|The fintech entrepreneurs reshaping finance|
AMP Credit Technologies, a specialist provider to banks and other financial institutions in Asia of credit scoring and loan portfolio management technology that enables lending to micro small and medium-sized enterprises (SMEs), launched in the UK last week.
It seems strange timing. For the first time almost since the financial crisis, the intense political pressure on banks to lend more to SMEs seems at last to be abating.
In the UK, the Federation of Small Businesses (FSB) announced in March the results of a survey of 1,630 firms, showing that the number of businesses which have applied for a loan from their bank and been approved this year has increased to 57% compared with 45% 12 months ago.
John Allan, chairman of the FSB, says: “It is incredibly encouraging to see the banks approving more credit for small firms, suggesting we may have finally turned a corner on this front.”
The European Central Bank’s (ECB) latest lending survey in January showed that, even though growth is far less robust in the eurozone than in the UK, bank lending standards eased in the final quarter of 2014 on loans to both large corporations and to SMEs. The ECB’s expectation is for this trend to have continued in the first quarter of 2015.
However, there are still large numbers of SMEs that are struggling to raise financing, especially smaller companies that simply lack those forms of collateral that banks invariably require to lend against.
| It’s lending based on quite traditional credit scoring against cash flow and character, not on use of social media and the like|
Thomas J DeLuca,
At the Innovate Finance global summit for fintech firms in London in March, Louise Beaumont, head of public affairs at GLI Finance, argued: “Out of habit and a lack of wider awareness, many SMEs will approach their bank as the first port of call in order to discuss finance options.
“The reality is that banks are set up to lend to Industrial Revolution-era companies with tangible assets to secure loans against, whereas millions of companies are now fundamentally knowledge economy companies, with IP assets, meaning banks are often ill-suited to best serve such businesses.”
AMP Credit Technologies, which started life named Advanced Merchant Payments, has built an entire business around banks’ lack of inclination to lend to companies with strong cash flows but no collateral. While the company itself lends to these micro SME borrowers, it does not see itself as an alternative lender.
Rather it sees its biggest opportunity in licensing its credit-scoring technology so that the banks themselves – which benefit from a much lower cost of funding as well as abundant loan origination opportunities – can do the lending instead.
Thomas J DeLuca, founder and chief executive of AMP, is a serial entrepreneur with long experience in the payments-processing businesses, especially around merchants’ credit card payments. This fits the typical profile of the underserved micro SMEs that AMP aims to catalyze bank lending for.
He says: “Our borrowers are typically small B2C companies in the retail and service sectors, often ‘mom and pop’, sole trader companies. They could be doctors or optometrists, or they could be florists or restaurants or IT consultants.
| Banks are set up to lend to Industrial Revolution-era companies with tangible assets|
“While these businesses invariably lack the collateral that banks require to lend against, they often have strong cash flows, based on large volumes of small payments. They also typically have a single-business bank account that provides a clear electronic footprint for tracing the history of those cash flows. By analyzing those flows, we calculate capacity to repay. It’s lending based on quite traditional credit scoring against cash flow and character principally, not on use of social media and the like.”
DeLuca continues: “Banks that wouldn’t normally lend to such micro SMES in the absence of collateral or years of consolidated financial accounts, by using our credit-scoring system can now provide unsecured loans at reasonable risk-adjusted margins comparable to credit card APRs.”
AMP has been operating for five years in Hong Kong, Singapore and the Philippines. Typical loan maturities are from six months up to one year, approved quickly, and taken out typically by borrowers as working capital to stock up on inventory before a busy period for sales, to finance marketing campaigns or modest new capital-equipment needs.
Even though banks have a ready supply of such micro SME borrowers to lend to, it’s revealing of their unwillingness to credit score these obligors that many of the lenders that have taken AMP’s service in Asia have also required the company to put its own skin in the game and lend to these borrowers as principal alongside the banks.
“We license our technology on a software-as-a-service model and banks that use it will always control origination and we can customize our credit-scoring algorithms in line with their particular concerns,” says DeLuca.
“We also lend as principal ourselves and have done almost $50 million of lending alongside banks, with a default rate at 3% that the margins well cover. But the big opportunity here is for the banks, with their low cost of funding and many thousands of such customers, to put loans on their balance sheets and provide a new unsecured short-term working-capital lending product to these SMEs that they simply can’t offer now.”
As well as credit scoring, AMP also conducts portfolio management on the loans. It automates repayments for the borrowers – and loan collections for the banks – and finds that micro SME borrowers would often prefer to stagger repayments in frequent small sums out of daily cash flow, rather than in the big monthly payments the banks are set up to receive, but that often coincide with rent and salary payments falling due for borrowers.
|The key lesson I learned was: don’t try to disintermediate the banks in their core business and think you’re going to win|
Thomas J DeLuca, AMP
DeLuca says: “Banks simply aren’t set up to manage loan repayments like this. Yet it’s a very good approach from a risk-management perceptive. Where there is any interruption in those daily repayment flows, that sends a valuable and immediate warning signal that the lender needs to keep a close eye on the borrower.”
It seems almost a humbling admission for banks that they do not manage these kinds of loans themselves or provide the short-term, unsecured working-capital facilities so many of their small-business customers are crying out for.
Tellingly, DeLuca declines to name any banks that take the service, citing contractual non-disclosure obligations. AMP’s decision to open in the UK and Europe suggests, however, that some of the banks using it in Asia are local operations of the big European lenders.
He says: “I know that all banks have the data to do these themselves, but often it’s siloed in different systems inside different business verticals. Many banks now have people looking to extract and use this data. Sure, in theory, they could eventually produce the technology we have right now. But it will cost them time and money and in the meantime we’ll have installed our systems at many of their competitors.
“The core value-add here is that AMP’s credit scoring and systems have been tested and refined for almost five years, across a variety of markets and conditions, with our own money at risk. We have done the hard work, so that our bank clients need not.”
DeLuca is not down on the banks, though, unlike many of the younger first-time entrepreneurs now setting up alternative finance companies aiming to eat the lunches of the disgraced fallen giants of the financial industry. He’s been there: done that. It didn’t work particularly well.
|SME financing: special focus|
DeLuca says: “I’ve been in payments for over 20 years including in merchant aggregation during the dot-com boom at the end of the 90s when the banks weren’t at all comfortable with taking the risk around merchants with credit card receivables and weren’t familiar with e-commerce technology.
“But guess what: over time, they looked at what we did, got comfortable with the risks and bought the technology. The key lesson I learned was: don’t try to disintermediate the banks in their core business and think you’re going to win.”
DeLuca’s next start-up was Planet Payment, a multi-currency payments processor enabling internationally focused processors, acquiring banks and merchants to accept, process and reconcile credit card transactions in multiple currencies.
That successfully went public on the LSE's AIM in 2006, listing on Nasdaq in 2012. Its first big-bank customers were in Hong Kong and China, and that’s where DeLuca naturally started AMP in 2009, seeking to apply that experience around payments processing to providing finance to micro SMEs.
He says: “We always intended to launch in the UK as a base also for addressing the European region, which is home to so many of these micro SMEs.”
His target is banks and non-bank financial companies which have a significant portfolio of SME clients, which would include both big international banks as well as local lenders, for which the SME segment is often their core audience.“Even some of the bigger SMEs that do have access to bank credit might benefit from this type of finance,” DeLuca says. “Banks may provide conventional three-year term loans to these types of borrowers, but only after 120 days of application form filling.
“Yet often SMEs see an immediate opportunity, for example to acquire stock, that needs financing much faster and shorter term, even if that is at a higher rate comparable to a credit card.”