“Silicon Valley is coming.”
-Jamie Dimon, CEO, JPMorgan Chase
Jamie Dimon, CEO of JPMorgan Chase, said it best in his recent letter to shareholders with his reference to emerging digital lenders. Ironically, his comments came a week before the biggest conference for these companies was about to begin. The annual LendIt conference was held last month at Times Square in New York City and GonzoLender descended boldly on the scene to evaluate the mysterious underbelly of digital lending.
The opening remarks by Lending Club CEO Renaud Laplanche adequately summarized the perspective of lending platforms attempting to solve a problem traditional banks have been woefully unsuccessful at solving: “Banking is an engineering problem.” As the sessions progressed a theme began to manifest that the traditional banking model has failed our customers and these digital lending platforms intend to reshape the industry, one process at a time. The lending attack on community banks and credit unions has been waged.
It would stand to reason that a conference agenda packed with topics as relevant as “Online Loan Applications/Originations,” “Marketing to Prospective Borrowers,” “Risk-Based Pricing,” “Auto-Decision Rates,” “Lending to Millenials,” “Credit Scoring Engines and Models” and “Loan Servicing” would bring in loads of banks and credit unions from across the country. Outside of some stout representation from the likes of Citibank and CapitalOne, there was only one credit union and one community bank in attendance. I’ll repeat that: one credit union and one community bank.
For all the banks and credit unions that did not make it to the LendIt conference, here is GonzoLender’s take on the event.
THE PLAYERS
It’s fair to say digital lenders are disrupting banking just like Amazon, Facebook, Uber and Google disrupted their respective industries. While it may not be any one individual platform directly taking on the entire banking model holistically, the cumulative effect of all of the lending platforms across all verticals is substantial.
Digital lending platforms are looking to displace traditional financial institutions by providing superior technology and analytics supported by more efficient processes. A factor further supporting their case is not having to contend with reserve requirements and fund expensive branch networks. In addition, their ability to market, acquire, service and collect from customers on a massive scale is something with which community banks and credit unions just can’t compete.
These companies are thinking outside the traditional banking box and hiring non-banking whizes to execute. Perusing the backgrounds of the platform owners and employees it’s easy to see there is an abundance of education, talent and experience from the likes of Harvard, Yale, Princeton, Google, PayPal, Facebook, MasterCard and eBay. The staffing, approach and execution thus far is spot on.
LENDING VERTICALS
There has been a vast influx of platforms and they are varied by geography, type of platform (e.g., peer-to-peer or Marketplace) and lending vertical. These lines are blurring quickly as platforms expand into other countries, shift their source of funds model, and tiptoe into new verticals. Consolidation among these companies is likely as they continue to expand, and interesting battles will certainly arise when crossing into new lending verticals.
Consumer Lending
The major players here are Lending Club and Prosper with SoFi, LendKey, Avant and others trailing the pack with a collective lending volume of roughly $9 billion in 2014. The vast majority of the traction has been in the unsecured and credit card refinance space where borrowers can swiftly and easily move to a more attractive option. The low hanging fruit is getting harvested by the truckload. The ability to drive partnerships and intervene with point of sale lending opportunities will be necessary to keep feeding their customer pipelines.
Small and Midsize Business (SMB)
The SMB market is dominated almost equally by OnDeck and CAN Capital. The really hard nut to crack with SMB is product. It’s very hard in an online environment to identify what product a small business needs without some personal interaction. But the opportunity here is tantamount considering the typical community bank and credit union have a notoriously hard time processing, underwriting and approving such loans, and certainly not with the same speed as these platforms. As presented during the conference, 40% of small businesses want a loan under $50,000, and these must be executed more efficiently.
Residential Real Estate
A number of players share this highly competitive space, including SoFi, Lending Home, Money360 and LendZoan. Of all the verticals, this has the largest potential opportunity. Mortgage lending is the fat-cat vertical and is relatively untapped at this point. With that, however, comes some challenges. The loan decisions for residential real estate are much harder to automate because of potential fraud, and the completion process is more complex than personal loans due to appraisals, physical inspections, state/county requirements, etc. But, the payoff could be massive, especially considering the delivery advantage these platforms have with their ability to process a mortgage loan in two weeks compared to 30 or 40 days for the average FI.
Other Verticals
The remaining providers can be grouped into a variety of other verticals such as student lending or point-of-sale lending opportunities including doctors’ offices, furniture stores, car dealers and/or geography such as those in the United Kingdom, Australia, Canada and China. The market in China alone is more than double all of the other markets combined.
DIGITAL LENDERS VS. TRADITIONAL FINANCIAL INSTITUTIONS
Throughout the event the ongoing comparisons between digital lending platforms and traditional FIs rivaled the number of flashing bulbs a few short steps away in Times Square. With the exception of a couple of rougue outliers, the tone was predominately weighted toward these emerging platforms doing a better job.
Traditional FIs have the advantage with low-cost capital to deploy and a constant borrower pool to tap. Digital lenders have an edge with deployment of technology and origination fulfillment capabilities in tandem with a lack of regulatory controls. We can argue who wins the credit analytics game – for now at least, until there are seasoned portfolios to review and proper performance can be measured.
The analytics these platforms are using is clearly more robust than the typical FI. Borrowers can be qualified from more than just traditional FICO data and in some cases against as many as 30 different credit tiers. Analytics drive deep to the heart of design and are quite scientific. Fraud rates are segmented down to the applicant’s computer browser to determine higher levels of risk, and a variety of application templates and navigation options are constantly tweaked and tested for correlated success rates. The next community bank or credit union that GonzoLender witnesses using comparable methods will win a sweet prize, anything from a gift card to a t-shirt!
Also, the technology is clearly better. It is not uncommon for these platforms to tout cool functionality such as 90% plus auto-decision rates and dynamic, point-of-sale usability, the ability to “vouch” for a borrower, and real-time adjustments of loan terms as the borrower makes changes, e.g., a slider that enables a borrower to change his requested payment amount and the rate and term dynamically change with it. And, for starters, the web sites are excellent. To prove it, check out Able Lending, LiftForward, Upstart and Funding Circle as a few examples.
WHAT’S NEXT?
POS Disintermediation: Closer ties with point of sale lending opportunities will be a key development. Lending Club unveiled at the conference what it is calling “The Cube,” a seven-inch box that allows for a paperless loan application, backlit digital display, WiFi connectivity and voice recognition, and it can stand in virtually any POS location including car dealerships and bank branches. Activities like these are bound to choke origination opportunities from traditional FIs.
Technology: In a few years, the ability to create stunning, fresh technology won’t be a differentiator among peer platforms, but it will be when compared to community banks and credit unions. Robust analytics and transparency of data will continue to be important for everyone.
Regulations: There is much debate whether regulations will ramp up in this industry given the fear of potential predatory lending. However, the lack of a fully developed market and unclear ownership for regulatory oversight are the leading reasons additional regulatory requirements may stay at bay.
Consolidation: The number of platforms being created today is staggering. As they continue to grow into other countries and lending verticals, the overlap and potential inability to generate sufficient returns will cause concerns with investors. Only a handful will likely make it public and survive the next five years.
Partnerships: The ability to arrange partnerships with banks and others will define these platforms’ survival. Institutional and individual investors alike are lining up to fund these loans, but the borrower pipe must stay full to keep these engines running, and partnerships with banks and credit unions will likely be a prime source. A number of recent partnerships have already been announced such as Lending Clubs partnerships with BancAlliance and Citibank as well as LendKey with Navy Federal Credit Union.
The interesting dichotomy is this: while these platforms are attacking every lending vertical relevant to the community FI, they need partnerships with FIs for a consistent source of borrowers. Even Jamie Dimon stated in his letter to shareholders that he may be looking to partner with some of these digital lending platforms where it makes sense.
GonzoLender’s advice to the community FI: Keep your eye on these platforms as competition, but don’t shortchange the potential opportunity to partner with these platforms if the conditions are right.
-dj
Or are you missing out on a huge opportunity while you live with the nightmare of outdated systems?
At Cornerstone Advisors, we have seen mortgage loan origination systems in financial institutions of all sizes. We’ve seen the great and the not so great. Visit our Web site or contact us today and we’ll talk about steps you may need to take to put your mortgage operations to work capturing market share.
