sense for a short-term loan.

The FAQ section of Advance America’s website has a similar message: “A typical fee for a payday loan is $15 per $100 borrowed. … Often, the cost of a cash advance may be lower than the alternatives considered by many people, such as paying a bill late or incurring overdraft fees from banks and credit unions.”

To Jamie Fulmer, svp of public affairs at Advance America, the entry of new players on the market is a positive development, but the notion that their products are substantially different from payday loans may be a stretch.

“A lot of these companies that are touting a better alternative are trying to make their product look better than a traditional payday loan, and that’s just marketing spin,” he said.  “Some are not operating under the same regulatory framework we’re operating under, and some are doing exactly what we’re doing but marketing it in a different way.”

Still, the fees for small-dollar loans draw criticism from consumer advocates.

“Whether it’s Elevate or a payday loan operator, it’s primarily the same problem — these loans are high-cost and targeted to individuals who don’t have capital or assets to begin with that are excluded from personal loans or high-credit products,” said Ricardo Quinto, communications director at the Center for Responsible Lending, a nonprofit advocacy group with links to a credit union.

From a venture capitalist perspective, it’s too early to tell if fintech lenders’ business models can be sustained over the long term.

“The bets they’re making is that they’ve got all sorts of data, and put that into an algorithm and make better determinations of whether someone is able to repay a loan,” said Vica Manos, director at Anthemis Group. “We still need to see how it plays out. None of these lending propositions have actually been tested in a crisis situation — they haven’t gone through a downturn to test how robust the algorithms are.”

Posted on

Dating, schmoozing and booze: SoFi is trying to make online lending more social

Last month, a talk at New York City’s Times Center by bestselling author and CNBC host Nicole Lapin drew lines out the door. At first sight, it would seem like any other talk at a storied venue that hosts conferences, some that involve wine and schmoozing afterwards — and there was plenty at this one, too.

But this was different: it was a “social” hosted by online lender SoFi, which wants to make finance more social — hence the moniker. Through a community-building approach, the company, a six-year-old startup, differentiates itself among its competitors that are both startups and banks. SoFi holds over 200 events for its customers (which it calls members) across the U.S. each year. They run the gamut of financial therapy sessions, happy hours, home-buying workshops, and even dating.

“It was interesting — I went there by myself,” said Reetu Sharma, a 34-year-old New York City-based member, about a SoFi singles event. “It started off with cocktails, where you could just mingle with whomever, and then every ten minutes they would ring a bell and you would go to the next person and start talking to them — SoFi had an incentive that if you found someone you liked and went out on a date with them, they would pay for your dinner, so that was really cool.”

The sense of community that SoFi has built is an added benefit, said Sharma.

“It shows that they’re investing in our future, and they want us to have good, well-rounded lives — there’s a lot of good financial benefits that come from being in a relationship, and there’s also financial hurdles that you have to go through that SoFi is wiling to help out with, like buying a house,” she said. “They can tell that everything is interrelated and that they can be a part of people’s lives even when the loans are paid off.”

Through events and community connections, customers’ attraction to the SoFi brand is how it grows its reach.

“If you go back to our core value proposition, it’s around speed, transparency and alignment,” said co-founder and CEO Mike Cagney. “Speed is about mobile-enabled finance, transparency is the fact that we have no fees and deal in a very straightforward manner with members, and alignment is the community piece — we have a vested interest in the success of our people.”

The company, which was founded in 2011 as a peer-to-peer lender between Stanford alumni and graduates, has since evolved to offer lending products (underwritten by the company, and then sold to institutional investors) as well as wealth management and insurance offerings. To get approved for a loan, the company considers factors like cash flow, income, education and professional history, rather than just FICO scores and debt-to-income ratios. It has raised $1.9 billion in equity funding and has originated $19 billion in loans since its inception, and almost $5 billion just this year. While SoFi wouldn’t confirm revenue numbers, it reportedly will earn $200 million on a pre-tax basis in 2017 on revenues of $650 million.

Despite the cost involved in running the events (SoFi wouldn’t share exactly how much), Cagney said it’s worth the investment in a getting a loyal following. The company currently has 300,000 members nationwide.

“We have a huge competitive advantage relative to banks in cost of acquisition,” he said. “We’re all priced roughly at the same rate, it’s not like one of us is much cheaper or more expensive, but we acquire members at a fraction of the cost that banks acquire customers, and we attribute this to what we’ve done on community service and product design.”

With SoFi’s intent to apply for an industrial loan company (ILC) charter (a bank license that allows a non-bank to offer services a bank would provide), the company will be branching out into other product offerings, including bank accounts.

“The ILC is for delivering bank accounts to my members,” he said. “It’s frustrating that today we can’t be a place to deposit your paycheck so this is the step to get to that point.”  And even without a banking license, the company intends to have a SoFi deposit bank account through their broker-dealer, which will be launched later this year.

For those who observe the evolution of industry, SoFi’s foray into other business areas is a smart move.

“There’s plenty of evidence that unsecured consumer lending is pretty risky and there’s a number of good reasons why that market might decline going forward as regulatory steam picks up,” said Celent analyst Stephen Greer.

The company is putting more emphasis on new areas, including wealth and asset management, insurance, and international expansion, Cagney said, noting that he hopes SoFi’s growth will fuel change in the banking industry.

“At some point SoFi is going to go public,” he said. “It’s not that SoFi is going to supplant the banks, but we will drag the banks into a different type of service model that’s more mobile, that’s technology based and has high service and high community value — people will start to understand that what we’re doing is really the way the next generation wants financial services delivered.”

Photo: “Raise Week” event at New York City’s Times Center, courtesy of SoFi

 

Posted on

Why Elevate Credit created an in-house think tank

A think tank is normally associated with academic institutions or consultancy firms, but one financial technology company is doing its own research to stimulate debate about credit inequality while boosting its brand at the same time.

Elevate Credit, an online lender, offers small-scale (between $500 and $3,000) loans to non-prime borrowers, or people who have credit scores lower than 700. Elevate, which went public last month, decided to take the research it does on its target market and publish it publicly through its in-house think tank, the Center for the New Middle Class. The research is published on the Center’s website and its findings have been fodder for stories in mainstream media outlets, including Business Insider and Bloomberg.

“We get reams of data to understand the best way to underwrite a customer but what we needed to do is humanize the data,” said the Center’s executive director, Jonathan Walker. “We needed to find a way to understand the stories behind the data to help better identify the products and services that are necessary.”

Beyond traditional credit scores, Elevate Credit looks at data including transactional history and utility bills to offer credit to people who otherwise would be overlooked by the banks. Walker said Elevate set up the Center in October after discovering that its typical customer doesn’t fit the stereotype.

“What’s really driving people into the non-prime space is out of their control — it’s often because of job losses or unexpected expenses like medical bills,” Walker said. “Too many people talk about the non-prime consumer as being lazy or careless or just uneducated, and the reality is far from that.”

The Center is located in Elevate’s corporate offices in Fort Worth and employs five Elevate employees who crunch the data on a part-time basis. The team comes from backgrounds such as market research, data analytics and sociology. Elevate uses data from surveys and focus groups it organizes and insights from its 100,000-plus customers. The Center’s output often takes the form of reports focusing on how the target population manages money. For example, based on a survey of 600 non-prime Americans, Elevate did a study that looked at how they handle emergency expenses. Another study looked at how often non-prime populations keep watch over their transaction history and credit scores.

Walker said what motivated Elevate to create the Center was the lack of research on credit inequality, with most studies focusing on income inequality. Since not all non-prime borrowers are poor, conclusions from income inequality research aren’t always applicable to those who can’t access credit.

“If you apply an income inequality solution to a credit inequality problem you don’t solve the problem at all,” he said.

As the research arm of a business with a stake in the findings, some may question the objectivity of the conclusions, but Walker said the company wants the Center’s content to stimulate debate about policy issues — a move that ultimately boosts the brand.

“What we hope is that the Center content is engaging thought leaders, whether it be academics, journalists and policy makers, and we also are hoping to get a broader audience of people who are interested.”

Posted on

Banks being disrupted…by search engines?

banks being disrupted by search engine

Traditional banks are finding out new competition lurks everywhere.

Pureplay startups like marketplace lenders, Lending Club and Prosper are originating billions of dollars of loans every quarter. Though volumes are small compared to total SMB outstanding loans (which in 2013 stood at $585 billion), some banks are turning to the marketplace lenders to buy loans, opting to partner instead of compete.

This move towards alternative lending, core to banking services, isn’t just a US phenomenon. Funding Circle, another leader among the current class of startup online lenders, has global aspirations.

Funding Circle’s co-founder, Sam Hodges recently explained to  Tradestreaming:

Our vision for Funding Circle is as a global lending exchange, where business from all over the world come to find finance from an army of investors, big and small. Small businesses are underserved in most of parts of the world, and we believe our marketplace model can help millions of businesses and investors to get a better deal. At the moment, we are focusing all of our energy on building a successful business here in the UK, USA and Europe.

There are high hopes for marketplace lending. Some investors, like Foundation Capital’s Charles Moldow, are betting on the market, between cannibalization and traditional banks moving into marketplace lending themselves, can grow to be a trillion dollars.

From banks to ecommerce platform

It’s not just marketplace lenders taking aim at banks. Traditional ecommerce players want in, too. Amazon is offering loans to handpicked sellers on goods on its ecommerce platform.

Like marketplace lending, ecommerce firms entering financial services isnt’ just happening in the US: PayPal’s Working Capital loans for small businesses has lent more than $1 billion to over 60,000 small businesses in the U.S., U.K. and Australia. Alibaba, the giant Chinese ecommerce platform, launched a money market fund for sellers to store their working capital. Within just 10 months, the fund, called Yu’e Bao had more than $90 billion in short term capital. That’s money that used to be kept in banks.

Search engines becoming lenders

On the heels of Alibaba’s success in money markets, Chinese search engine Baidu appears ready to launch its own banking solution. Looking to avoid some of the regulatory commotion around Alibaba’s own financial service offering, Baidu intends to partner with Citic, the 7th largest Chinese bank with 600 physical locations.

While Google got out of the direct lending business to its advertisers, it is now running a pilot with Lending Club. The marketplace lender is offering advertisers on Google a loan to fund their AdWords campaigns.

The nature of banking is changing and therefore, the players leading the charge are rearranging themselves. [x_pullquote cite=”TechCrunch” type=”right”]This year, over $11 billion has been invested in financial technology services companies. That’s up over $5 billion from the previous year, and the highest amount invested into financial services technology companies in the past five years[/x_pullquote]Pureplay lenders are filling an important role and ecommerce platforms have found a way to offer financing to some of their best customers. As this plays out, there are more companies popping up to help banks compete. Firms like LendKey provide banks with the tools, technology, and process optimization employed by nimble tech startups. More companies keep launching to help make the banking sector more competitive to the demands placed on them by consumers who are demanding the same speed, transparency, and service commonplace in other industries disrupted by technology.

This opportunity hasn’t been lost on investors, who are pouring money into alternative financing businesses. Lending Club and OnDeck both had well-received IPOs that gave the companies billion dollar marketcaps.

In 2015, there’s been hundreds of millions of dollars invested into alternative lenders. Just this week, alt lender Earnest announced a round of $275 million (equity and debt).

 

Regulation and branding will assure that banks aren’t going away but it’s getting more complicated to compete in core banking services. Direct competitors are emerging to challenge banks head on while others, like ecommerce players, are indirectly competing indirectly with them. Through general growth, partnerships, and some disruption, the banking industry is quickly evolving.

[x_author title=”About the Author”]