Banks should consider alt-fi lenders, Direct Lending Investments president says
One of the most interesting aspects of attending a conference like this week’s Fintech Global Expo in San Diego is learning how different parts of the alt-fi community interact with each other to create mutually beneficial opportunities.
One such example is the relationship between Direct Lending Investments (DLI) and Dealstruck. DLI allows investors to participate in small business loans. Dealstruck provides small business financing.
The two firms work together, with DLI buying some Dealstruck loans, which provides Dealstruck with additional capital. Dealstruck’s Candace Klein and DLI’s Brendan Ross share how they work together, what they will speak about this week, and also share their thoughts on many different areas of alternative finance.
The second annual Fintech Global Expo takes place on May 28 and 29 in San Diego.
Brendan Ross actively looks for quality loan opportunities to invest in. The President of DLI looks for companies that have been making deals for a while and who focus on developing unique deal flow and acquisition channels. He was attracted to Dealstruck because of its experienced leadership team and strong company and board, saying they are one of the few platforms he buys loans from.
Traditional banks could be playing a much larger role, Mr. Ross believes. Every time they do not provide a customer with a loan they owe them at least a referral to an alternative lender like Dealstruck.
“Whenever a bank says no to a customer and does not refer them to a platform like Dealstruck, they are sending that customer to Google.”
“At that point the chances of them having a great experience have gone down alarmingly.”
Candace Klein estimates 90 percent of Dealstruck borrowers are initially turned down by a bank. Turning to Google likely gets them connected with a broker who shops them out to the highest bidder. The “winner” tries to sell them unfamiliar products with murky actual rates that often range between 30 and 90 percent APR.
Dealstruck aims to reach those borrowers before they have taken out three higher-cost loans, which is quite common, Ms. Klein said. Dealstruck is using a variety of marketing methods, including video ads, which she said are converting well, e-mail based marketing, direct mail, SEO, and database marketing via text message.
Indirect methods include working with broker partners, with the downside being the success depends on the broker. Dealstruck also works with banks and credit unions and has a unique partnership with UPS where they have funded some franchises but also many business customers using individual UPS locations.
“These are bringing us deal flow that would otherwise go to Google,” Ms. Klein said.
The idea of mandatory referrals from banks to alternative lenders is used in the United Kingdom, which is one of a few regions further ahead on the alt-fi development curve than the U.S. Do platforms look to such places for inspiration and for a sense of where the American market may be headed?
“We’re behind the times,” Ms. Klein admitted while suggesting the United Kingdom and China as two regions to look to for inspiration.
While comparisons can indeed be made with the U.K., Mr. Ross said much of the small business lending in there is asset-backed, and if a country limits itself to that type we have a situation not too far from the U.S. circa 2015.
“Banks in the U.S. will stillloan your own money back to you,” Mr. Ross said. “Unfortunately, those businesses in the U.S. which are cash flow rich but asset poor will have a hard time.”
“Those types of companies are best served by alternative lenders. Otherwise, I am not sure if those who need it most will easily get money.”
Mr. Ross says DLI has about $200 million in such loans in its portfolio and is buying between $35 and $40 million of small business loans every month, more than anyone else in the industry he estimates.
DLI’s relationship with Dealstruck is extremely positive, Mr. Ross said. It is part of DLI meeting with existing lenders to outline the benefits of selling some of their portfolios which is often a better way to grow.
“We help lenders become comfortable with selling some loans instead of continuously raising equity and operating in the oldest of all possible models which is a bank.”
Ms. Klein said Dealstruck has been actively lending for about 18 months, with $60 million lent to date. The first loans they sold were to DLI. Working with partners like DLI is the most efficient way to add capital, she explained.
“In order to be truly successful we have to be offering term loans and lines of credit. That means our focus must be on borrower acquisition and servicing rather than finding high net worth individuals to buy loans.”
“Selling assets increases our liquidity so we can increase the amount we are lending each month.”
Ms. Klein said what began as DLI buying loans has turned into an interesting business development opportunity for Dealstruck. Referral partners often refer deals to Dealstruck, allow them to season on the platform and then buy them back three to six months later.
“What is interesting with Dealstruck is if banks say they can refer their turn downs and allow us to take the risk for a while it is a safer portfolio for them.”
DLI’s strategy of showing platforms the benefits of selling part of their portfolios has paid off. Both Ms. Klein and Mr. Ross said a year ago the problem was finding capital to meet borrower need. Now the platforms are focusing on customer acquisition.
The entire marketplace lending industry in its current form has yet to experience the down cycle that will undoubtedly result in the failure of some platforms or even the maturation of a generation of loans. Only then will we have a better knowledge of how successful the industry actually is. Within the next 18 months, we should know what the true default is, Ms. Klein and Mr. Ross believe.
When we can look back and assess the industry, expect underwriting strength to be a key factor in both default rates and platform survival both believe.
Neither Ms. Klein nor Mr. Ross expect increased regulation. Ms. Klein said Dealstruck is regulated in every state because they are licensed in every state and are held to usury laws in every state.
Mr. Ross said that the industry does not need new regulation because it is not a new field.
“I want to emphasize there’s absolutely nothing novel about lending money to businesses. This isn’t some phenomenon we are rediscovering. There isn’t going to be increased regulation because this isn’t new.”
“To the extent anything is new it is in the way capital can flow from someone like me to someone like Dealstruck and that is facilitated by the transparency of the reporting.”
“Nothing needs to happen on the regulatory side because this country has regulated lending for more than 100 years.”
As marketplace lending matures it is seeing common issues such as increasing available capital for borrowers, proper industry wide pricing, marketing reach and even human resource concerns. Ms. Klein said she would not be surprised if some sort of industry association is developed. Many will also want to establish uniform standards and a code of conduct to promote credibility to the marketplace. That will allow new borrowers to properly compare apples to apples.
Growing access to capital for female entrepreneurs
Towards the end of our conversation, Bankless Times asked Ms Klein and Coastal Shows Founder and CEO Andrea Downs what influence if any marketplace lending has had with female entrepreneurs.
“Women own more than 51% of privately held companies yet have access to less than five percent of traditional capital,” Ms. Klein said. “A higher percentage of women and minority-owned businesses are served by alternative platforms.”
Ms. Klein said as much as 30 percent of Dealstruck loans are made to female entrepreneurs.
With well-founded fears of being rejected by banks, they head to Google. That makes no sense for either party, Ms. Downs said.
“If banks decide to work with a Dealstruck from the beginning, not only is it way better for the client, it’s better for the bank because the client has money to put into the bank, money that might have walked out and never gone back.”
Ms. Klein added to that by saying referring an applicant to Dealstruck they keep that customer in the pipeline so they can graduate to the bank’s product line in the future. She said many small banks do not offer lines of credit for example, so they can access Dealstruck to provide complementary products.
“The banks don’t lose borrowers and they add products. We’re able to offer something so it is a win-win.”