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Manatt Fintech’s Top 5 Takeaways of 2018

The team from Manatt looks back at 2018, sharing their expertise on digital finance and marketplace lending.

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[Editor’s Note: This is a guest post from Brian S. Korn, Leader, Digital Finance and Marketplace Lending, Partner, Manatt Financial Services (above left) and Benjamin T. Brickner, Associate, Corporate and Finance. You can learn more Manatt’s work in digital finance and marketplace lending by visiting their website.]

In the financial technology industry (fintech), 2018 was a fascinating and fast-paced year. The digital finance industry has started to mature and flourish, with more creative niche originators than ever before, more investments now available online and general acceptance of marketplace lending as a bona fide securitization vertical.

It was also the second year of the Trump administration, and unlike in prior years, the industry avoided major scandal and enjoyed a lighter-touch regulatory environment at the federal level. Without further ado, here are our top five fintech takeaways for 2018:

  1. Now accepting fintech charter applications. Hello? Is this thing on??

The third time was the charm for special purpose fintech charters issued by the Office of the Comptroller of the Currency (OCC). After three comptrollers—first Comptroller Thomas Curry, then Keith Noreika and now Joseph Otting—each had a hand in promulgating fintech charters, the OCC finally announced in July that it will accept applications from fintech companies for special purpose national bank charters.

The announcement was accompanied by a helpful OCC policy statement and a Department of the Treasury fact sheet that effectively endorsed marketplace lending and the prospect of special purpose fintech banks. Fintech charters promise a national pre-emptive lending license that removes the risk of the prevailing bank partnership model and the compliance burden of state-by-state licensing.

Raining lightly on this parade was news that fintech chartered banks would be subject to the same capital and compliance burdens as other banks. But they will not be required to accept deposits, and therefore will be exempt from obtaining deposit insurance and from Federal Deposit Insurance Corporation oversight.

Raining harder, however, is the prospect that the first applicant likely will be joined with the OCC in a pending lawsuit by the New York State Department of Financial Services (DFS) and other state regulators. A previous lawsuit challenging the authority of the OCC to grant fintech charters was dismissed for lack of ripeness—the OCC had yet to receive an application, much less grant one.

With a live fish on the hook, however, the new suit presumably will proceed on the merits. The OCC and state regulators are likely to have deeper staff and legal budgets than a fintech charter applicant caught in the crossfire. However, Superintendent Maria T. Vullo, one of fintech’s toughest critics, recently announced her departure from DFS in February 2019. It is unclear how this fierce consumer protection advocate’s departure will affect New York’s position on fintech charters.

With the promise of greater market access tempered by legal uncertainty, we expect to see a rush to be second in line for a fintech charter in 2019. Despite the risks, we believe the OCC stands on solid ground and expect their view ultimately will prevail.

  1. Fintech has weathered recent market volatility well and shows little sign of slowing.

The final months of 2018 have seen increasing volatility and downward pressure in equities, with triple-digit declines in major U.S. indices a regular occurrence. At the same time, loan volume is up and investment in loan-based and other fintech products is higher than ever. While this might seem counterintuitive, we believe investors have grown comfortable with online investing and major platforms now have an established record of delivering forecasted returns. These maturing trends may be making inroads into public equity markets’ inherent liquidity and transparency.

Moreover, fixed rate returns, limited losses of principal and a relatively steady consumer borrowing base with historically low unemployment (for now) have increased crowdfunding platforms’ appeal as increasingly safe and secure investment vehicles. Given the checkered history of crowdfunding and predicted parade of horribles following the 2007–09 financial crisis, it is ironic to now see alternative online finance becoming a benchmark of safety and security.

  1. Credit markets are open and borrowers are increasingly flexible.

The credit market for online lending is deeper and wider than ever before, with several platforms accessing these resources in the latter half of 2018. Platforms that previously could not attract institutional funding until originating at least $100 million now have their choice of facilities at earlier stages of growth. Banks are using platform facilities as early entrees to securitization relationships as banks seek to develop footholds farther upstream. We see the overlap between recent Structured Finance Industry Group ABS and LendIt conferences as evidence of this trend.

At the same time, U.S. consumers (and to some extent, small businesses and real estate industry members) have shown a willingness to borrow at rates higher than their actual default risk would normally dictate. This affords platforms greater flexibility to access capital from different sources. Banks tend to lend at mid- to high-single-digit rates, and we have even seen some platforms attract Libor+250 and +200 pricing, down from +450 and +600 one year earlier. Some banks are even using these facilities to comply with Community Reinvestment Act requirements to provide banking services to low- and moderate-income individuals.

Advance rates are also creeping back over 90%, with less capital needing to be raised from mezzanine funding and equity in order to maximize a facility. Family offices, hedge funds and hard money lenders are still providing facilities to earlier-stage platforms and those with riskier borrowers at rates around 11–15% plus 1–3% warrant coverage. Committed facilities are also a higher percentage of the credit deals we see today, whereas the prior year was dominated by forward flow and option loan purchase programs. In other words, if a platform originates within a predetermined definition of “Eligible Loan,” the facility gets funded.

  1. Marketplace lending is a bona fide securitization vertical.

Break out the champagne! The dire predictions of a slowdown in marketplace lending securitization as a result of the 5% risk retention rule and just plain unfamiliarity with the sector have not come to fruition, as 2018 was the most robust yet. More deals were done, more sponsors completed transactions (now more than ten sectorwide) and the market seems finally to have shaken off the 2016 LendingClub scandal. According to PeerIQ, through the third quarter of 2018, more than $40 billion was issued across 134 transactions, up 34% from the prior year. Upstart, Upgrade and Laurel Road joined the roster of new issuers, along with repeat issuers LendingClub, Prosper, SoFi and CommonBond.

Banks are taking the sector seriously, with Citigroup, Deutsche Bank and Credit Suisse leading the league tables. Also of note is that marketplace lending rating agencies were led by DBRS and Kroll Bond Ratings, with traditional powerhouses S&P, Moody’s and Fitch lagging behind.

It remains to be seen, however, whether the party will continue in 2019 given possible weakness in economic growth and the threat of divided government and future government shutdowns.

  1. States and “regulation by class action” are running counter to relatively relaxed federal oversight.

State financial agencies continue to wield the hammer in the fintech industry. Strict enforcement of states’ securities laws (often referred to as “blue-sky laws”) is a staple of any fintech legal department, as are frequent notices on failures to license, charge a lawful interest rate, calculate the rate correctly (including origination fees) and make required disclosures. Federal consumer lending compliance—including Truth in Lending, Fair Credit Reporting, and Unfair, Deceptive or Abusive Acts or Practices—provide important structure to much of the compliance a platform must undertake.

The federal agencies regulating unlawful and unfair lending conduct have noticeably taken their foot off the gas in the last year. For example, the Consumer Financial Protection Bureau, which for most of last year was headed by Trump appointee Mick Mulvaney, brought only nine enforcement cases in 2018. At the same time (and perhaps also as a result), states have become more aggressive in enforcing conduct by members of the financial services industry.

The bank partnership model of lending—wherein loans are originated through fintech platforms by chartered banks and then sold back to the platforms—has been under regulatory assault for several years. The 2017 Madden v. Midland decision still looms large over originator and investor behavior in the Second Circuit states of New York, Connecticut and Vermont, where the decision now applies.

True lender cases have since been decided, even in preliminary motions, that have had wide impact on online lending and the bank partnership model in the states or jurisdictions in which they are brought. The most prominent pending case is the one brought by the Colorado attorney general against Avant and Marlette, with a countersuit by WebBank and Cross River Bank, the two banks that originate loans from borrowers sourced by these platforms. The case is pending, but we expect the final decision will have far-reaching effects on the industry.

Publicly Listed Fintech Companies – a Tale of Two Sectors

Deepak Lalit, Managing Director of LendIt Advisors reviews the public companies attending LendIt and their recent track record.

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[Editor’s note: Deepak Lalit is the Managing Director of LendIt Advisors, which is a new business line within LendIt Fintech that launched in 2017. LendIt Advisors has access to deep relationships across the entire Marketplace Lending ecosystem, and its objective is to connect Loan Originators with sources of Capital. Deepak has over 10 years of experience in Financial Services, with a specialty in Alternative Lending. Deepak has previously qualified as a Chartered Accountant (CA) and a CFA Charter holder.]

It is no doubt that Fintech has been THE buzzword of the last five years. While it may be hard to agree on the exact definition – there is a strong consensus that we are living in a time where technology is accelerating the pace at which traditional financial norms are being disrupted. The companies which master how to leverage their technology are creating huge opportunities for revenue growth in seemingly shorter and shorter periods of time. This makes the fintech sector very interesting from the point of view of an Equity Investor.

In this article, we briefly look at the broad performance of the publicly listed Fintech Companies, and discuss the investment opportunities that are available to US investors, and why we should all be paying attention.

How have the stock prices fared?

To understand the broad performance of the sector – the KBW Nasdaq Financial Technology Index (KFTX) is a good place to start. It is an equal weighted index of 50 companies ranging from the more recent IPO’s such as Square (SQ) and LendingClub (LC) to some of the more established players like VISA (V) and PayPal (PYPL). The criteria for inclusion into the index is where the distribution of a company’s financial products and services is exclusively through electronic means and their revenue mix is predominantly fee-based.

Since inception in June 2016, the index has returned 46%, outperforming the broad market S&P 500 by a whopping 24%, and even the tech-heavy NASDAQ by a meaningful 9%. [Read more…]

What will the financial services industry look like in five years?

Bo Brustkern, the CEO of LendIt Fintech and Co-Founder of NSR Invest shares his thoughts on the future of financial services.

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[Editor’s note: Bo Brustkern is Co-Founder and CEO of LendIt Fintech and Co-Founder of Lend Core, which operates NSR Invest and Lending Robot. He is a serial entrepreneur with a passion for building companies and he has spent the past six years focused on the fintech space.]

Attempting to predict the future is a fool’s errand particularly in the fintech arena, where change can be surprising, lightning quick and brutal. But I’ll play the fool and give it a go. This article briefly touches on many of the themes being explored at our LendIt Fintech USA 2018 conference, which is now just days away:

Audits Will Go the Way of the Dodo Bird

Stop me if you’ve heard this one before. No, seriously: the blockchain is for real. The protocol of trust is here to stay, and it’s going to disrupt everything. Just know, it is going to have a massive impact on the future of financial services. Here are some examples:

At our p2p robo-advisor, Lending Robot, we publish a record of all transactions executed by our Series Fund to the Ethereum blockchain. An immutable record of all transactions, making future audits far less complex and expensive. While the blockchain has not rendered audits unnecessary yet, I believe we’ll see it happen within the next five years.

Smart Contracts Are In, Long, Paper-Intensive Financial Processes Are Out

As I write this, Lending Robot is raising a private round of growth capital. The closing process, called “papering” for very obvious reasons, is just as onerous and Microsoft Word-oriented as I remember it back in the early 2000s when I was a young VC. Where are Ethereum-based smart contracts when we need them? Indeed, I believe we’ll see smart contracts proliferate broadly in the next five years.

Cross-Border Payments Become Seamless and Inexpensive

Our conference business, LendIt Fintech, is a multi-currency enterprise regularly dealing in USD, CNY, GBP and EUR, just for starters. Cross-border payments are costly and time-consuming. For good reason; cross-border transfers have the compounding challenges of anti-money laundering laws, know-your-client regulations, exchange rates and stacked bank fees. Again, I believe that the protocol of trust (blockchain) coupled with a universal, fungible currency (crypto) will disrupt cross-border payments in the next five years.

Say Goodbye to Expensive Transaction Fees

Several recent announcements from well-known crypto companies claimed to allow businesses to set up alt-coin enabled checkout systems. After several months of trial and failure, our conference business finally broke through with a success… BitPay to the rescue. I’m delighted to say that LendIt Fintech accepts Bitcoin as a payment method. And here’s the pleasant surprise: processing fees for crypto payments are materially lower than credit card processing fees. Compare roughly 3% (old skool) with 1% today. Imagine a future with sub-1% transaction fees… I believe it’s going to happen, and soon.

“Investing for Everyone” Takes Hold

Some of the most exciting innovations are occurring in wealth management. While Betterment and Wealthfront may have taken early headlines and a few billion AUM, it’s not robo-ETFs that I’m excited about. That stuff is… well, let’s say comparatively easy… and most of the innovation over the past decade is not impacting the non-accredited investor, which accounts for about 92% of us. What’s more exciting are the new Regulation A+ funds that are beginning to proliferate. Noteworthy are Fundrise, which offers real estate investments to retail investors, Street Shares, which specializes in small business lending, and SeedInvest, which is democratizing venture capital. Imagine a future where investment products proliferate not just for the already-rich, but for aspiring intelligent investors across the economic spectrum. This reality is already on the way.

Fintech is Everywhere

Fintechs are enhancing the customer experience along four axes: choice, price, convenience, and predictability. They are meeting the needs of educated, aware, demanding consumers and they are attacking traditional financial institutions at every angle. They are everywhere: personal loans, business credit, insurance, investing, wealth management, mortgage lending, student loans, financial education, visualization and interface, credit scoring, credit management and achievement, merchant services, payments, payroll, benefits. Did I get everything? I’m sure not.

Enabling this is the amelioration of regulatory requirements by governments across the globe. While Estonia is famous for its digital citizenship, called e-residency, the UK’s Financial Conduct Authority is arguably the most innovative regulatory body when it comes to promoting financial services innovation. Since 2016 the FCA has been building and promoting its regulatory sandbox built for UK fintechs to launch and test their products under proportionate regulation, which is essentially a scaled-down compliance requirement that scales up once it’s clear that a concept is commercially viable.

Not only has the UK government created a hospitable environment for fintechs at home, but it has begun exporting the blueprint for its regulatory sandbox to other nations. The idea is that fintechs that meet common regulatory standards will be able to offer their products around the world without burdensome regulatory requirements at home or abroad. It’s quite possible that we’ll see multiple governments around the world set up regulatory frameworks that scale in proportion to innovation, allowing fintechs access to a broadly compatible, cross-border regulatory system.

Summary: The Engine is Roaring & the Runway is Long

We are right now experiencing the confluence of massive change. Sovereign identity, deep learning, decentralized networks, trustless systems, and scalable regulations are conspiring to fundamentally change financial services. Indeed, the fabric of our economies is being rewoven right under our feet. I am delighted to participate in this time of massive change because I am optimistic about what will result: increased speed, safety, security, convenience, and privacy. Governments competing for innovators, and consumers benefiting across the board.

Do you agree? What do you think will be the lynchpin of change in financial services? Tell me in the comments section below.

How Fintech is Fixing Broken Credit

David Lin, Head of Credit at PayU gives his take on expanding credit and how this looks in practice with their investment in Kreditech.

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[Editor’s note: This is a guest post from David Lin, Head of Credit at PayU. David is an experienced FinTech risk executive with a background in consumer and small business lending across international and US markets. At PayU, David works with the team to successfully launch lending products by leveraging technology and data science to manage risk while balancing customer experience and optimizing operational effectiveness. He specializes in assessing, quantifying, and mitigating risks by incorporating performance monitoring and benchmarks regarding growth, delinquency, losses, recovery and overall profitability.]

For millions of people, a lack of access to credit is just another part of life. Yet, without this access, it can be incredibly difficult for businesses and customers to connect with each other. In fact, according to The World Bank, despite a 20% increase between 2011 and 2014 in the number of adults with access to formal financial services worldwide, an expected 2 billion adults worldwide are unbanked. In addition, some 200 million businesses are excluded from the formal financial system.

The fact that traditional credit bureaus serve only a slice of the world’s adult population is not new. However, access to credit doesn’t just equate to financial inclusion; millions of people have money in their bank accounts but aren’t given access to credit for spontaneous purchases because they don’t fit the usual profiles. With traditional credit models simply not catering to large sections of the population, it is more important than ever to find ways to offer innovative solutions to this problem.

The problem is particularly prolific in high growth markets; with a 2015 PwC report putting India’s unbanked population at 233 million (that’s nearly every 1 in 6 people). In South East Asia, a further 264 million people are without access to credit (including a staggering 80% of Cambodians). And even beyond the individuals affected, some 200 million businesses are excluded from the formal financial system.

Fortunately, the advancements we’re seeing in fintech innovation, particularly in emerging markets like India and LatAm, means we are starting to see positive change, with credit’s net widening at an increasingly rapid pace. This has been aided by increasing customer demand, tech innovation and a supportive regulatory environment.

Thanks to our deep and evolving understanding of local nuances and payments preferences, we have been able to witness the importance of access to credit and just how many people currently don’t have access through traditional means. The industry has a huge tool at its disposal though: technology. And we should all be using it to challenge the ‘norm’, deploying state-of-the-art solutions to develop new and innovative models that can provide broader access to credit.

How and why traditional credit models are fast becoming outdated

[Read more…]

Is Personal Service in Fintech Getting Lost Amid the Digital Mindset?

Many consumers love the convenience of digital communication but still seek live human interaction

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[Editor’s note: This is a guest post from Mark Lusky of Mark Lusky Communications, a writing and marketing communications firm, operating since 1982. He specializes in ghostwriting expert advice articles, blogposts and other bylined content for clients, along with writing e-books, whitepapers, case studies, websites, opinion pieces and other communiques—incorporating marketing skills and perspectives acquired as a regional marketing director for Ringling Bros. and Barnum & Bailey Circus. He will be attending LendIt in San Francisco this April.]

Amid up-and-coming fintech company trends toward cost-saving models that depend heavily on automated digital systems, the human touch is getting lost in the shuffle. In some cases, this doesn’t pose a problem. Many millennials and other younger groups prefer transacting business without any human intervention. Make it online, quick and done—and they’re happy.

If they have a problem, communicating via email, checking out forums, or consulting a canned knowledgebase are acceptable because they lack the need or desire for personal contact.

However, there’s a substantial segment of the consumers that not only wants, but demands, human service—particularly when it comes to customer support. Many people want to consult a live human being for help versus being relegated to digital resources.

If you feel that your borrowers are okay with the digital-only ways, so be it. But, how do you know? If you’re surveying existing customers, it’s likely that most of them are somewhat satisfied, or they wouldn’t be customers. How about prospects? What are their expectations? You may be leaving a huge amount of money on the table—without any easy way to discover or remedy it.

Conflicting Reports, Views Abound

[Read more…]

Credit Analysis and Valuation Methods for Marketplace Lending Loan Portfolios

We dig in to the complex topic of valuation with this Q&A piece conducted with Houlihan Lokey

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[Editor’s note: Many of us have questions on marketplace lending loan valuation so when we were approached to see if we would be interested in a Q&A post on the subject we jumped at the chance. The Lend Academy team created the list of questions and Gunes Kulaligil, Director in Houlihan Lokey’s Financial Advisory Services business provided his answers.]

As Marketplace lenders continue to lend at a fast pace, there has been a significant increase in the past several years in non-bank consumer, student and small business lending. Although these platforms operate in a similar fashion, there is a wide variety of underwriting guidelines thereby producing loans with notably different credit profiles and terms. As a result, prepayment and default performance vary significantly based on the platform originating the loan and the credit grade of the loan as determined by the platform. Additionally, loan performance and platform performance have been mixed, with losses sometimes coming in higher than expected and governance issues shaking investor confidence in the sector.

Despite these challenges, origination rates have climbed back towards their prior highs, and funding sources have been expanded with increased interest from whole loan buyers in flow agreements as well as investors seeking to acquire tranches from securitizations. The recalibration of performance expectations has hit many platforms and continues to be an ongoing process, thus highlighting the need to determine the relevant default and prepayment drivers necessary for accurate fair value analyses. While a robust and liquid secondary whole loan trading market has not emerged as some market participants had hoped, secondary transactions are occurring, especially as loans are aggregated into securitizations. Many of these transactions occur at a premium to par and can provide meaningful insight into pricing and relative credit performance of one platform versus others over time.

1. What are the most prevalent methods of valuing loan portfolios today?

Discounted cashflow (DCF) methodology at the loan or cohort level is the most prevalent valuation methodology used today to value marketplace loan portfolios and related assets, including tranches in securitizations and servicing rights, regardless of the lending vertical. I emphasize “today” because marketplace lending is an evolving corner of consumer & business lending that is small and fragmented in general, with over a hundred lenders, both small and large, with a handful of large lenders accounting for the lion’s share of the issuance. Despite its still nascent nature, marketplace lending has caught the eye of nimble credit-focused alternative investment managers and the relatively risk averse large bond funds alike. Credit investors usually acquire whole loan portfolios or subordinate bonds off of securitizations on a levered basis, whereas many of the larger bond funds focus on the senior bonds in securitizations.

The investment thesis from the credit funds’ perspective is the opportunity to achieve mid single to double digit returns on a levered basis with a short duration versus the bond funds’ thesis which could essentially be described as a yield pickup strategy where the buyers expect to achieve unlevered single digit returns with shorter duration than whole loans and ample structural credit support present in securitizations in the form of subordination and excess spread. Non-bank lending owes its ability to attract the attention of such a diverse group of investors not only due to the sector’s capacity to offer a wide range of credit exposures and duration, but also due to its future growth potential with a confluence of support from increasingly tech-savvy borrower demographics, a de-regulatory environment and innovative partnerships in the Fintech ecosystem.

2. Are valuation methods standardized? If not, why not? How does this lack of a valuation standard affect investors?

[Read more…]

Reimagining Lending Risk Management for the Digital Era

Venkatesh Bala from Biz2Credit shares new ways that lenders should think about risk management.

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[Editor’s Note: This is a guest post from Venkatesh Bala, PhD, the Chief Risk Officer for Biz2Credit, LLC, a leading online marketplace for small business credit based in New York. Biz2Credit has facilitated more than $1.7B in funding since 2007.]

As of February 2018, US bank lending of various kinds – auto loans, commercial credit, mortgages, credit cards or small business lending – constituted $11.7 Trillion, representing around 60% of US GDP and 70% of commercial banking assets. Maintaining the health and profitability of these assets over the business cycle is critical for the banking and financial sector and for the overall US economy.

Banks are grappling with how best to use digital technology in their organizations. Advances in digital technology, data science and machine learning/AI present new opportunities to manage lending risks and maintain a strong balance sheet that is resilient to changes in the credit cycle.

To achieve these objectives, it is possible to envision a new digitally-enabled playbook for risk management. Managing the risk with bank and other lending, instead of being a highly specialized silo, can instead become an enterprise-wide responsibility and capability.

The reason is that all business functions – from underwriting, servicing and collections to sales, marketing and treasury, impact the portfolio risk. Marketing, for instance, directly affects the riskiness of customers coming through the door, while sales interactions determine whether relationships are built with more or less risky customers. Equipping these functions with relevant risk information through digital means can empower them to reduce the totality of risk from lending.

Near-Term

Near-in, the biggest benefit lies in loan underwriting and monitoring. Digital data is now available from an ever-expanding set of sources, including bank statements, social media, credit bureaus, mobile phones and call centers. The key insight is that this data can be combined with lending outcomes and used for risk reduction.

Small business lending offers an illustrative example. Picture three satellite images of gas stations in different parts of the US, with various landmarks present in the images. The first is near a school and a church, the second is close to suburban housing and the third lies between a church and a large apartment complex. Which of these gas stations has the highest revenue, and which the lowest? Which of them is most at risk of default on a small business loan? [Read more…]

Why Congress Needs to Act Now to Fix the “Madden Issue”

The new CEO of the Innovative Lending Platform Association has written an op-ed focused on the Madden decision and how it could be fixed by Congress to better serve small businesses.

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[Editor’s Note: This is a guest post from Scott Stewart, CEO of the Innovative Lending Platform Association. ]

Courts are distorting credit markets in a way that hurts Main Street small businesses, and Congress now has an opportunity to fix it.

Imagine you opened a salon two years ago with a chair for both you and your business partner.  Over the years, you built a small clientele and grew steady revenues.  Your business is profitable, and you want to add two more chairs to your shop.  You estimate that the expansion will cost $20,000 but will yield $40,000 annually in new revenue.

Together, you discuss taking out a small business loan with both large and small banks, but they turn you down citing your 640 personal credit score and the lack of two years of business tax returns as the reason for the decline.  So, you reach out to online lenders in the hopes of securing the capital you need to expand and grow your business.

After reviewing your application, an online lender offers your business a $20,000 loan that can be funded in a day and paid back in weekly installments over a six-month period.  The APR seems high – it’s about 40% – but the total cost of capital is only $2,115.  That means you’ll pay $2,115 to borrow $20,000 to fuel your expansion, and that expansion is expected to yield a $40,000 return on your investment.  You and your partner decide to seize the opportunity.

Unfortunately, a recent decision by the Second Circuit Court of Appeals in Madden vs. Midland Funding, is making it difficult for online lenders to offer businesses the funds they need to grow and succeed.  The Madden decision undermined the legal doctrine known as “valid when made,” which has been a cornerstone of banking law for over 100 years.  The principle is simple.  If a loan is legal with respect to its interest rate, then it does not become invalid or unenforceable when sold to another party.  Numerous bi-partisan and non-partisan groups have come out in opposition to the Madden decision, in part because of the dangerous uncertainty it has inserted into the financial markets that are critical to supplying credit to individuals and small businesses.

[Read more…]

6 Key Trends in Fintech to Watch in 2018

In this guest post Alexander Prokhorov from FinSight Ventures shares what trends his firm is focused on in 2018.

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[Editor’s note: This is a guest post from Alexander Prokhorov. He is a managing partner and co-founder of FinSight Ventures, which focuses on fintech and enterprise software and was an early investor in LendingClub, DianRong, FinanceIt, and Earnest. He has more than 16 years of experience in direct investments and financial services.]

Over the past three years, Finsight has invested in close to a dozen fintech companies around the world, and we recently celebrated our fifth exit. As I consider the best places to put fresh capital to work, the following trends deserve attention:

  1. Convergence of Software and Financial Products  One of the important lessons that Square taught the market is that bundles of software solutions (loyalty, POS, analytics, scheduling and many others) and lending are essential drivers in advancing growth of payment processing. Going forward, successful lending and payments solutions will need to be bundled with other software offerings. Finsight recently invested in DailyPay which integrates with payroll systems and is aiming to help more than 70 million hourly workers in the US get instant access to their wages. In 2018 in Europe, PSD2 regulation will drive banks to open access via APIs to consumer and business accounts to third party companies. For example, a consumer can direct a fintech company to pay utility bills directly from their bank account. This is a very important development, and one which shifts the power of bank data and management of funds back to consumers and businesses and will allow for further convergence of software and financial products.
  2. InsureTech  The transformation of the insurance industry will continue its pace from online distribution, which disrupts offline distribution channels such as brokers (like Limelight and others), to the development of new products (like MetroMile and Lemonade).
  • According to CB Insights, in 2019, more than 80% of insurance products for SMB in the US will continue to be distributed through offline channels

Technology is bringing greater overall efficiencies, lowering costs to back office, disrupting intermediaries, promoting mobile real-time engagement with customers, and sparking new insights to product and pricing.

  1. The Power of the Machines  Artificial intelligence and machine learning are transforming many industries, including financial services. Companies like LendingClub are using machines to discover new relationships and patterns to introduce more tailored financial offers to their customers. Finsight recently invested in SBDA Group, which analyzes transactional data found in consumer banks and helps to provide insights for more effective cross-selling of other products.

Elon Musk puts it this way: “The pace of progress in artificial intelligence (I’m not referring to narrow AI) is incredibly fast. Unless you have direct exposure to groups like Deepmind, you have no idea how fast – it is growing at a pace close to exponential.”

  1. Emerging Economies  Many growing companies in Africa, Asia, and Latin America are developing and adopting financial solutions, often faster and with more innovation than in developed economies.
  1. Wealth Management  Much has been said of standalone robo-advisors such as Wealthfront, Betterment and Nutmeg, but likely other leaders will emerge over time as technologies continue to empower and transform how financial advice is delivered. Currently, tools serving advisors are providing better access to different asset classes, decisioning, trading strategies, digital data.
  1. Rise of Crypto and Blockchain  2018 will be the year of accelerated adoption by retail investors globally and the arrival of institutional capital to the crypto assets, further validating the notion of crypto as the “store of value” for the millenium. At the same time, software companies, corporations and governments are increasing adoption of  applications powered by distributed ledgers.

These six key fintech trends are at the forefront of our investment planning strategy going into 2018.  I believe that based on what we’ve seen in 2017 and what is coming next, 2018 will be an exciting year to be investing and innovating in financial services.

Recovering Non-Performing Loans: Better Options

In this guest post Brett Boehm of TBF Financial explores better options for lenders when it comes to non-performing loans.

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[Editor’s note: This is a guest post from Brett Boehm, principal and director of business development for TBF Financial. He can be reached at bboehm@tbfgroup.com, phone 847.267.0600, Ext. 101 or via LinkedIn and Twitter @TBFfinancial.]

Business models for online small business lenders focus on speed, agility and customer service. When it comes to managing non-performing loans, however, many fintechs rely on tactics that worked in their grandparents’ era but conflict with newer business models.

They chase non-performing loans (NPLs) past the charge-off date when there is a better option: selling the loans to a reputable commercial debt buyer. More fintechs are learning about this strategy and a major online small business lender is using it to earn money on NPLs, then reinvest the money into making more loans.

Commercial debt buying is an accepted practice for recovering payment in financial services that works well with fintech models but in fact was pioneered in the banking and equipment finance industries. The online small business lender in the example above is using commercial debt buyer services to reduce internal overhead, earn cash now versus waiting for recoveries 12-18 months or more and improve budgeting. If the lender expects to charge off $100 million of NPLs a year and the purchase price is $.05 per NPL, then the lender knows it will recover about $5 million. (The purchase price in this example, $.05, has been weighted against the outstanding balance on the NPL.)

Like all businesses, however, some commercial debt buyers and their brokers are reputable and others are not. Vetting buyers and brokers is a necessary but manageable process, described below. But first, it is important to understand the recovery options available.

Recovery Options

A small business lender knows that a certain percentage of loans will become NPLs and typically has parameters the business must stay within to remain profitable. The lender may pursue NPLs on an in-house basis indefinitely past the charge-off date or turn them over to a collections agency at some point. Both options create problems in the fintech business model.

Managing NPLs in-house throughout the life of an account is slow, inefficient and diverts resources that could be used to support customer lending. There is one upside: the lender maintains control over the account and may win the customer’s future business in the event its finances improve.

Lenders that instead have collections agencies chase bad accounts improve internal efficiency but the process is a lengthy one offering relatively little return. The biggest drawback is the potential for negative customer contacts that can sever the possibility of a future relationship.

The best recovery option for online small business lenders is to manage NPLs in-house until they become charge-offs, then use the services of a reputable commercial debt buyer. This is how it works.

  • The lender works with the commercial debt buyer on a one-time basis, periodically, or in a forward-flow relationship where NPL information is sent regularly to the buyer.
  • A non-disclosure agreement (NDA) is signed and the lender provides information to the buyer on the pool of non-performing assets. This includes the number of accounts and amount of outstanding balances.
  • Buyer assigns a value to the NPLs and offers a price.
  • Lender signs the purchase agreement. Typically, buyers in forward-flow relationships will send payment within 24 hours.
  • Reputable buyers then work to collect the debts over time, without using the lender’s name and in a sensitive manner, and without reselling the debt.

Deal Only with Reputable Buyers, Brokers

The following are important steps to take before using the services of a commercial debt buyer or brokers representing them.

  • Meet in person or by phone to discuss the buyer’s philosophy, collection process, experience, references from similar sellers and security procedures.
  • Make sure collection tactics are sensitive to debtors and that the buyer does not re-sell the debt. This way, any issues that arise post-sale can be resolved by repurchasing the loan from the buyer.
  • Never provide financial information without a signed NDA.
  • Carefully vet brokers who represent commercial debt buyers. Verify that they have a buyer accessible that they have worked with before.  Make sure the broker uses NDAs to protect all parties’ confidential information.  Find out how the broker is going to disseminate portfolio information and where it is going.  Ask how the NPLs are going to be collected and if they could be re-sold at some point.

Some brokers are reputable but there are dangerous ones, too. Deals have fallen apart because a broker showed a portfolio around without NDAs, or parts were sold off without the seller’s knowledge. In these cases, reputable commercial debt buyers will refuse to touch the portfolios.

Deal only with a reputable commercial debt buyer and its broker, and the deal will be smooth and legitimate.

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