The decision last year by JPMorgan, America’s biggest bank, to outsource underwriting and servicing of small business loans to OnDeck in a pilot white-labelling deal, looked like a watershed event in the nine-year history of marketplace lending.
OnDeck was set up in 2007 with a mission to lend to small US businesses with 10 employees or fewer at a time when recession hit the country, banks required government bailouts and capital to lend was severely curtailed.
Rob Young, OnDeck
OnDeck extends short-term business loans of up to $250,000 over 12 months, or up to $500,000 over three years.
It pioneered a hybrid funding model to source funding for these loans, including the use of securitization vehicles, banking lines and a marketplace lending component attracting institutional investors, rather than the retail investors that many peer-to-peer platforms chase.
It is regulated as a commercial lender, not as a deposit taking institution.
The key technological breakthrough for OnDeck came in organizing the abundant data available on small businesses into a proprietary credit algorithm, which it calls the OnDeck Score.
“In close to 10 years in operation, we are now on the fifth version of the OnDeck Score,” Rob Young, senior vice-president of International at OnDeck, tells Euromoney.
“Banks traditionally didn’t have enough data on small businesses to analyze their credit and so by default leant on the basis of the personal credit scores of the business owners.”
He adds: “We discovered that small businesses invariably leave a clear and substantial trail of unbundled data, much of it online, as well as through partnerships with credit-card companies that can be collated into full analysis of cashflow.
“We have now been able to track this for small businesses through varying cycles in the broad macro economy, their specific business sectors and local markets.”
Giant on the prowl
OnDeck has parlayed this into a lending business that, so far, has extended more than $4 billion of credit to over 45,000 businesses, mainly in the US and Canada, in 700 industry sectors. It has also expanded into Australia and, given the apparent approval of none other than Jamie Dimon for its credit underwriting process, now looks like a giant on the prowl.
Its total lending to date is, for example, more than twice that of the two biggest UK marketplace lenders, Funding Circle and Zopa, combined. At the Innovate Finance Global Summit in London in April, there was much rumour and gossip about OnDeck’s ambitions to establish itself in Europe.
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“Small business lending is quite a specialist activity in which even the largest US banks have no more than 3% to 4% share nationally,” points out Young, who before joining OnDeck was vice-president of corporate development and new ventures at Wonga.com.
“So in the US, where there are thousands of banks, the ingredients to bring new technology to bear, supported by substantial venture capital equity, and create a significant business was clear back in 2007.”
In December 2014, OnDeck floated on the NYSE in an IPO that valued the company at more than $1 billion.
The company learned early on that small business owners really do want to speak to a person at the institution lending them money.
Young says: “OnDeck is not built just on proprietary credit scoring and hybrid funding. It also spends a lot on customer service. In the process, we give customers a better experience than dealing with conventional banks.”
The deal with JPMorgan has given OnDeck a new shot of confidence.
“This is not a case of the bank sending us those borrowers its own systems decline,” says Young. “This is them white-labelling not just credit scoring but also customer handling to us. We ourselves don’t outsource anything. We do direct origination. We do our own loan servicing, our own collections and we have skin in the game.
“We are very excited by this project with JPMorgan and since it was announced a number of banks have approached us about similar arrangements.”
Will that see it come to Europe? In March, OnDeck was named a leader of the Innovate Finance transatlantic policy working group, a forum that aims, among other things, to foster public policy supportive to fintech in the US and UK.
“OnDeck wants to build a stable, long-term business step by step,” says Young. “We entered Canada in 2014 and Australia in 2015. We will add countries sequentially, not open up in lots of countries all at once.
“Generally, we consider countries with robust small-business data, a clear access to capital, and where the regulatory position is well established; as we look at different countries.”
The fly in the ointment for marketplace lending is gathering concern, especially in the US, over signs of poorly underwritten consumer loans being originated by parties that retain no skin in the game and distributed through securitizations.
Industry insiders promoting secured lending collateralized against real estate suggest that while a benign rate environment has kept default rates low since the financial crisis, an economic downturn or rising rates could see loss rates shoot up fivefold at some platforms.
At OnDeck, loss rates look quite high already at around 6%.
“That loss rate has remained stable since 2007 over a period in which we have grown and expanded rapidly,” says Young.
“We are very careful on borrower origination. As well as direct origination from borrowers that approach us, we do take referrals and recommendations of borrowers from a network of trusted advisers, such as company accountants. We went through a big process of certification last year to ensure these advisors meet our standards.”
He points out: “A lot of the investors that provide funding through our marketplace channel are actually specialist credit investors that understand credit market dynamics around small businesses well.
“As OnDeck has achieved scale and breadth across 50 states and 700 sectors, we have learned to adapt pricing and terms to adjust the portfolio as we gain insights into how a pizza restaurant in the north-east or a car component maker in the Midwest might fare at different points in the cycle.”