Fintechs: small business lenders fill a market gap

Fintechs help fill a credit gap, but at a price

Technology-driven lenders – fintechs – are providing fast but pricey credit for small businesses.

The small business sector has long lamented that it gets a rough deal on credit and that it could grow faster if Australia’s big lenders just showed it some love. Now the fintech sector is testing that theory. Fuelled by financial technology, fintechs are specialist small business financiers that have created a market for quick cash injections.

By leveraging e-commerce and advanced analytics to enhance credit underwriting, fintechs claim they can loan amounts of A$5000 to A$500,000 more freely, faster and on more favourable terms than traditional business banking operations.

"We see Australia as a very technology-forward market and a good indicator of what other markets will look like.” Kareem Al-Bassam, PayPal Credit Australia

Rather than taking on the banks directly, fintech lenders appear to be filling a gap in small business lending. They typically lend for shorter terms and at higher rates – perhaps this is why the banks seem more inclined to view them as friends rather than foes.

Taking on the risk

It’s not that banks don’t lend to good candidates; they do. There are few specific figures on bank lending to Australia’s small businesses; the best indicator is probably the volume of bank business loans of less than A$2 million. Such loans topped A$200 billion in total before the global financial crisis (GFC) and recently began to rise again.

However, as banks have grown larger and more hierarchical, a 2015 Reserve Bank of Australia (RBA) paper noted, they have found it harder to do old-fashioned relationship lending.

As well as becoming more risk-averse since the GFC, there are other factors at play: small businesses tend to have a shorter financial history and less supporting documentation than large corporates; their revenue streams are generally more volatile and their size limits diversification of products, customers and resources; and the loan sizes typically required to accelerate small business growth are costly for banks.

All this adds up to the banks charging small businesses more for money and requiring them to work harder to get it. And that leaves an opportunity for financiers who can assess prospects more easily and accurately.

“The fintechs are using big data and predictive analytics to target businesses that some of the traditional lenders won’t lend to,” says Chris Wilson, partner of consulting and head of the fintech practice for Deloitte.

“The reality is that banks have their rules about who they lend to and some [businesses] don’t fall into the positive side of that ledger. We can look at that as a negative, but they are the rules they have in place and they’ve been very successful businesses as a result. That’s what their risk appetite defines as the boundaries.”

A different business model

The fintech sector is booming. Global investment in the sector grew by just over 200 per cent in 2014. In China alone, fintech investments across Asia-Pacific surged more than 500 per cent to US$2.7 billion in the first quarter of this year. 

Recent research by Roy Morgan shows that 64 per cent of those who have tapped into fintech loans will never choose to enter a traditional bank branch again. 

Key players include Australian start-ups such as CreditSME, Prospa, Moula and Banjo, which was founded by three former NAB executives. International lenders are also having an impact. 

US start-up Capify entered the Australian market in 2010 when it took over local lender AUSvance and has now provided more than A$100 million in unsecured loans to small business. Another US start-up, OnDeck, followed in 2015. Even established businesses have entered the alternate lending market – one example being PayPal with the launch of PayPal Working Capital. 

Fintech lenders generally don’t operate like traditional banks. Their loans are unsecured and delivered faster, but borrowers pay for the privilege. Interest rates start below 10 per cent a year but can range above 45 per cent.

The typical fintech also has a different business model. Prospa’s Series B funding round late last year included a A$50 million securitisation deal with the Carlyle Group and was the first of its kind in Australia for unsecured, online business loans. OnDeck has a hybrid model that includes funding loans from its own balance sheet as well as securitisation vehicles; however, the volume of its loans onsold in the US dropped for the first time in the three months to 31 March, falling from 40 per cent of its loan book to 26 per cent. Moula does not rely on the onsale of loans.

“The fintechs are using big data and predictive analytics to target businesses.” Chris Wilson, Deloitte

Its growth was fast-tracked last year through a A$30 million funding round led by low-doc lending pioneer Liberty. Co-founded three years ago by former accountant Aris Allegos, Moula lends eligible small businesses up to A$250,000 with flat interest rates of 1 per cent a fortnight. 

Chris Wilson“We are very transparent about what it costs and we take a responsible view to lending,” says Allegos.

“We don’t lend to everyone. We can obviously do a top-level underwrite to make sure they’re bringing cash in to pay us back, but we’re also looking at what else is going to sit alongside our debt to make sure we’re not overleveraging these businesses. That’s the last thing we want to do, because it means they can’t pay us back and it means they’ve put their businesses into a bit of a debt spiral.” 

An average Moula loan size is around A$50,000, and Moula customers range from those typically constrained by working capital, such as retail and hospitality businesses, through to service businesses poised for growth.

“We’ve lent to a lot of accountants,” says Allegos. An online application takes about 10 minutes and can become a loan within hours if Moula can access the business’s online accounting information. There are no set-up fees or charges for early repayments. 

Moula’s loans are unsecured, but the company’s underwriting platform identifies potential risks, such as length of time in business, revenue and credit quality, to reach what Allegos describes as a “safe harbour”. From there, Moula’s platform pulls in other data from accounting APIs to inform its lending decisions. 

“We can get really granular and look at the volatility of cash flow, ATO arrears or unpaid super,” explains Allegos.

“If you went to a bank, they’d have a human looking at this data. We’ve just utilised technology and the benefit of having all these cloud-based accounting solutions to make that underwrite a lot quicker.” 

Technology has also helped remove much of the risk. “Right now, our defaults are very healthy to say the least,” says Allegos.

Scale to grow

Like the small business market they serve, fintechs need customers in order to survive. Moula has partnered with Xero in the search for loan customers. Moula’s recent small business survey, however, showed that only about 4 per cent of the market knows that it exists.

John de Bree, managing director of Capify Australia, says that while the alternate lending market in Australia is maturing, few understood what it was in 2010. “We would send direct mail out saying ‘do you want money for your business?’,” he laughs.

Around 60 to 70 per cent of Capify loans now go to repeat customers. However, its base is expected to grow significantly due to its recent partnership with Chinese e-commerce giant Alibaba, which currently has 1.9 million Australian SMEs doing business through its site. 

“We are spending a lot of time on partnerships and looking to sign up large brokers who have a database,” says de Bree.

“Unless we do a lot of above the line [advertising], it’s hard for us and our competitors to get to the SMEs.”

Joining forces

Rather than beating the banks, Deloitte’s Wilson says many fintechs may end up joining them, partly to solve the customer-acquisition problem. “If you’re a [fintech] lender focused on the SME market, very quickly you’re going to discover that having the scale and distribution of a large player is useful,” he says.

“Therefore, the desire to disrupt them out of the market is quickly replaced by the very necessity of survival and accessing customers through their channel is very useful.” 

Fintechs are innovative, but the banks’ scale and distribution help reach new customers. Alliances have already been formed. Australian alternate lender Prospa recently partnered with Westpac, and the Commonwealth Bank now does referral deals with US-founded OnDeck. 

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“There are interesting opportunities for both parties to work together,” says Wilson. “A small business may go to a traditional lender and then be passed through to one of the alternate lenders who have different ways of looking at the credit modelling.”

John Shipman, who leads PwC’s Asia FinTech Consulting Group, believes acquisitions will be on the horizon. “I think the ones that are very successful will be some that are absolutely hoovered up by the Big Four banks and the banks in the region,” he says. 

Shipman notes that while acquisitions are likely, autonomy is often more desirable. “Big financial services organisations have massive legacy platforms and a way of doing things that is stifling and suffocating to fintechs,” he explains. 

In the meantime, lenders like Moula aren’t out to beat the banks. Allegos believes the two can exist in harmony.

“Interestingly, because we are playing in a space where they haven’t, there is probably more opportunity to work together to be complementary rather than to fight over market share,” he says. “Then, ultimately, all we are doing is making the customer experience better across the board.”

The test to come

Just what lasting contribution the new small business lenders will make is still unknown. Before we can pass judgement on their success, says Wilson, we should see whether they can survive tough times, as the banks have done. “A lot of these players have not existed in a market that has gone through a downturn,” he notes. 

“Australia cruised through the GFC relatively unscathed – how do we make sure we haven’t started lending in a way that may not necessarily be commensurate with good lending? I think the best way to test that will be when there is some kind of shock to the system.”

Using data to target the market

Small businesses represent more than 95 per cent of all businesses in Australia. They employ more than 4.5 million people and produce over A$330 billion of the nation’s A$1.62 trillion in yearly economic output. 

This huge slice of the economy is varied and complex. Chris Wilson, partner of consulting and head of the fintech practice for Deloitte, says that makes it a tricky one for traditional banks to target. 

“The percentage of those that are sole traders versus those who employ people versus those who are quite large makes it a complicated market to segment and therefore the traditional players are challenged,” he explains.

“Arguably, it’s easier to segment the retail market ... and that’s what the banks do very well.”

The fintech lenders have overcome the segmentation challenge through advanced analytics.

“They are getting very good at homing in on a segment that they can get to know very well,” adds Wilson. “A lot of them are actually driven by a different way of looking at data, so they’re much better at targeting the companies that the banks may not target.”

Helping small businesses climb higher

When Trevor Douglas wanted to boost the stock of climbing boots for his arborist supply business, Treegear, he didn’t go to the banks. Instead, the small business owner went straight to PayPal Working Capital for a A$20,000 loan. It was approved in a matter of minutes. 

“It seemed like a bigger and slower process to go to the banks,” Douglas explains. “I needed the money just before Christmas and I didn’t think it would happen in time with the banks.”

“Ultimately, all we are doing is making the customer experience better across the board.” Aris Allegos, Moula

PayPal started its Working Capital business as a pilot in the US in 2013 before launching in Australia a year later. Today, PayPal Working Capital has loaned more than US$1 billion to more than 60,000 small businesses in Australia, the US and UK. 

Kareem Al-Bassam, general manager of PayPal Credit Australia, says Australia was a pioneer global market for PayPal Working Capital.

“We have strong penetration with small-to-medium businesses here,” he says, “and we see Australia as a very technology-forward market that has been an early adopter and a good indicator of what other markets will look like in future years.”

Unlike other fintechs in this space, PayPal Working Capital has a ready-made customer list of more than 110,000 Australian PayPal merchants, many of whom require funds to accelerate their business growth. 

As their online business transactions are made through PayPal, credit assessments can be made quickly, and most of the online application form is prepopulated because PayPal knows who they are. Douglas paid off his first Working Capital l

an in five months and says quick access to finance has been crucial to Treegear’s growth. Since launching the business full-time in 2012, he says it has grown by 60 per cent year-on-year. 

“I’ve borrowed another A$44,000 for more inventory and a piece of machinery,” he says. “I want to manufacture my own stuff and keep growing.”

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