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BankingsResponsetoAlternativeFinance|BAI|BankingStrategies|Strategy|ManagementIssues

BankingsResponsetoAlternativeFinance
Giventhatalternativefinancecompaniesarelikelyheretostay,bankswouldbebetter
offviewingthemaspotentialpartnersratherthanascompetitors.BY CHARLES
WENDEL
May22,2015|0Comments
AttherecentLenditconferencefocusedonalternativelending,keynotespeakerLarry
Summers,theformerSecretaryofTreasury,saidthathewouldnotbesurprisedifwithinten
yearsalternativefinancecompanies(AFCs)generated75%ofnonsubsidized(nonSmall
BusinessAdministration)smallbusinessloansand30%to40%ofdirectconsumerlending.
Today,thesmallbusinesspercentagegeneratedbyAFCsdoesnotexceed2%andthe
consumerpercentagemaybeinthe5%to10%range.
Bankscannotaffordtoignorethisgamechangingpossibility.RatherthanviewAFCsasjust
anothersetofcompetitors,bankshavetheopportunitytoworkwiththemtoincrease
revenues,expandtheirmarketfocusandleveragealreadywelldevelopedprocessingandrisk
managementplatformstoimproveproductivityandperformance.
DigitallyenhancedLending
Whatisanalternativefinancecompany?DescribedbyoneAFCCEOasemphasizingdigitally
enhancedlending,theseentitiesdonottakedepositsandareusuallyownedbyprivateequity
firms,whichseeasubstantialgrowthopportunitylendingtocompaniestowhichbankseither
cannotorwillnotlend.AFCsimbedtheeffectiveuseofinformationtechnologythroughout
theirbusinesssystems(includingorigination,underwritingandmonitoring)tostreamline
processes.Intheirview,thisprovidesaqualityofriskmanagementthatallowsthemtolendto
companiesconsideredunbankable.
HerearesomefactorsfuelingthegrowthofAFCs:
Banksdefinetheircreditboxnarrowly,creatingalendingopportunityfor
AFCs,particularlywithbusinesses.Whilebankswanttolend,manyhavealsoincreased
thehurdlesthatbusinessesmustmeettoborrow.Weestimatethatbanksoverallconsideronly
about10%ofallbusinessloanprospectsasbankable,leavinginexcessof$1trillioninloan
opportunitiesforothers.BankshavecreatedthegrowthopportunitythatAFCsareenjoying.
AFCsprovidegreaterspeedindecisionmakingandfunding.A2014FederalReserve
studyestimatesthatsmallbusinessownersspend24hoursresearchingandapplyingfora
loan,contrastingsharplywiththe24to48hourturnaroundthatsomeAFCscanprovide.
Duringaduediligenceprojectforaclient,wefoundthatasignificantnumberofbankable
creditshaddecidedtoworkwithAFCsfortheirspeedandresponsivecustomerservice,despite
highercost.

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BankingsResponsetoAlternativeFinance|BAI|BankingStrategies|Strategy|ManagementIssues

FundingisplentifulforAFlendersandtheirborrowers.Privateequity,
securitizations,bankloansandIPOsareallavailabletoAFCsandsupporttheirgrowth.Some
companiessuchasLendingCluboperateasmarketplacesinwhichtheyact,ineffect,as
intermediariesbetweenborrowersandlenders(ofteninstitutions,includingbanks).
Marketplacelendersfurtherexpandthedollarsavailabletofundloans.Aneconomicdownturn
willlikelyreducefundingtomarginalplayersbutmoreestablishedlendersshouldcontinueto
attractbackers.
AFCsoperatewithstrongriskmanagement.SomebankersIspeakwithviewAFCsas
thesecondcomingofsubprimelendingandexpectthesamebadendasthatbusinesssuffered
duetopoorlendingpractices.However,inmanycases,thequalityofriskmanagement
processesfollowedbyAFCsmayexceedthatofbanksinbothdepthandquality.Nonbanks
havedevelopedanalysesthatoftenincorporatetraditionalbankingdata,credithistorydata,
cashflowinformation,variouspublicrecordsandevensocialmediadata.Riskalsoinvolvesan
areaofcontinuedinvestmentandfocusforthesefirms,astheypushthemselvestobuild
strongerunderwritingprocesses.
AFCsarebenefitingfromanimprovedreputationandenhancedPR.Aboutfive
yearsago,alternativelenderssufferedfrompoorpublicityandanimagethatoftenportrayed
themasthesmallbusinessequivalentofpaydaylenders.However,astheindustryhas
matured(and,insomeinstances,astheirlendingrateshavedeclined),theirimageimproved.
MuchofthemedianowportraysAFCsasareasonablealternativetobanks,withstoriesoften
stressinghowtheycametotherescueofasmallcompanyandapprovedaloanrequestthata
bankhadpreviouslydenied.
AlternativeFinanceisheretostay.Onebankerrecentlycommentedtomethathehad
seenthisrodeobefore,suggestingthatAFCsrepresentedalendingbubbleratherthan
permanentdisruption.Certainly,somelenderswillblowupoverthenextfewyears,whether
fromfraud,badlendingpracticesorunforeseencircumstances.Butmanywillcontinueto
succeedandexpandbyvirtueofcustomerneed,innovation,effectivemarketing,continued
accesstofundsandlackofresponsefromtraditionallenders.Alternativefinancehasbecomea
gamechangeritisnotgoingaway.
So,whatshouldbetheproperstanceofbanksinregardstothisphenomenon?
AFCsunderstandandrespecttheprivilegedpositionandpositivereputationthatbanks
continuetohavewithmostcustomers.Theyalsorealizethatbankscanprovideaccesstoa
largecustomerbaseatareducedcostoforigination.FormanyAFCs,cooperationwithbanks
makesalotmoresensethancompetition.Fortheirpart,bankscanleveragetheAFCs
investmentinprocessandriskrelatedtechnologytoreducecostsand/orexpandrevenue
opportunities.
Cooperationislikelytoinvolveoneormoreofthefollowingoptions:
Referrals.ThisinvolvesAFCsobtainingreferralsfrombanksforloansnotacceptabletobank
criteria(turndowns).Thebankreceivesareferralfeeandretainsallthecustomersother
business.However,thisactivityraisescomplianceandprivacyconcernsatmanybanksand
mayalsonotprovidesignificantrevenuestobemeaningfultoeitherthebankortheAFC.

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BankingsResponsetoAlternativeFinance|BAI|BankingStrategies|Strategy|ManagementIssues

Businessexpansion.AFCscanworkwithbanksproactivelytoassesstheircurrentcustomer
baseandidentifynewloanopportunities.Thebankcanfundthosethatmeetitscriteriawhile
theAFCwillprovideloanstononbankabletargets,eitheronaprivatelabelorcobranded
basis.ThishasbecomeanincreasingfocusofsomeAFCsandmayrepresentanattractive
growthareaforbanksthatwanttoincreaseloanstosmallbusinesses.
Integration.AhandfulofAFCscurrentlyoffertheirorigination,servicingandrisk
managementplatformsasaservicetobanks,allowingthemtostreamlinethelendingprocess,
lowertheircostsandimprovethecustomerexperience.Mostbankslosemoneyonloansless
than$100,000thisapproachcanreduceoperatingexpensesandallowthebanktofocuson
originationratherthanbackofficeactivities.Byintegratingwiththebank,theAFCcanbecome
thebankssmallbusinesslenderforallloansunderthe$50,000to$100,000range.
Investmentsandfunding.Somelargerbanksandinstitutionalinvestorsarecurrently
purchasingwholeloansorloanportfoliosoriginatedbyAFCs,allowingbankstotake
advantageoftheirownlowcostfundingandaccesstodeposits.Thisactivitydemandsstrong,
independentriskanalysis.BanksareoneofthemainfundersofAFCs,participatingina
secondarywayinthehighrateloansthatAFCsgenerate.
Atthispointwealsoknowofthreebanks,onetoptenandtwosmallerinstitutions,thatare
tryingtoemulatetheAFCslendingapproachbyapplyingtheanalyticsthatAFCshave
spearheadedtotheirownbankportfolios.Morebanksarelikelytodothesame,althoughthe
extentofabankswillingnesstoalteritstraditionalapproachtoriskmanagementandpricing
remainsaquestionmark.
IfabankdecidestoworkswithAFCs,utilizingoneoftheaboveoptions,howshouldtheythen
selectapartner?
HundredsofAFcompaniesnowoperateandtheLenditconferencedemonstratedthatnew
playersareenteringthemarketeveryweek,tryingtodifferentiatethemselvesbasedupon
factorsincludinglendingfocusandindustryorloanproductexpertise.Abanksinternal
checklistneedstoincludehoweffectivelytheAFChasanticipatedandaddressedthebanking
industrysregulatoryandcomplianceissueswhetherthesolutionthatanAFCoffersis
turnkey,therebylimitingthetimeandresourcesrequiredbythebankand,thewillingnessof
theAFCtocustomizeitsapproachtotheneedsandpreferencesofthebank.Eventhisbrief
checklistwilleliminatemostAFCsascandidatesandallowbankmanagementtofocusonhigh
priorityprospects.
Mr.WendelispresidentofNewYorkCitybasedFinancialInstitutionsConsulting,Inc.He
canbereachedatcwendel@ficinc.com.
2015BAI.AllRightsReserved.

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